Semantics

There's been a war of words in the media lately about whether recent tariff headlines coming out of Washington and Beijing constitute a trade war, a trade spat, battle, skirmish, or other descriptive word. While we love to name things, at some level what we call it doesn't really matter. The bottom line is we're in a period of escalating tensions with the world's second largest economy and little about it is good.

This obviously impacts markets in the short-term. According to Bespoke Investment Group, almost all the market's larger down days in the past few months have been related to tariff news.

This was also true of the market's performance yesterday, following the Trump administration upping the ante by proposing limits on investment by China into US corporations. The idea here is to thwart the ability of Chinese investors and companies (many of which are indirectly controlled by the Chinese government) to gain access to our most important technologies and, presumably, to take them home and copy them.

But who has the upper hand in this game of tit-for-tat trade-related chicken? Let's review the situation from both sides of the Pacific to get a feel for who is likely to blink first.

The first view is from excerpts of a recent Wall Street Journal article. The second is from Andy Rothman, an investment strategist at Matthews Asia, a highly-regarded mutual fund company based in San Francisco. I've heard Andy speak on several occasions and his first-hand experience yields beneficial insights.

Continue reading...

From The Wall Street Journal - 

With their escalating trade feud showing little evidence of hurting their economies, the U.S. and China aren't close to backing down. Investors may get squeezed between the two giants before one of them cracks.

The U.S. has already put tariffs on steel and aluminum and will add a 25% tariff on $50 billion in Chinese imports starting next month. China is matching the U.S. tariff for tariff. These actions have sent U.S. steel prices higher and U.S. soybean prices lower. But the broader economic effects so far appear negligible.

That could change soon. The administration is set to announce restrictions on Chinese investments in the U.S. next week, and President Donald Trump has threatened to retaliate against China's retaliation and put tariffs on more goods.

The administration thinks that China has more to lose in this dispute, since China runs a big trade surplus with the U.S. The real issue isn't who has more to lose, but how long each side can bear the pain. This is where it could get dangerous for investors. Worries about what could come next weighed heavily on shares of companies that depend on China for business, such as Caterpillar and Boeing, last week.

China's leaders may not back down until there are serious economic or social consequences from the trade fight. The government has the ability to control the Chinese stock market, and leaders don't have to worry about elections. The White House does have to pay attention to the stock market, since sharp declines inevitably stoke economic fears. And it has midterm elections coming up.

From Matthews Asia - 

The tariffs announced by President Trump—and the Chinese response—are troubling but do not constitute a trade war because the macroeconomic impact is likely to be insignificant.

Trump said the U.S. will collect a 25% tax on $50 billion of imports from China [... but due to the total amount that China exports around the globe] the new tax will be levied against only about 2% of all Chinese exports.

It is also important to recognize that the Chinese economy is no longer export-driven. Net exports (the value of a country's exports minus the value of its imports) account for only 2% of China's GDP, down from a peak of 9% in 2007. In contrast, domestic consumption now accounts for the majority of China's economic growth and more than half of its GDP.

We have also considered the impact on China's economy of the reciprocal taxes Beijing will levy on $50 billion of its imports from the U.S. Based on our estimates of the price elasticity of both Chinese exports and imports, we expect the current trade dispute to reduce China's GDP growth rate by about 0.1%. That would have reduced the [first quarter 2018] GDP growth rate of 6.8% to 6.7%, for example, a modest slowdown that would not influence how we think about investing in China.

I am in Beijing now, and last week a senior Chinese government economist told me that authorities have reached the same conclusion about the impact on the country's economy.

Finally, we acknowledge that disputes can turn into wars.

The Chinese government's tariff response mirrored the Trump taxes and Beijing has called for restraint and negotiations. There are reasons to hope that Trump will not respond with another round of tariffs, which probably would lead to another response from Beijing. Trump can claim that the tariffs delivered on his campaign pledge to get tough on China, and then move on to negotiations over issues that really matter to U.S. companies, such as better protection of intellectual property and market access in China.

The president may also want to show restraint because Chinese retaliation is designed to inflict pain on Trump supporters, such as soybean farmers, which could help Democrats take control of the House in November.

Most importantly, an angry Xi Jinping probably could scuttle a denuclearization deal between Trump and Kim Jong Un.

Still, Trump may think a trade war with China is easy to win and decide to escalate. If that happens, my view is that the damage to the Chinese economy and investment environment will be much less than many expect, because the U.S. accounts for a small share of total Chinese exports and because China is no longer an export-driven economy. An economy driven by Chinese companies selling goods and services to Chinese consumers should be well-insulated from the impact of a trade war with the U.S.

https://www.wsj.com/articles/the-trade-wars-first-casualties-1529762400

https://us.matthewsasia.com/perspectives-on-asia/market-updates/matthews-asia-perspectives-view/article-1359/Our-Views-on-the-U.S.-China-Trade-Dispute

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