US-China trade row: Jostling for position

An update – what you need to know

While the war of (trade tariff) words has continued between the US and China, an outright trade war remains in neither side’s best interest. As the jostling and associated market volatility may continue in the near term, it’s important to retain perspective.

The bigger picture for China&s growth continues to be domestic and regional consumption demand. The Macquarie Asian Listed Equities team believes their portfolios remain positioned to benefit from this growth, largely sheltered from the announced trade tariffs.

What has happened – key events to date

  • 22 March: US Trade Representative released ‘301 report’, citing unfair trade practices
  • 3 April: US announces $US50 billion in tariffs targeting ‘Made in China in 2025’, to stifle China’s strategic objectives
  • 4 April: China responds with $US50 billion tariffs on US imports, targeting those most likely to impact President Trump’s political support base
  • 6 April: President Trump threatens an additional $US100 billion of tariffs, provoking fears of a US/China trade war
  • 10 April: Chinese President Xi Jinping affirms China’s commitment to further open up China to the rest of the world, alleviating the key issues raised by the US
  • 10 April: President Trump welcomes the conciliatory comments from China’s leader.

Why all the attention on China?

China has long been target of Donald Trump’s ire over issues of international trade. This is due to the large trade deficit between the two countries, with Trump pointing to it as evidence of China’s unfair and unbalanced trade practices.

Donald J. Trump twitter1

Donald J. Trump twitter2

Source: Twitter, posts are attributable to the author listed, as at the date shown.

While the US trade deficit of goods with China is by far the highest among its trading partners, we believe it’s more reflective of China’s increasingly important role in the global supply chain rather than for the mercantilist ambitions it is accused of.

US goods trade deficit with major countries (2017)

US goods trade deficit with major countries 2017

Source: CEIC

It’s also worth noting the US’ trade deficit with China has been persistent for decades, existing even before China joined the World Trade Organisation (WTO) in 2001. Further, the US has not had a foreign trade surplus since 1975, as the nation has grown to become one of the world’s main sources of final demand, relying ever-more on imports to meet its increasing consumption needs.

US net trade in goods

US net trade in goods

Source: US Census

What is the bigger picture for China?

Given the recent focus on the trade channel between China and the US, it’s easy to forget that programs such as China’s ambitious Belt and Road Initiative – with the potential to strengthen and connect trade between China and 65 other countries, covering half the world’s population – continue to progress.

While the US remains a significant destination for Chinese exports (around 25%), we should remember that China’s export-led growth strategy has been playing a decreasing role in its growth over the past decade, as the focus shifts towards boosting consumption, as highlighted in the graph below.

Breakdown of China’s GDP

Breakdown of China's GDP

Source: CEIC, NBS, Macquarie. As at 10 April 2018.

We hold our conviction that boosting domestic demand and rebalancing the economy towards consumption as a growth driver, away from investment and exports, remains the focus for China’s economic growth strategy in the medium to long-term. Our portfolios are constructed to benefit from this shift.

Conclusion

We believe the current announced tariffs will result in a negative but limited economic impact for both China and the US.

We view these latest actions as part of the jostling process between the two countries as they prepare for a showdown at the negotiating table, rather than pre-emptive strikes in what could be a protracted and destructive trade war.

Tensions may increase further in the near-term during this period of jostling, with a risk of policy errors in the process, but we view these as risks rather than core concerns. Throughout the posturing, senior officials from both sides have been at pains to highlight their preference to negotiate and avoid a protracted trade war. It’s important to keep this incentive front of mind, and avoid losing perspective.

Our investment strategy is dedicated to capturing and profiting from the growth of domestic demand in China and the wider Asian region, by investing in quality companies that stand to benefit from the rise of local consumption. While we continue to monitor the situation closely, our strategies are not materially exposed to the risks associated with the announced trade tariffs.

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Appendix – a detailed timeline of key events

22 March 2018

The Section 301 report was released by the US Trade Representative, finding China to be engaging in unfair trade practices and theft of intellectual property. The White House indicated it would respond, among other measures, by introducing a 25% tariff on strategic Chinese imports to level the playing field and “achieve more fair and reciprocal trade.”1

3 April 2018

The US government published its list of 1,300 imported Chinese products which would be subject to a punitive 25% tariff. While the 1,300 products subject to the new tariff are wide-ranging, they chiefly take aim at industrial products such as industrial robots, semiconductors, satellites and machinery parts. The intention is to stifle the Chinese government’s ‘Made in China 2025’ industrial and economic upgrading plan, and to prevent China from dominating the market in these key emerging industries.

The products subject to the putative tariffs are estimated to be worth around $US50 billion, in-line with earlier announcements, and represent approximately 10% of US imports from China. These new tariffs are expected to result in an immaterial 0.1% negative impact to China’s GDP growth for this year.

4 April 2018

In response to the US government’s actions, China swiftly announced its own retaliatory tariffs of 25% on over 100 US products also to the tune of $US50 billion in value. This primarily consists of cars, small aircraft, soybeans, sorghum and other agricultural products.

The products targeted by China’s proposed tariff comprise some of the top US exports to China. In our view this is designed to inflict an economic cost for US businesses, and also to increase the political pressure on Washington to refrain from escalating its actions towards China. Those most affected by these new retaliatory tariffs will be farmers and other politically-sensitive constituencies, particularly important during this election year. China is the world’s biggest importer of soybeans and the destination for 56% of American soybean exports.

China imports from the US

China imports from the US

Source: CEIC, HSBC. Note: Soybean, sorghum, orange juice are grouped under vegetable products.

6 April 2018

President Trump threatened to target an additional $US100 billion of Chinese imports with tariffs should the government be required to escalate the trade row. This provoked investor fears of an all-out trade war between the world’s two largest economies, and a derailment of the global economic growth story.

10 April 2018

In Chinese President Xi Jinping’s keynote speech at the 2018 Boao Forum, he affirmed calls for greater global trade openness, and also reiterated pledges to improve market access and ease foreign ownership restrictions, increase imports and expand protections for intellectual property – all key issues in the current row with the US. The Chinese leader’s conciliatory comments were welcomed by the American president, raising hopes that a new trade agreement will soon be struck between the two countries.