The China Problem

May 10, 2019

 

 

Stock markets around the world sold off this week on rising risks of a trade war between the United States and China.  With the worlds largest and second largest economies trading threats in advance of negotiations, hopes began to dim that an agreement would be reached.  Clearly China aims to be a global competitor with the United States, and the Trump administration appears intent on leveling the playing field for US companies while the US still has the upper hand.  Likely there will be no quick easy fix, and this battle will merely be the first among many conflicts as China rises to power.  Nonetheless, an outright trade war is in no one’s interest and the most likely outcome is an uneasy truce.

 

China aims to be a global leader, and Chinese Premiere Xi has made no secret of his plans for China to become the world’s largest economy by 2050.  According to the U.S. Chamber of Commerce, these ambitions are built on local protections.  China’s strategy, as espoused in the Made in China 2025 plan, is multi-step.  Step one is to “Localize and Indigenize”, developing indigenous technology and control segments of global supply chains.  Step two is to “Substitute” foreign technology with Chinese technology throughout China by advancing domestic production.  Step three is to “Capture Global Market Share” by exporting products globally and competing with existing global suppliers.

 

While global competition is nothing new, the coordinated fashion in which China directs its industries, along with multiple documented instances of Chinese industrial espionage has prompted some to restate the above Chinese strategy as “Rob, Replicate, Replace”.  Thus, one of the primary objectives for the US trade delegation is increased intellectual property rights.  The Office of the United States Trade Representative claims that China seeks to introduce foreign technology by “collection of market intelligence by state entities for the benefit of Chinese companies”, effectively accusing China of state-run industrial espionage.

 

The problem for the US is what to do about it.  China’s induction into the World Trade Organization in 2001 was supposed to begin the process of opening China’s market to the rest of the world.  While some progress has been made, many western economists argue that China has been the primary beneficiary of the agreement. China's economy has grown from less than $2 Trillion in 2001 to more than $12 Trillion in 2018 while successfully discouraging foreign penetration of its market.  With the Chinese economy slowing, and the US economy enjoying renewed strength, many see now as the time to push the ‘reset’ button on trade and negotiate a new deal.  On the other hand, the Chinese are notoriously tough negotiators and have a long-term view that allows them to sit out short-term pain.  Therefore, it is possible that tariffs are not a short-term, but rather a long-term strategy to blunt the competitive rise of China.

 

The US does have some leverage.  59% of the US trade deficit comes from China, and the US imported $524 Billion from China last year.  Chinese exports to the US comprise 4.1% of China’s GDP, while US exports to China comprise only 1% of US GDP.   As a result, US tariffs that reduce Chinese imports could significantly hurt the Chinese economy with little impact to the US even if the Chinese retaliated.  From the US perspective, the timing is also good since the Chinese economy is currently struggling so US tariffs are more likely to hurt, while US economic data remains strong. 

 

As an investor, it is always difficult to navigate these types of binary, geopolitical risks.  Remember that pundits were terribly wrong on Brexit, both in terms of the vote, and the subsequent market reaction.  I make no prediction on what will happen with China, but I will make two assertions about the China problem.  First, it is most likely that the US economy will be little impacted even if tariffs are enacted.  Yes, depending on the severity of the conflict, there will be some negative impact, but the US does have the leverage in the negotiation.  Secondly, the most likely outcome is a tense compromise since neither party wins in an outright trade war.  We continue to keep defensive positions that will hold up if tensions continue but refrain from trying to ‘trade around’ this type of event.  A long-term view is still the best approach.

 

  1. Executive Office of The President, Office of the United States Trade Representative. Findings of the Investigation into China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation under Section 301 of the Trade Act of 1974.  March 22, 2018   

  2. U.S. Chamber of Commerce. Made in China 2025: Global Ambitions Built on Local Protections. January 6, 2017

U.S. Census Bureau.

Share on Facebook
Share on Twitter
Please reload

Recent Posts
Please reload

Archive
Please reload

Related Posts
Please reload

DISCLOSURE Information on this website and others should be used at your own risk. Past performance does not guarantee future results. Securities investments involve risk; returns in such investments vary and may involve gain or loss. The materials and content herein are not a substitute for obtaining professional tax, personal financial planning, or other relevant financial advice from a qualified person or firm. For full disclosure click on the disclosure link at the bottom.

Subscribe to our Weekly Newsletter

2945 Townsgate Road Suite 200

Westlake Village, CA 91361

+ 888-571-5582

help@cedarstoneadvisors.com

Send Us a Message