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Surprise! US runs 'trade surplus' with China
TRADE tensions between the US and China have evolved since we last wrote on this a few months ago. There was a false sense of relief after Treasury Secretary Steven Mnuchin had stated that the trade war is on hold.
Many believed that President Donald Trump would be convinced by additional purchases of petroleum, agricultural products, and other goods which would cut the US trade deficit with China on the headline level.
However, in recent weeks, the Trump administration has pushed forward with implementing trade tariffs on the first US$50 billion of imports from China. Important to note, on July 6, the first US$34 billion in tariffs goes into effect and in August, an additional US$16 billion. China has responded in kind with US$50 billion in tariffs.
What subsequently unnerved markets was President Trump's announcement of an additional US$200 billion in tariffs on imports and him threatening to double the amount of tariffs if China issues counter-measures. In addition, trade between Europe and the US dwarfs that of US and China, and the subject of car tariffs was also brought up.
What is interesting here is the strong negotiating position of President Trump at the moment. Thus far the scenario illustrates his "Art of the Deal" acumen.
- The US economy is outperforming due to tax cuts which was President Trump's biggest accomplishment last year and shrewdly timed ahead of trade negotiations. The economy is also experiencing falling unemployment and still facing moderate inflation.
- Furthermore, the global equity market has made its clear verdict thus far, regarding which country is more impacted by trade tensions. The US stock market has hardly been affected while the China domestic stock markets are turning bearish and Europe underperforming.
- At the same time, China's economy is undergoing a targeted slowdown with a decline in the shadow banking system and reforms being a crucial key component in Chinese President Xi Jinping's five-year plan.
- After the summit between North Korea and the US, China did not receive any favourable dealings on trade. In fact the rhetoric from the US intensified.
- Finally, this is one of the few areas where the Democrats and Republicans are unified, again underestimated by consensus. It doesn't appear China or the rest of the world was expecting this scenario. In the past weeks, we have seen China react with a reserve rate requirement cut and some weakness in renminbi as safety valves to support the slowing economy and hedge some downside risk.
But is it just about the deficit anymore? This has also raised the question to what extent national security and Made in China 2025 are also impacting negotiations.
The White House has seen a noticeable increase in national security and trade hawks gaining stature, with individuals such as Robert Lighthizer, Peter Navarro and Mike Pompeo all gaining prominence. It also underlies the concerns on intellectual property protection and forced technology transfer which have existed for years when the West deals with China.
These are fears which have been long lasting and are worsening as western governments are becoming increasingly vigilant and concerned. However, this is now resulting in a number of countries in Europe and Australia setting new rules for reviewing foreign investment from China and other countries.
In the latest news, the US will continue to use the existing CFIUS (Committee on Foreign Investment in the United States) to review foreign investments with respect to national security grounds rather than expanding into direct, targeted rules against countries including China.
This was a small positive, but the committee until recently rarely ruled out takeovers due to national security, which is set to change. What is clear is that we need progress here but in absence of that it could restrict foreign investments.
This is not encouraging in the long-term but frankly a result of the current environment. Don't expect quick wins - clearly large deals in sensitive sectors in Europe or the US look unlikely in the short-term.
What are the next phases of the trade negotiations?
While many tariffs have been announced, the implementation lags the announcements by months allowing time for talks. The impact of an all-out trade war would be costly for both parties, though however, they are probably less than assumed by the market. The impact on GDP in the US and China could be less than 1 per cent.
However, it is important to keep in mind as discussed, the trade statistics are a terrible indicator of trade competitiveness. For example, any goods produced and sold in China are not counted in trade statistics. That means Apple (and numerous other US multinationals) who sells US$48 billion in China and 310 million phones in 2016, do not show up in trade statistics at all.
Surprisingly, if one adds back the sales of these US subsidiaries operating in China (which incidentally have been growing at an 18 per cent annualised pace and have been the fastest area of the growth in trade between the two countries), the US$375 billion trade deficit would astonishingly flip to a "trade surplus" with China (NOT a deficit). In fact, the US runs a trade surplus globally on the same metric.
This means that for the US stock market, which until now has been detached from trade tensions, the US multinationals shares could finally see a sell-off ahead of the important mid-term elections in the US if there is no resolution.
At the same time, China would like to contain the damage to its own economy and gradually open. Therefore, there is still the possibility of a deal but the risks have increased.
However, its timing has likely been pushed out over the summer and could still take place in the autumn.
The crucial uncertainty is how long the trade tensions will last. If it extends beyond early autumn, there could be an impact on global confidence, capex, and growth.
Otherwise, this provides an opportunity to cautiously add to selected exposure to China, Europe, and selected US equities but patience will be key. The probability of a recession globally is still low for the next 12 months and the biggest surprise could be how long the US cycle turns out to be.
- The writer is chief investment officer, Asia BNP Paribas Wealth Management