There are always two sides to every story

There are always two sides to every story.  You have to see the perspectives of both sides to understand a situation and to anticipate what may be ahead.  Take the trade issue with China – a pivotal global economic concern.  The stakes are high.  Not only does it set two major economies at odds, it sets the tone for global trade in general (how open is it), influences the global growth trajectory, and has geopolitical impact.  The approach is risky. This is not the jawboning of the past where rhetoric was just that – words; now there are tariff shots across the bow and the reloading of policy guns.   Let’s look to see what each side believes.

 

Trump has been clear in saying that he thinks the balance of trade with China is unfair.  First, there is the gap in the trade of goods.  According to work by Goldman Sachs, the US trade deficit (in goods) with China is $373bln which is almost half of the total trade deficit (in goods) the US has with the entire world ($768bln).  Most of the deficit with China is in the category of computers ($167bln) followed by apparel ($49bln), electrical equipment ($40bln), and miscellaneous manufacturing ($38bln).  Then there is the issue of market access.  Current consumption by Americans equals $12.8trln a year (bigger than the size of the entire Chinese economy) which is roughly $39,000 for every single one of the 325mm people in the country (all ages).  Access also relates to corporate intellectual property.  China has become increasingly acquisitive, especially in the technology sector.  So much so that recently there were laws enacted on national security grounds requiring increased US government scrutiny of acquisitions of US companies holding “critical technology” as well as investments by foreign investors into US private equity and venture funds seeking to back into ownership of critical technology.  From the US perspective, this scrutiny is necessary to counterbalance what is seen as unfair treatment when US companies operate in China and are required to transfer technical knowledge or seek to acquire Chinese companies but are blocked.

 

China on the other hand sees things a bit differently.  According to work conducted by Deutsche Bank, when you add in the amount of goods sold by US subsidiaries operating in China (thus not included in trade data) as well as services (both imported and through US subsidiaries) then the US actually has a small surplus!  In terms of market access, as attractive as the US consumer is, think about the sheer masses in China whose incomes are on the rise.  There are roughly 330mm millennials in China alone (the size of the entire population in the US) whose incomes are broadly expected to surpass their parents (unlike the US where Stanford economist Raj Chetty estimates the probability at roughly 50%).  There is both size and growth to their consumption story.  While the tariff talk has not yet centered on technology and intellectual property, do not expect China to back off when it does.  Technology is a critical component to their government’s roadmap to the future (which they call Made in China 2025) and deemed strategically necessary.

 

Putting the perspectives together, the US-China trade spat is about something bigger.  It is not about aluminum and soybeans.  It is not about this year’s trade deficit or the next.  It is about the long-term strategic importance of intellectual property (as the key ingredient to the economic model of the future) and about market access between one of the richest (US) and one of the biggest (China) markets in the world.  It also has very real geopolitical impact.  With economic prosperity comes international influence.  China is spreading its influence through the multi-trillion dollar One Road, One Belt initiative that is resurrecting the Silk Road trade routes through Asia to Europe (and coupling it with a sea route).  It is a massive project that will take years but seeks to tie the world (outside of North America) together through investment (as China invests into neighboring country infrastructure) and trade.  This is at the same time that the US has pulled back from Asia by exiting both the Trans-Pacific Partnership and the Asian Infrastructure Bank (both of which moved forward).

 

A simple perspective might think that due to the relatively smaller portion of goods trade that China cannot retaliate against further US tariffs (Trump announces bigger numbers frequently).  A more complex view recognizes that the roughly 5% devaluation of the Chinese yuan versus the US dollar these past few months is not coincidental (albeit perhaps proving the point that China’s currency is a policy tool).  Or the $1.1trln of US Treasuries held as part of China’s reserves could eventually be a tool (or even just the absence of purchases as the US issues more debt to fund deficits). There are also all of those US subsidiaries in China where business can be made tougher through inspection or regulation.

 

Expect the focus of trade issues to re-center on China soon as the US seeks to set aside differences with Mexico, Canada, and the EU.  China on the other hand is likely watching the US mid-term elections to see how much political capital Trump may have on his side of the negotiating table. Investors best settle in because this story is going to take a while to unfold.