On 22 March 2018, Trump signed a memorandum of understanding aiming to slap tariffs on Chinese imports. The presidential memo differs from an executive order, in that it is an instruction to the US Federal Trade Commission to formulate a specific plan to impose tariffs on Chinese goods within 15 days. Upon the announcement of the news, US stocks plunged with the Dow Jones Industrial Average index tumbling 724 points.
Investors were worried that China would respond with retaliatory tariffs against the US, sparking concerns of an escalating trade war. Investors responded by selling down stocks of US companies with products that are well-received in China.
Boeing, for instance, the global market leader of aircraft manufacturing fell as much as 5.2 percent on the day. Others like Texas Instruments shed 4.3 percent, while Nike – the world’s most popular sports brand – saw its share price plunge 2.9 percent. Notable sell-down also includes industrial powerhouse 3M which plunged 4.7 percent and US automobile giant General Motors which fell 3.3 percent.
At the time of writing, the list of Chinese goods to be slapped with tariffs, worth some US$60 billion, has yet to be made known. But on 2 April 2018, China came up with the list, imposing tariffs on US$3 billion worth of US goods that include agricultural items such as fruits and pork. The prelude of a potential trade war has taken the stage, so we should see some form of trade negotiations to commence soon.
Not long before the announcement about tariffs on China products, US stocks also responded negatively when Trump signed an executive order to impose 25 percent tariffs on imported steel and 10 percent on imported aluminium. However, almost immediately, Trump said he would grant exemptions to major allies like Canada, Brazil, Mexico, EU, Australia, South Korea and Japan. The only condition is that the US can negotiate for better trade terms with these countries and hence reduce its trade deficit.
But the irony is that the exempted nations are ones most dependent on access to US steel and aluminium market and those that are not exempted only make up a negligible fraction of US imported metals. So how would it substantially help the US improve its trade balances? Looking at it, Trump probably lost the first battle in the opening salvos.
Similarly, the US-China tit for tat on tariffs could also end up uneventful for Trump. Based on the estimate that about 1,500 Chinese goods would be targeted, a US$60 billion target value would translate to an average of only US$4 million per item. Comparatively, the US is running a trade deficit of over US$300 billion against China, so would it be meaningful to be imposing tariffs on some US$60 billion worth Chinese goods as well?
From China’s end, its initial retaliation was also somewhat muted, as it responded with tariffs on only US$3 billion worth of US agricultural products. The “symbolic” move is already a sign that China has taken a step back.
According to US Nobel Laureate in Economics Paul Krugman, Trump is absolutely “ignorant” in wanting to wage a trade war with China. Krugman added, that China would emerge the eventual winner in a full-scale trade war with the US. This is because most of the Chinese imports are no longer manufactured in the US hence the impact on American industries is going to be limited.
Moreover, many Chinese-assembled goods are made up of components produced from the US and Japan. By imposing tariffs on such end-products, it would ultimately weigh on the US economy and its major ally Japan. This is coupled with the fact that many US companies also assemble products in China! In fact, it is exactly because of the significantly lower labour costs in China, that many US companies like Apple, can achieve high margins by locating end-assembly operations in China.
Upon the third day that Trump signed the memorandum, the US Treasury Secretary confirmed that the US and Chinese government have already commenced trade negotiations. So, investors should not worry too much about ongoing dynamics to escalate into a full-scale trade war.
Rumours have it that the US is negotiating with China for lower tariffs to be imposed on US produced cars, as well as greater liberalisation of the Chinese financial sector. Given how much the US will benefit from these proposals, the rumours are likely to be true.
The US is a major car producer and its financial industry wields much clout. Using “trade war” as a bargaining chip, Trump may be trying to force China into negotiations for such deals.
To begin with, more and more Chinese are driving US branded cars that are assembled in China. With regards to China’s financial sector, it is indeed true that the Chinese government is rather restrictive towards foreign ownership.
Under the pressure from US, as well as its desire to open up its economy, the Chinese government may yield and reduce tariffs on imported cars. While some Chinese investors may be worried that it would lead to a sell-off of Chinese automakers’ stocks, I believe Chinese automakers will be more resilient than expected.
In terms of functionalities, Chinese-produced cars of the same brand do not differ much from those produced and imported from the US. Besides, lower costs of production means that domestically produced cars have a pricing advantage over US imports anyway.
Eventually, the Chinese government would also ease restrictions for more foreign access to China’s financial sector. But it would not just be to the US, but rather to all other global institutions. As a result, Hong Kong would also benefit since its investments are also classified under “foreign investments” in China. Our local banks will also benefit, given the size of the Chinese market.
At the end of the day, I have strong conviction that the tensions arising from a looming trade war will end amicably: Neither the US nor China wants to engage each other in a long-drawn economic battle.
Catch Dr Chan Yan Chong at our upcoming Shares Investment Conference 1H2018, on 5 May 2018!