THE BARROOM BRAWL – the on-going trade war rhetoric b/w Washington & Beijing

The U.S. and China are already into a unilateral war and a battle of words over trade that has resulted in announcements of several tariffs on imports from both the countries.

Let me first vet a clear picture of the Trade happening between the two. The trade deficit in 2017 has greatly widened between the two countries, with the U.S. importing $507 billion worth of goods from China, while the Chinese imported $138 billion from the USA. Now, this would mean that the U.S. is facing a trade deficit of around $379 billion. Trump and many other Americans attribute this huge deficit to the Chinese taking brutal advantage of the U.S. trade laws, IPRs and subsidies for domestic companies. 

Last year the United States, the European Union, and Japan agreed to make common cause on this. But now Trump has alienated those allies by imposing tariffs on Japan’s steel and aluminium exports on national security grounds and threatening to do the same to EU allies while raging a unilateral war with China.

Major imports of the U.S. from China (% of $507 billion)

Electronics – 29%, Machinery – 22%, Apparel & Toys -10%, Furniture – 6%

Major imports of China from the USA (% of $138 billion)

Aircraft – 13% Agricultural produce & Oil seeds- 11% Vehicles – 11% Machinery – 9% Minerals & Fuels – 7% Electronics – 7%.

How will the to-be imposed tariffs affect the U.S. imports & exports? How is China prepared to retaliate to the war of tech and trade? What businesses are most likely to get hurt?

If you’re desperate to know answers to the above in a layman’s version read on.

Trump has already imposed tariffs on $250 billion in China-made goods exported to the U.S. He has also threatened to impose tariffs on the next $200 billion worth exports if China retaliates to this list of $50 billion in levies that kicks-in on July 6. China imports around $138 billion a year and any attempts by China to retaliate/match Trump’s tariff plans back with another tariff plan might work in vain, as it would obviously run out of products to target.  In such a scenario, China might think about changing industrial structure - may be it might in short, come up with policies that would erect high entry barriers (in the world’s second largest economy).

Economically, both the United States and China would lose from the trade war. Cruel tariffs would push up import prices, hinder exports, cost jobs and compress economic growth. Though China sells more to America than it buys in return, I feel Beijing is stronger and stable economically and politically, and is strategically prepared for the war.

Some vital considerations include

• The Chinese government is in a healthy fiscal position and is free to compensate any industries harmed by trade war.
• The U.S. government is facing a large budget deficit of around 4% of GDP that is expected to rise in the next few years. Any further spending would require congressional approval, which may not be forthcoming.
• China has a better scope to mitigate any economic challenges than the Trump administration does - The U.S. Federal Reserve is independent unlike the China’s central bank.
• China has appreciated the currency since Trump took his office and it can nudge down any time making the exports competitive.
• The retail sales of China touched the retail of U.S. in 2017 which signifies that by the end of 2018, China’s retail sales would have obviously become 7-8% larger than that of the U.S. That means China will replace the U.S. as the single largest market in the world a historical attempt since the end of WW II.
• Chinese consumers have a 30+% saving rate unlike the U.S. that is leveraged to the maximum.
• Trump thinks that he is targeting Germany’s ‘Industry 4.0’ and China’s ‘Make in China 2025’ drives by raging a tariff war against EU and China, while he is desperate about  ‘Make in America Again’ with a vision to make the U.S.A, a manufacturing hub like in 50's.
• Xi doesn’t have to worry about re-election. China shall afford to play regardless of time. But in the case of USA, voters may plunge in to elect a Democratic Congress the next year; they could also vote him out of office in 2020. 

Trump's policy seemingly misreads the reasons the U.S. runs a trade deficit in the first place."Last year, we lost $500 billion on trade with China," Trump said, fallaciously at a  news conference. Trump's math is off - by more than $100 billion.

Around a third of the content of U.S. imports from China is actually of foreign origin. Am quoting an extreme example I see in newspapers, iPhone X, though Trump hasn’t targeted the same.   

Of the $1,000 retail price of iPhone X, about $370 represents the cost of making each phone, including parts and assembly costs. The most expensive part, the display comes from Samsung in South Korea and represents about $110 of the final price of the phone. $44.45 for memory chips, goes to Japan's Toshiba and South Korea's Hynix. Other suppliers, from Singapore to Switzerland, provide parts and components that are assembled by a contract manufacturer in China. The value Chinese workers add by assembling those parts together represents only between 3 - 6% of the retail price of the phone. Since it retails for $1000, the bulk of the value added is American. Apple’s margin and that of U.S. retailers, while $370 (the aggregate entire cost of making) is rolled into the ‘export value’ and is accounted as a part of China’s total trade deficit with the U.S.

That also means any tariff on Chinese shipments of iPhone to the USA would also hurt the countries caught in the middle of that supply chain, as well as the American consumers who would pay more for the phone.

U.S. exports to China are agricultural produce and finished products consisting of mostly American content and sold by U.S. firms. On the other hand China’s exports to the United States are typically Chinese-assembled goods that contain many foreign parts and components - that are often American-branded. 

The threat isn’t just for American-branded products that American consumers love. This war also poses a threat to the U.S. based manufacturers that rely on Chinese parts and components to be globally competitive. Trump’s $50 billion list already targets aircraft propellers, machine tools, and other intermediate goods which with now increased costs would threaten manufacturing jobs in America. These tariffs avoid major consumer goods such as clothing and footwear which will inflate the prices of some consumer goods, such as televisions. Not to mention the huge cost inflation for low income Americans. They are already drowned in debts and 10% hike in the living expenses could mean a life or death for many of them.

37% of the U.S. imports from China comprise parts and components on which U.S -based manufacturers rely. Seven major tech companies- HP, IBM, Dell, CISCO, UIS, Microsoft and Intel source more than half of their products and components from China.

Apparently forayed to thwart the ‘Made in China 2025’ campaign with an illusion to ‘Make in America again’ in order to develop its own high-tech products, Trump’s tariffs would mainly affect lower-tech products that China actually exports to America right now. Even if the proposed tariffs were to slash China’s exports of these products by a quarter, the direct hit to China would be $6.5 billion — roughly 0.05 percent of the country’s GDP. For an economy growing at 6.8 percent per year, that would be nugatory.

So the Chinese value added of its exports to the United States is perhaps $329 billion — some 2.7 percent of China’s $12 trillion economy. So even if Trump imposed a blanket tariff on China’s exports to the USA by 25 percent, the direct hit to GDP would be 0.7 percent which would definitely hurt. But it would still leave the Chinese economy growing at 6.1 percent a year.

I believe China is strategically better in fighting the war because it has been preparing for it since TPP (Trans-Pacific Partnership) was mooted. This is because TPP was seen as a replacement to disrupt current global chain that uses China as the export hub. It propounded the Belt-and-Road Initiative in 2013 to lessen its dependence on being a global export hub.

I feel that China’s retaliation to the U.S. tariffs is spear-headed with potential targets and calculations.

1.   The primary target was $16 billion of the U.S. civilian aircraft exports. Boeing’s share price slumped when the Chinese move was announced. There are chances that Boeing might slash down the prices to hang on to Chinese market, and in such a scenario, the tariff costs might not fall on China.  Even in an unavoidable scenario, Chinese have a reliable alternate supplier save them – Airbus from Europe.

2.  Second it was the $12.8 billion of U.S. soybean exports. Plus China is the largest importer of American agriculture products - another benefit of being a large market and the farmers’ lobby is a strong one. China accounts for more than half of American soybean exports, giving it market power. China is capitalizing on that by targeting soybeans that are mostly produced in Trump-supporting states in the Midwest – Ohio, Lowa, Indiana. Indeed, as talks of a trade war heated up, the hit to U.S. farmers was immediate: Soybean prices plunged. Here, too, China has an alternative supplier: Brazil.

On top of all that, Trump doesn’t seem to have a strategy. An international alliance would have been more effective in pressuring China to open its markets, respect intellectual property rights and domestic subsidies than doing it alone. 

Unlike smaller economies like Korea or Taiwan, China’s enormous domestic market ensures that China can withstand the damage caused by a trade war. And also because Chinese market is huge, the profits contribution of the Chinese market are large enough for companies like GM, Ford, Boeing, Caterpillar, Corning, DuPont, Starbucks, Coca Cola, Qualcomm, Intel, Apple etc to really feel the loss. You shall expect a huge political backlash from corporate America to any political figure that starts the trade war.

It is simply impossible to replicate China’s massive infrastructure (ports, roads, bridges, rails, power plants, waste water treatment facilities, etc) and enormous manufacturing capacities in other countries in a matter of years. Countries like Vietnam, Indonesia, etc cannot replace China as the alternative suppliers immediately. If China shifts 10% of its orders to Vietnam, Vietnam will immediately see huge congestion in their ports and highways, huge shortage of electricity and skilled labor.

As I have already mentioned China’s banks are not independent unlike Fed, now there can be orders to cut interest rates to the people’s bank of China and boost domestic demand if necessary. State-owned banks shall be told to extend more credit.

What Trump missed out is the fact that the United States is making surplus in services, which sold $38 billion more in services to China than it bought in return, the biggest bilateral surplus. Trump's obsession with the trade deficit in goods made in China ignores a widening the U.S. - China trade surplus in services.

Am I the only one rambling with a hallucination that there is a paradigm shift happening in the U.S. economy orienting more towards services while moving away from manufacturing?