Is a Trade War Imminent?

By Mark Bern, CFA

This week the tariffs on steel and aluminum were scheduled to go into effect.  Those tariffs were pushed back today after having been diluted last week. 

This week the Administration announced new 25% tarrifs on at least $50 billion imports billion in Chinese imports per year, perhaps as high as $50 billion.  The Chinese have declared that they would relalliate with tariffs on 128 imports from the U.S, including grain and hogs. ($3 billion last year).

The total U.S. trade deficit was $566 billion in 2017 and of that total $375 billion was with China.  That is more than 65% of the total annual deficit.  The reason for the deficit is that China has many barriers that keep imports out.  An example is on cars.  China charges 25% fee for U.S. cars sold in China while charging only 2.5% on cars made by Chinese companies. 

If a technology company wants to manufacture products in China it must be 51% owned by a Chinese company.  This is why there are so many joint ventures pairing U.S. companies with Chinese companies in China.  We cannot build a plant there and sell to the Chinese consumers without a controlling Chinese partner.  Chinese companies can, however buy U.S. companies if they can pass the rigors of our antitrust laws and not create a national defense problem for our country. 

Facebook, Google, Amazon and Twitter cannot operate legally in China.  The Chinese government sensors or blocks social media within the country.  That often gives Chinese domiciled companies a monopoly or duopoly situation without American competition in the home market. 

The list goes on and on.  The Chinese government does not play fair, plain and simple.

I do not like President Trump on a personal level and I especially do not support his irrational use of Twitter.  But I do admit that he has a point in terms of the trade situation with China.  The playing field is not even close to being level. 

So, is this just the preamble to an all out global trade war?  I, for one, do not believe so.  What I believe is that the President is using his bluster, tweets, announcements and policy changes to keep everyone guessing.  He has a big stick and maybe (just maybe) he knows how to wield it.  What I believe he is doing is creating some leverage or advantage to use in negotiating. 

I have done a led a good number of negotiations in my previous role as Manager, Corporate Alliances.  Negotiating with Microsoft, Accenture, AT&T, Sofbank, and many more companies, large and small, I learned early that the other side will always try to win as much as s/he can and that negotiating from a position of weakness never ends well.  I always established what the other side wanted and how they would benefit from an alliance first to determine what advantages I had.  Usually, I started out by asking them what they wanted from us.  That list gave me the amunition that I needed to get what I wanted.  If not, I was always ready to walk away.  If they knew I wouldn’t walk away I had already lost before we started.

I assume that President Trump knows more about negotiating that I do so what I see in what he is doing is establishing his position of strength first and then entering into negotiations with an established belief on the other side of the table that he will walk away if he does not get what he wants.  His antics have everyone confused and unable to predict what he might do next.  Personally, I’d love to be his negotiator.  When the other party has more to lose it becomes much easier to improve the deal. 

With NAFTA, both Mexico and Canada have a lot more to lose relative to their respective economies than does the U.S.  As a matter of fact, that is the case with just about every trading partner we have.  It does not mean we need to score outright wins and force everyone eles to lose.  It means that we have an opportunity to level the playing field.  We have never been in this position before. 

In the past, every time we entered into negotiations with another country on trade they knew we would not walk away.  They knew that they could always extract more from us while giving us very little.  The result is the huge trade deficit we now have.

A trade deficit, in and of itself, is not a bad thing.  But when it keeps on growing to such an extreme it can become dangerous because we owe so much to certain trading partners that, unless things change, we will never even the score.  The surpluses being built up by governments that don’t exactly like us (and in some cases could become enemies in the future) is dangerous because they control such large amounts of our national debt that they could, should they choose, inflict great damage on our currency and economy by flooding the global debt markets with our bonds, bills and currencies. 

So, my expectation is that the President is building negotiating positions in a bold attempt to right the wrongs by every previous Administation, Republican and Democrat, by extracting concessions from trading partners that have build barriers to take advantage of us for too long.  I hope it works. 

Until we find out the markets are going to remain volatile with more sild swings up and down.  In the end, I highly doubt we will end up in a trade war of global proportions.  This week we announced tarrifs of up to 25% on as much as $62 billion in trade.  The market reaction was to wipeout $2 trillion worth of market capitalization.  I think that what we just witnessed was an overreaction.  It may not be over yet but at some point reality will set in and the markets will bounce back. 

Remain calm, there may be nothing to see here.  But in the short term perception and emotions always rule the markets.  The emotion ruling this week was fear.  Neither fear nor greed are rational emotions but both move the markets. 

“In the short run, the markets are a voting machine, but in the long run the markets are a weighing machine.” – Benjamin Graham

The fundamentals are still strong and showing no signs of future weakness coming so hang in there until we see signs that are troublesome.