By Marco Bonaviri, Senior Portfolio Manager, Banque REYL & Cie
For several weeks now, the various protectionist measures announced by Donald Trump have attracted considerable attention. Tariffs on imported solar panels and washing machines have been followed by levies on steel and aluminum[1]. On March 22, President Trump signed a presidential memorandum targeting China’s « economic aggression » under Section 301 of the Trade Act of 1974, introducing punitive measures on $60 billion of imports from China, or around 12% of the roughly $506 billion worth of goods imported from China into the United States in 2017. The U.S. administration justifies these measures as compensation for alleged intellectual property violations. Washington is notably targeting Beijing’s joint-venture system imposed on American companies: in exchange for access to the Chinese market, U.S. firms are required to share part of their technological know-how with local partners. The U.S. administration has 15 days from the signing of the memorandum to present the official list of products and tariffs concerned. This will be followed by a 30-day period during which U.S. manufacturers may file any objections.
Confirming the protectionist shift in the U.S. administration, President Trump has also instructed Trade Representative Robert Lightizer to use the WTO dispute-settlement process to address discriminatory Chinese licensing practices. Finally, Mr. Trump has asked the Treasury to prepare, within 60 days, investment restrictions aimed at preventing companies controlled by China from acquiring U.S. firms active in sensitive technologies and strategic sectors[2]. In other words, the U.S. administration is relying on the « Committee on Foreign Investment in the United States » (CFIUS) to block takeover bids for American companies, as illustrated by the recent blocking of Singapore-based Broadcom’s hostile bid for Qualcomm.
These punitive measures, the first to target China directly, signal a shift in the paradigm governing Sino-American relations. Under Mr. Trump, the structured discourse that has prevailed between the two superpowers for decades is becoming more direct and confrontational. Although he had previously refrained from labeling China a currency manipulator, the U.S. president is now choosing another line of attack, accusing China of economic aggression and, more specifically, theft of intellectual property and unfair competition. To make the point, the products targeted by the tariffs are also expected to be an integral part of the « Made in China 2025 » program, an ambitious industrial policy designed to strengthen China’s manufacturing sector. Mr. Trump has also made clear that the recent measures are only the first in a long series. In addition to trade and investment barriers with China, President Trump has multiplied diplomatic provocations, particularly regarding Taiwan, notably by signing a law on March 16 allowing U.S. officials to travel to Taiwan[3].
President Xi Jinping has so far kept a low profile in the face of repeated verbal attacks from the U.S. administration. Consistent with this approach, China has urged the United States to negotiate amicably during the 30 days prior to the entry into force of the recently announced tariffs. Beijing says it does not want to enter into an escalation of trade tensions, but rather seeks to negotiate and thus present itself as a champion of free trade. Nevertheless, the Chinese authorities have said they are ready to deal with a possible trade war. China has already retaliated against the steel and aluminum tariffs by imposing levies on more than 120 imported U.S. products worth $3 billion. China’s response to the taxes applied on $60 billion has not yet been disclosed, but could affect $15 billion to $25 billion of U.S. exports to China, according to some estimates[4].
The protectionist measures recently announced with great fanfare primarily serve President Trump’s political interests. On the international front, the threat of import tariffs gives him significant leverage in certain bilateral negotiations. A classic carrot-and-stick strategy, in short. This is particularly the case with Canada and Mexico, which are expected to be exempt from tariffs on steel and aluminum in exchange for concessions in the renegotiation of NAFTA. Fortified by his negotiating skills, Donald Trump appears to be counting on the shock effect of punitive measures to force his partners to the negotiating table from a position of relative strength. A tactic many observers liken to negotiating with a gun to one’s head. This is most likely the objective of the measures envisaged by the U.S. president against China: to force it to accept an amicable bilateral agreement aimed at narrowing the roughly $100 billion trade deficit with China. Beijing and Washington have reportedly already begun trade talks behind closed doors following a letter sent by Mr. Mnuchin and Mr. Lighthizer to Mr. Liu, asking China to put in place measures that would facilitate U.S. imports.
At home, the U.S. administration denounces the widening of its trade deficit with the Asian giant, which it attributes to unfair trade practices. At the end of 2017, the U.S. trade deficit stood at $566 billion, its highest level since 2008. The bilateral deficit with China, meanwhile, reached an all-time high of $375 billion. This situation is accompanied by harmful macroeconomic consequences such as rising debt and declining competitiveness. There is therefore bipartisan consensus in Washington that action on the trade deficit is now necessary. The punitive measures against China thus allow President Trump to win support within the Democratic camp. This is the case, for example, with Senator Chuck Schumer, the Democrats’ Senate leader. For Donald Trump, who faces midterm elections in November 2018 and the possible loss of Congress by the Republicans, the rallying of part of the opposition is a windfall. At the same time, Mr. Trump is proving that he can deliver on his campaign promises by defending America against what his supporters describe as the trade war China has been waging against the United States for decades.
China and the United States remain, nevertheless, highly interdependent. Economically, the Middle Kingdom remains the largest creditor of the Americans, and the U.S. Treasury’s financing needs will be very substantial over the next two years. As for the Chinese, their priority is to defuse the excesses of their economy in an orderly manner. To do so, they will need a supportive global economic environment. While the impact of the first wave of tariffs announced by the United States and China is, for the time being, very modest in terms of economic growth, the risk of an escalation in tensions leading to a global trade war is by no means negligible. Trade and investment links between China and the United States are deeply embedded in the global supply chain, and a trade war between these two countries would therefore inevitably have consequences for companies and consumers in other countries. This risk is becoming one of the main concerns for investors in the coming months, with the potential to trigger episodes of stress and possibly lead to a sizeable cyclical bear market.
At this stage, however, it remains likely that Donald Trump, who is no stranger to negotiation tactics, is brandishing the threat of protectionism and a trade war primarily to force the hand of his opponents in subsequent talks. The U.S. administration’s objective appears above all to be reducing the massive bilateral trade deficit with China, not entering a global trade war that all economists agree would be harmful to all countries. If, along the way, Donald Trump can strengthen his electoral base and score points ahead of the midterm elections, that is the icing on the cake. Ultimately, the defining issue in the rivalry between the two superpowers is to secure greater global influence at the political, economic and technological levels. It therefore remains essential that the Chinese government does not respond to this bluff with an escalation of protectionist measures. Let us not forget that Xi Jinping, the strongman of China who has just been named president for life, could also lose patience.
[1] Although these measures do not concern China alone, the exemptions granted to many countries after the initial announcement lead us to believe that China is the true target.
[2] Among others: information technologies, robotics and automation, aerospace, maritime equipment, rail, renewable energies, electrical equipment, agricultural equipment, new materials, biotechnology, medical equipment
[3] However, the « one China » policy at the heart of relations between the two countries is not being called into question.
[4] Source: Bank of America Merrill Lynch
