• Bob Sellers

China -- a Cheat Sheet

The financial markets are keeping an eye on the U.S.-China relationship, and right now they're not too sure about them.

• Uncertainty: Wall Street hates it – and at least part of the recent volatility in the financial markets is the result of what’s going on between the Trump administration and China. Is Trump on the right track imposing tariffs, or could there be unintended consequences? Will China and Trump work out a deal by March 1stthat prevents higher tariffs? Right now that’s uncertain. And Wall Street doesn’t like it.

• Fact: China is moving from a state-run economy into a more capitalist, market-driven economy.

• Fact: China is still run by Communists.

• Fact: To accomplish its economic goals – “global dominance” -- China will cheat. It will steal technology, create its own competitive products, and keep its currency and/or prices artificially low in order to gain global market share.

Challenge: Republicans AND Democrats agree that China cheats, but they don’t agree exactly on how to stop it. But China shouldn’t expect a Democratic majority in the House to change the direction of this trade skirmish that could grow into a trade war. The executive branch is the major force here.

• What tariffs cover: 10% tariffs put on hundreds of Chinese goods by the U.S. That includes everything from medical devices like pacemakers to airplane parts to communication satellites. In response, China put retaliatory tariffs on a variety of products from pork to passenger cars to – oh, yes – soybeans. The Trump administration has responded by offering to pay Midwestern farmers hurt by the soybean tariffs. China obviously targeted farmers in order to hurt Trump politically and weaken his hand. So far it hasn’t.

• Wall Street wants to know: Will the three-month tariff truce end well? Is Trump serious about continuing to raise tariffs up to 25%? Is he just using tariffs as a tool to get China to make concessions at the negotiating table? Could China’s response lead to an economic cold war? Could tit-for-tat retaliation lead to a recession?

Why China is kind of a big deal

• China has 1.4 billion people, four times as many people as in the U.S. Those people are potential consumers for U.S. companies. But China is also an economic competitor, and doesn’t have any plans to hand over its domestic markets without a fight.

China’s domestic goal: As revealed in its 2016 Five Year Plan, China seeks to increase innovation and domestic growth through private investment, relying more on the markets and less on government investment. This has been part of their plan for years, and their efforts have been positive, but spotty. (CIA World Factbook regarding China.)

• China’s global goal:China is also an international competitor and seeks to become THE dominant world economic power. The White House released a report in Juneoutlining China’s goals and how it’s trying to accomplish them. It starts with this:

“The Chinese government is implementing a comprehensive, long-term industrial strategy to ensure its global dominance…. Beijing’s ultimate goal is for domestic companies to replace foreign companies as designers and manufacturers of key technology and products first at home, then abroad.”

Here are a few ways that China doesn’t play well with others, and why Trump and trade advisor Peter Navarro have taken a hard stance against China:

  • China steals key technologies and intellectual property (so it can create products for its own markets as well as global markets)

  • China participates in cyberespionage, contributing to its cheating efforts

  • China puts high tariffs on American imports, an obstacle for U.S. companies

  • China subsidizes (or owns) companies to try to dominate certain global markets

  • China subsidizes domestic manufacturers with cheap loans and looks the other way on environmental regulations

To be determined: Will the U.S. and China work out their problems? Here are two scenarios.

• Bullish argument: The U.S. and China will work out their differences because they both have an incentive to do so. China’s incentive is that the United States is its biggest trading partner (19% of total exports), with 325 million potential consumers with a higher per capita income than the 1.4 billion people in China.A stark example of the difference between the two countries can be found in the percentage of the labor force in agriculture: in China, it’s 27%; in the U.S., 0.9%. China is trying to move further into the 21stcentury with one foot still in the mid-20thcentury.

• Bearish argument: China may NOT be willing to come to the table because of this question. How does China successfully compete internationally without cheating? China may see “playing fair” as a threat to its economic well-being.China has some deep pockets, and if it gets its nose out of joint on U.S. tariffs, it could decide to retaliate by increasing or adding its own tariffs, and by cutting back on buying American products. Before you know it, China’s economy slows, the American economy slows, and the consequences might be unpredictable. And what scares Wall Street? Uncertainty. Let’s say that again. What scares Wall Street? Uncertainty. That’s where we are right now.

• Wild card: In a development right out of a spy novel. Canada has arrested Meng Wanzhou, the CFO of China’s telecom giant Huawei Technologies. She’s being detained in Vancouver, British Columbia, and faces extradition to the U.S. to face charges for violating sanctions against Iran. Wait, what? It came as a surprise to China too, especially because much of what telecom giant Huawei does appears harmless, like selling more smart phones than Apple. But it also does something more sinister. The Pentagon says some of its technology, in areas of artificial intelligence and machine learning, have military applications that pose a threat to our national security. And Huawei is accused of selling such equipment to Iran, in violation of our sanctions against that country – and did it under from a separate subsidiary in order to skirt the sanctions. If that did happen, Meng says she didn’t know anything about it. Meanwhile, one of two homes that Meng owns in Vancouver was broken into and the culprits got away! It’s unclear how this will unfold, but just imagine another country detaining a Fortune 100 executive and sending them back to Bejing for trial. That’s probably why China has arrested and detained two Canadians in Bejing. President Trump has said that the U.S. might back off its claims against Meng if trade talks go well. But Canada is telling Trump not to politicize extradition cases. This could get ugly fast, or go it could all go away. Another element of uncertainty with China.

• One of Trump’s challenges is to send clear messages that don’t unnerve Wall Street. When Peter Navarro spoke last week, he said that if progress wasn’t made, tariffs could go up to 200%. He corrected himself shortly thereafter, saying they could go up to 25%. But Navarro and his hawkish attitude on tariffs has a habit of spooking the markets. On the other hand, economic advisor Larry Kudlow tends to settle the markets down. But Kudlow is a free-market capitalist. Not our words, his. He suspended his website when he went to work for Trump, but here is a screenshot before he showed up to work on Pennsylvania Avenue (below). Kudlow has been trying to walk the fine line of believing in free markets, while supporting a president who is imposing tariffs. Kudlow portrays them as a tool.

The ideal result would open more Chinese markets to American companies and stop China’s cheating, creating a more level playing field for all, including the United States. Sounds a little like free trade, doesn’t it? While virtually all Democrats oppose Trump on most issues, they know as well as Republicans that China is not playing fairly. What nobody knows is how to change that. The Trump administration’s approach is to use tariffs. Will it work? We’ll get back to you on that.

• Wall Street will probably let out an audible sigh of relief if there’s a trade deal by March 1st. Of course, by then there could be a Mueller report and talk of impeachment – or not. We’ll cover that in a future issue.

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