We have been writing about the US-China trade war since April 2018. Our view remains that the nub of the issue is more about technological rivalry and alleged intellectual property theft than about the trade in goods, which nonetheless form a significant part of the altercation.
Made in China industrial policy
China has placed several high tech industries at the centre of its “Made in China 2025” industrial policy, which puts it in direct competition with the key growth industries of the US. Chinese companies in these industries are expected to benefit from various forms of state aid, while the US believes they should be open to fair competition from international peers.
President Trump’s favoured tool in the altercation has been raising tariffs on the trade in goods. There is now a 25% tariff on $250 billion worth of Chinese imports and a threat to impose the same tariff on the entirety (another $250 billion worth of goods) if a satisfactory resolution is not found. In retaliation, China has imposed 25% tariffs on $110 billion worth of US exports to China.
Negotiations had been progressing reasonably well. By some reports, agreement had been reached on rebalancing goods trade, lowering of tariffs and even on higher standards for intellectual property rights and protections. The latter are in fact being implemented into Chinese law.
In our view, the sticking point was the US demand for a reduction in Chinese state aid for key industries. Indeed, in May, both sides walked away from negotiations with the US blaming China for backtracking on prior commitments and China blaming the US for being indignant towards it.
But then in June, on the side lines of the G20 meeting, Presidents Trump and Xi agreed to resume negotiations which remain ongoing.
The (President) Trump card has been the threat of 25% tariffs on another $250 billion worth of goods trade. However, the composition of these goods is very different to those in the initial set of tariffs.
The initial set was biased towards “intermediate goods” which are items bought by companies during the intermediate stages of production. In other words, the impact has primarily been on companies which could choose to absorb higher costs in the short term, hitting profit margins.
The remaining goods trade under threat are comprised mainly of “capital goods” and “consumption goods”. These are typically finished items (like washing machines) or items that are consumed (like food and energy). These would be felt directly by voters.
In the run up to the 2020 election, that creates a very different calculus.
No hurry on deal
We don’t profess to have any skill in predicting President Trump, but our best guess is that he will aim to keep the negotiations going. However, there is a high risk of upset along the way. We also think he may turn his attention to Europe, possibly seeking better market access for US farmers, one of his core voter bases.
The trade war has caused a slowdown in world trade, but the biggest impact has been on business investment intentions which have plummeted. The uncertainty means companies are holding back on investing for the future. If companies get any more cautious, it could create weakness in the jobs market. That could seriously risk further economic weakness.
These concerns have led us to improve portfolio defences. We have improved the quality of both equities and bonds in portfolios by targeting companies that are more robust against fluctuations in the economic cycle.
We believe there is a chance of some resolution to the trade dispute (even if the question of subsidised sectors remains unanswered) and there is a chance of monetary policy easing to combat economic weakness. Each of these could send equities higher and so we remain neutral on our overall level of equity exposure, ready to move more decisively based on incoming data.