The US and Donald Trump: ‘America First’
‘Globalisation has tended to increase income inequality within already rich countries. While it enabled people with unique or distinctive skills … to deploy these skills in a wider market, it also intensified competition for unskilled labour, as low-tech manufacturing was able to relocate to low-wage countries’ – John Kay, author of ‘Other People’s Money’, 2006.
When Trump announced he was to take action against China in March as a result of an investigation, he looked into how ‘China’s unfair trade practices’ related to the likes of intellectual property and the transfer of technology. He ordered three separate actions to be taken against China: impose tariffs, lodge a complaint to the World Trade Organisation (WTO) and address concerns over Chinese investment in US industries, particularly tech firms.
US-China trade relations in Trump’s first year of office
- • January 2017: Trump withdraws the US from the Trans-Pacific Partnership.
• March 2017: Orders investigation into US trade deficit with China.
• April 2017: Trump and Xi jointly commit to outlining ‘100-day plan’ for US-China trade: including the US importing more Chinese products like poultry and Chinese markets being opened up to US biotech, credit rating services, payment services, bond underwriting and settlement and beef firms.
• April 2017: Orders investigation into how steel and aluminium imports impact US national security.
• November 2017: Trump makes state visit to China when he unveils $250 billion worth of commercial deals with Xi, as Trump raised the need to ‘immediately address the unfair trade practices’ that drive the US trade deficit with China.
• March 2018: US imposes steel and aluminium import tariffs, followed by further tariffs on Chinese goods, followed by retaliation from China on US imports
There are five pillars that Trump’s trade policy agenda is based on, which are as follows:
- Supports the national security policy
- Strengthens the US economy
- Involves negotiating trade deals that work for all Americans
- Enforcing and defending US trade laws
- Strengthening the multilateral trading system.
As well as China, the US has also had recent disputes with other countries over trade, including India and Russia.
Trade balance: how big is the US trade deficit with China?
Trump is aiming to address the imbalance in trade between the US and its biggest trading partner, China. The US has a trade deficit in goods with China that is five times the size of any trading deficit the US has with any other country – standing at $375 billion at the end of 2017.
That compares to its second biggest deficit of $71 billion with Mexico, followed by $69 billion with Japan and $64 billion with Germany, according to the US Census Bureau. In mid-March, the White House announced it was aiming to cut its deficit with China by $100 billion.
For further perspective, the biggest trading surplus in goods that the US has stands at just $33 billion with Hong Kong, followed by the Netherlands at $25 billion, the UAE at $16 billion and Belgium at $15 billion.
However, it is argued that China’s role in the global supply chain distorts this figure, referring to products shipped from one country to be finished off in China before being sent to the end market. Also, as the US is the biggest exporter of commercial services in the world (compared to fifth-placed China), the overall deficit is smaller once this is taken into account.
What products does the US import from China?
The US imports more goods from China than anywhere else. A total of 21.6% of all goods imported into the US in 2017 came from China, followed by Mexico (13.4%), Canada (12.8%) and Japan (5.8%).
Major US goods imported from China in 2017 (in billions of US dollars)
||YoY % growth
Misc manufactured commodities
Furniture and kitchen cabinets
Household appliances and misc machines
Motor vehicle parts
What products does the US export to China?
China is the third biggest market for US exporters, accounting for 8.4% of the country’s total. Only its two major geographical neighbours purchase more goods, with Canada taking 18.3% of all US exports followed by Mexico at 15.7%, while Japan takes 4.4%.
Major US goods exported to China in 2017 (in billions of US dollars)
||YoY % growth
Aerospace products and parts
Oilseeds and grains
Oil and gas
Waste and scrap
Resin, synthetic rubber, artificial and synthetic fibers
Pharmaceuticals and medicines
While Trump is pushing for China to purchase US goods, the growth in the amount of goods being sold by US companies to China has grown at least twice the rate of exports to any other country over the past 15 years – from just $22 billion in 2002 to $130 billion in 2017.
From ‘Made in China’ to ‘Made by China’
It has been suggested the underlying target of US action is actually China’s industrial strategy, named ‘Made in China 2025’. Although China is still the world’s engine of economic growth, it has been slowing and Xi is addressing the problem head-on by upgrading China’s low-cost manufacturing hub to the digitally-focused, data-driven innovation centre of the world.
At the most basic level, the country is looking to shift from ‘Made in China’ to ‘Made by China’.
But China needs to reach a level playing field in the technology space before it can start becoming a world leader of innovation across a wider spectrum of industries. Technology is at the heart of the trade-off between the US and China.
The importance of intellectual property in the US-China trade-off
Intellectual property (IP) accounts for 30% of all services exported out of the US around the world, and Trump fears far too much US-owned IP is leaking to Chinese firms. This is because China, according to the US, ‘require or pressure foreign companies to transfer technology as a condition for securing investment or other approvals’.
As far as the US is concerned, China is gathering the technology (in sectors like energy and telecommunications) it needs in order to make its industrial strategy succeed, and for China to become a leader in advanced technology. China is openly aiming to rapidly grow its domestic IP development. As a result, Trump is looking to deprive Xi of the technology he needs, rather than directly target trade in goods and services between the two nations.
That view is also backed by a report published by the European Union Chamber of Commerce in China, which stated there had been an ‘unprecedented wave of outbound investments’ in recent years from China into firms in industries of relevance to Made in China 2025. It continued that many of these investments have been in areas where foreign business is unable to make equivalent investments in China.
This all comes against the backdrop of heightened cyber security threats from around the world, with the US alleging that cyber theft had become ‘one of China’s preferred methods of collecting commercial information’ in order to achieve its goals.
The ten sectors at the heart of Made in China 2025, and therefore Trump’s crosshairs (including the latest tariffs), are:
- Information technology
- Numerical controls and robotics
- Aerospace equipment
- Ocean engineering equipment and high-tech ships
- Railway equipment
- Energy saving and new energy vehicles
- Power equipment
- New materials
- Medicine and medical devices
- Agricultural machinery
China and Xi Jinping: a leading global power by 2050
‘No country can retreat to their own island, we live in a shared world and face a shared destiny’, – Xi Jinping, Communist party meeting in October 2017.
Xi has tried to display that China is opening its doors, while arguing Trump is shutting off the US from the rest of the world. With the US out of the Trans-Pacific Partnership (TPP), China was seen as an obvious replacement at the cost of US influence, which has not materialised as of yet.
But the US and others are right to argue against the high barriers to trade and other factors foreign firms have to come under, which Chinese firms operating overseas are never subject to. Currently, Chinese companies in many sectors must remain controlled by Chinese investors, limiting foreign investors to 49% of the business. This pushes foreign companies to seek a collaborative joint venture with Chinese firms in order to break into many markets.
One of the reasons the US is looking to tackle China’s plans head-on is because much of the Made in China 2025 plans are more focused on closing the door to outsiders while ramping-up investment in other countries. For example, China is aiming to raise its self-sufficiency in key infrastructure materials to 40% by 2020, and to 80% by only 2025 – an ambitious goal that is likely to hurt foreign producers.
In the spirit of encouraging domestic innovation, Xi’s Made in China plans also cite references aimed at tightening rules on foreign investment, merger and acquisition activity and procurement of products important to Chinese national security. At the same time, it is encouraging its own businesses to invest more abroad, which some have argued demonstrates China is looking to share more of its own technology overseas. With its goals in the likes of infrastructure, it is also likely China will seek to gain more control over foreign metal reserves.
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The US and China: playing chess with North Korea
‘North Korea’s nuclear issue and the issue of trade between China and the United States are two different issues. They are not related. You cannot speak about them together’, – Chinese vice commerce minister Qian Keming, reported by Associated Press in July 2017.
North Korea may seem too big an issue for the US and China to use it as a powerful pawn, but the isolated nation has been increasingly fed goods from China in the face of international sanctions. With US efforts to tackle North Korea with economic starvation being undermined by China, Trump has voiced his ‘disappointment’ with China’s unwillingness to help solve the problem long-brewing on the Korean Peninsula, while continuing to reap the benefits of trade with the US.
Read more: How do the US and North Korea impact markets?
Following revelations that North Korean leader Kim Jong Un undertook his first foreign visit since taking power, travelling to China for a three-day trip where he spoke to Xi about ongoing commitments to denuclearise the Korean Peninsula, China is evidently keen on maintaining its role between the US and North Korea. Whether China will use this pawn when playing chess with the US over trade, however, is not yet clear.
How would a trade war impact financial markets and companies?
The impact of any trade war will be felt on several fronts, including currencies, commodities and companies. The pain inflicted on stocks would be two-fold, hurting US companies that source material and goods from China, such as Apple, and those that make large amounts of sales in China like Caterpillar and Starbucks.
Sectors that look particularly vulnerable to any trade spat include aerospace and defence. Boeing is the largest exporter in the US and has already seen the impact of a potential trade war hit its share price, with China able to look at European rivals like Airbus if it is forced to. UBS has highlighted mobile phones, computer equipment, semiconductors and clothing as highly exposed to any retaliation from China.
For indices, those heavily reliant on global markets and trade will suffer more as a result of any trade war, such as the German DAX for example. Similarly, the FTSE 100, packed with overseas earners, would be more affected than the more domestic-focused FTSE 250.
As well as the direct impact on US tariffs on steel (which needs metals like iron ore) and aluminium, any protectionist rise over the supply and demand of material in either the US or China could cause a fundamental shift in commodity markets. One example of how any US-China spat could spread is commodity-rich Australia, which sends more than 30% of its total exports to China, at a time when it wants to be more self-sufficient.
Safe-haven currencies will benefit during the uncertainty that will loom before markets know how serious a trade war this will turn out to be. The dollar would decline against currencies, such as the safe-haven Japanese yen and the euro, if tensions escalate. Meanwhile, Asian currencies from countries that would be particularly exposed to protectionist measures, like the Korean won and Taiwanese dollar, would likely fall out of favour with investors.
What US companies make their money from China?
According to UBS, the following companies are the most exposed to China based on the portion of their revenue that comes from the country:
Companies with the most exposure to China (based on portion of overall revenue coming from China)
The impact of a trade war on US car makers
China is the biggest international market for automakers and the likes of Ford Motors and General Motors (the latter of which sold more cars in China than it did in the US last year), have been increasing their focus on the country.
The fear for US automakers is that a trade war would simply push Chinese demand for European manufacturers like Fiat Chrysler, BMW or Mercedes, for example. A trend which is likely to impact numerous other sectors in the US.
How would US-China trade war affect international supply chains?
‘China remains enormously dependent on the United States and on the United States’ allies for its sustained economic growth. China is the largest trading partner of most countries in the world. That point is often made. Seldom made is the relevant next point. Most of that trade is in the form of intermediate goods that go to China for final assembly to be put in a box to go to the North America, Japan and Europe.’ – Dr Thomas Fingar.
China sits at the heart of the international supply chain and any disruption to trade between the US and China has the potential to severely disrupt operations. With more goods being finished off in China, exports from China have risen. China was responsible for just 3.6% of manufactured imports into the US in 1990, whereas imports from other Asian nations on the Pacific Rim accounted for 43.5%. In 2017, China accounted for 26.4% of the US total, having overtaken imports from all other Pacific Rim nations at 21.1%.
The tech space is good example. Apple sourced supplies from about 900 facilities spread around the world last year, and 358 of them were located in China, compared to 137 in Japan, 64 in the US, 55 in Taiwan and 34 in South Korea. Intel has around ten facilities that supply Apple, two of which are in China, compared to three in the US, two in Malaysia, one in Ireland and one in Israel.
According to Supply Chain 24/7, some US firms that would be impacted by a trade war include Ambarella, Texas Instruments, Marvell Technology Group, Genco Shipping & Trading and Diana Shipping.
How would a US-China trade war affect investment flows?
The US and China do not have investment flowing between them that matches their trade. According to research initiative US-China foreign direct investment (FDI) project, the pair jointly invested over $60 billion in one another in 2016, following a sharp rise from $29 billion the year before.
The growth in US investment in China, amid high entry barriers, is much lower than that of China in recent years. Chinese FDI into the US trebled year-on-year in 2016, while US investment into China was broadly flat.
The project also highlights that 88% of Chinese FDI into the US between 1990 and 2016 saw a Chinese company take a controlling stake in a US firm, compared to 69% of US FDI in China.
There were 109 Chinese companies included in Fortune’s 2017 list of the world’s 500 largest companies. The 20 largest Chinese companies are all publicly listed, and the Chinese government holds over a 50% stake in all but three of them – demonstrating the role of China’s government in foreign direct investment abroad:
*Chinese state does not own over a 50% stake
Trump is not necessarily looking to stop Chinese companies gaining a foothold in US companies but trying to get that same access for US companies in China. The US-China Business Council suggested ownership barriers were slapped on 100 industries in China in 2016.
Would China’s holdings of US Treasury securities play a part in any trade war?
China held nearly $1.2 trillion in US treasury securities at the end of 2017, representing 18.7% of the country’s total foreign holdings after selling down US debt over the year. This is down from recent peaks when US treasuries made 26.1% of total Chinese foreign holdings back in 2010.
While China’s holdings of US debt securities does give China leverage over the US, giving it the ability to sell-off, or threaten to sell-off, large volumes of US debt in retaliation to any actions, it is also not in China’s best interest to do so. Damaging the US economy would in turn hurt the growing market that China feeds off the most. It would also mean China’s dollar-assets would be worth considerably less, as any large sell-off of US debt by China would see a sharp decline in the dollar against global currencies.
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What about the US Federal Reserve and global growth?
According to the Economist Intelligence Unit, US consumers would bear the brunt of any trade war through inflation, while the impact on China would be limited. In a report published last year, US consumer price inflation was forecast to be up to 1.5% higher in 2018 should a trade war breakout. This is in comparison to baseline forecasts, with US private consumption growth to be over 1% lower than it otherwise would be in both 2018 and 2019, before narrowing in subsequent years.
The impact on China, as a major exporter rather than a hub for importing consumer goods, would be near-negligible, with private consumption forecast to be only marginally lower under a trade war scenario. While China could source substitutes for US products elsewhere by looking in places like Latin America, the US would have a tougher time finding such a vast amount of product elsewhere at the same price as China offers.
This, alongside any negative hits to US and global equities, would pose a problem for the US Federal Reserve (Fed) and its intention to hike interest rates further this year. The Fed would be forced to return to the drawing board if a full-on trade war broke out.
Learn more about trading interest rates.
In terms of global growth, a trade war between the US and China, and the ripple effect this would have around the world, would mean overall international growth would be severely impacted. The International Monetary Fund upgraded its global growth forecasts for 2018 and 2019 by 0.2 percentage points to 3.9% in January, but those numbers would be under threat should trade relations between the US and China turn sour.
Conclusion: neither the US or China want a trade war
‘Ultimately, a US-China trade war would be a fight that no side could win, or at least at an acceptable cost’, – Ayesha Akbar, portfolio at Fidelity, February 2017.
Trump’s hardening stance against China is just one cog, albeit one of the most important, in the US president’s trade policy that seeks to overhaul US manufacturing, bring back jobs from low-wage countries and level out the trade imbalances with nations like Mexico, but particularly China.
While Xi has recently cemented his leadership in China, he does not want to derail China’s economic development so soon after unveiling his vision for the country and its economy.
The US nor China want a trade war, but both seem willing to push the boundaries of one in order to get their messages across. The implications of such action would be widespread on financial markets, providing investors with plenty of opportunity.
With other factors in the mix like North Korea and the South China Sea, the trade-off between US President Donald Trump and Chinese President Xi Jinping will be a long one.