8 Potential Impacts of a U.S.-China Trade WarSubmitted by Heck Capital Advisors on August 2nd, 2018
What is a Trade War?
A trade war is an economic conflict in which countries impose import restrictions on each other in order to harm each other’s trade. Potential trade war strategies include not only tariffs, but also clamping down on foreign investments, devaluing domestic currencies, scaling back purchases of treasuries, and/or implementing subsidies for domestic industries, and quotas.
U.S. vs China
The U.S.-China Trade wars have been headlining daily news since early April. While a majority of consumers have not yet experienced notable impacts, concerns are rising over the risks of impacting industries, rising consumer prices, rising inflation, and dampened economic growth. President Trump’s goal for implementing tariffs is to decrease Chinese Intellectual Property (IP) and technology theft and protect U.S. jobs and businesses from unfair trade practices. However, no action is without consequences. With almost 20% of Chinese exports going to the U.S. annually, this high level of interdependence could create a far reaching and deeply impactful global trade war (Columbia Threadneedle). Please read some of the potential impacts below.
1. Harm to U.S. Companies and Industries
Manufacturing, Consumer Discretionary, Automotive, Tech Companies, and Agriculture industries will likely be affected. Future trade plans that are crucial to economic growth could be deeply impacted. The scope of the tariffs is far reaching. For example, manufacturing companies expect China to demand 7,240 airplanes valued at $1.1 trillion by 2036. Consumer Discretionary giant Starbucks predicts that China will be their largest market in less than a decade, and automotive companies like Tesla are planning to manufacture in China (Bloomberg). A trade war has the potential to slow these plans.
2. Money Down the Drain
Bloomberg Economics projects that a global trade war could cost the U.S. and Chinese economies $470 billion before 2020 (Bloomberg). Prices are lowest and consumer surplus is greatest when all economies agree to trade freely. With regulation however, trade becomes more expensive, and companies and consumers are forced to absorb higher costs. With a shift in the flow of goods and services globally, the location of production will change for many goods, which is costly and inefficient. In the short run, a trade war will likely lead to a widespread decrease in production and rising prices. In the U.S., higher prices may push the Fed to raise interest rates, further constraining production.
3. Inflation Risks
One of the largest impacts of U.S. tariffs would be an increase in prices for U.S. consumers from higher costs on input materials like timber and steel, as well as final products like foreign cars. This could cause domestic inflation rates to rise on top of the already existing concerns due to U.S. tax and spending policy, and low unemployment.
4. A Weakened Economy
The dollar is strong today, but there is concern that uncertainty around tariffs create more currency volatility. Firms facing uncertain costs often wait to see potential impacts, delaying planned expansions or purchases. Tariffs on steel and aluminum, for example, impact a wide range of industries due to the fact that these commodities are inputs of many goods. For these reasons, the trade war may cause a domestic slowdown and higher levels of uncertainty.
5. Impacts on China
With almost 20% of all Chinese exports going to the U.S., China is very reliant on U.S. trade. The IMF has recently estimated that in a trade war with the U.S., Chinese GDP would drop 0.5% and could fall further (Columbia Threadneedle). For example, China recently imposed 25% tariffs on American soybeans, which could be detrimental to the Chinese people. China imported $14 billion in American soybeans last year, as Chinese farmers cannot grow enough for themselves. Considering that China gets 90% of their soybeans overseas and must feed 1.4 billion people; tariffs on soybeans could create potential issues in the future (Bloomberg).
6. Global Reach
Effects of the trade wars will echo around the world. A trade war also has the potential to disrupt other Emerging Market economies, Mexico, Canada, the EU, and other countries. EMs are currently supported by solid fundamentals and growth. EM economies are expected to represent 60% of the world economy in 2035, up from 38% in 2017 (IMCA). While EM countries have the potential to gain purchasing power and drive global economies, the implementation of tariffs creates increased volatility and short term risk.
7. Domestic Business Benefits
In 2017, the U.S. imported $506 billion from China and exported just $130 billion resulting in a trade deficit of $375 billion, up from $347 billion in 2016 (Bloomberg). The U.S. argues that for every $1 billion in deficit, it costs the U.S 6,000 jobs (Trump Administration). The proposed tariffs could protect U.S. jobs and businesses from unfair practices that make is hard to compete on a global scale.
8. Technology Protection
A U.S. Trade Representative has estimated that Chinese IP theft costs the U.S. $225‐$600 billion annually and forced technology transfer by Chinese firms costs the U.S. $180‐$540 billion annually (Bloomberg). It is believed those numbers will go up as Chinese firms acquire more U.S. firms. The U.S. hopes that implementing tariffs on China will encourage an end to IP theft and forced technology transfer.
Tariffs could disrupt the balance of global trade and lead to trade wars that would hurt the economies of countries involved. In the U.S., the rising trade war could be a catalyst in ending the relatively long economic expansion. Aside from potentially detrimental impacts on the U.S. and China, other EM economies would be very susceptible to the effects of a trade war among the world’s two largest economies. Despite these concerns, many are hoping that negotiations will be made and markets will become efficient again.
What Should You Do?
A trade war is not something that you can control. We are happy to review our investment services and programs and our recent Perspectives which addresses these implications in detail. In our opinion, no one wins in a trade war, yet if negotiations can lead to more efficient and fair trade and services, the tough talk between U.S. and China can hopefully turn to profitable trade, economic growth, and better relations. Contact your advisor at Heck Capital to discuss questions about the trade wars’ potential impact on your portfolio.
Sources: Bloomberg, Columbia Threadneedle Investments, IMCA, Trump Administration
Authored by Benjamin Opsal, CFA on August 2, 2018
About the Author: Benjamin Opsal, CFA is a Portfolio Management / Investment Analyst Senior Associate at Heck Capital Advisors. Benjamin earned the right to use the Chartered Financial Analyst® (CFA®) designation after completing the program in 2016, fulfilling the work experience requirements, and gaining acceptance as a member of the CFA Institute. The Chartered Financial Analyst® (CFA®) charter gives a strong understanding of advanced investment analysis and real-world portfolio management skills. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.