July 3, 2018

In the 1979 movie, “China Syndrome,” a news reporter (Jane Fonda) and her cameraman (Michael Douglas) are unintentional witnesses to a SCRAM incident, an emergency core shutdown procedure at a nuclear power plant in California. The crew prevents a catastrophe, but the plant supervisor (Jack Lemmon) begins to suspect that the plant is in violation of safety standards and tries desperately to bring it to the attention of the public, fearing that another SCRAM incident will produce an atomic disaster.

Fast forward to 2018 and we find world trade with China, Europe, Canada and Mexico in a slow-motion meltdown of sorts where the initial actions of the Trump White House to bring the U.S. trade deficit back into some semblance of balance are at risk of devolving into a ‘pride before the fall’ scenario escalating into trade war that has the potential of widespread economic impact. Trying to have a rational discussion with nations on the receiving end of favorable tariff policies for the past 30 years is like trying to convert a heroin addict to a non-opiate drug. The threshold of pain for long-term trade junkies is remarkably low.

These countries and many others have been on a tariff-based drip system where the calculus is skewed so heavily against the U.S. it’s laughable. For example, the standard tariff for importing cars to the U.S. is 2.5 percent of their value, while the European Union charges a flat 10% on imported automobiles. Our trade deficit with the EU last year was $151 billion, up 147% from $61 billion since 2009 (source: U.S. Census).

And that’s just the average. For hyper-ecological nations like Norway, residents of Oslo have to pay a 25% tax on top of the purchase price (and shipping costs from the U.S.) due to the U.S. car’s low fuel efficiency. A new 2019 Ford Mustang Shelby GT500 is taxed so heavily in Norway that one Mustang might cost as much as $250,000 over there vs. a list price in the U.S. of just $54,845.

The U.S. trade imbalance with China is far worse than the U.S./Europe imbalance. In 2017, the U.S. trade deficit with China reached $375 billion in 2017, since the U.S. bought $505+ billion from China and U.S. exports to China were only $130 billion. (source: The Balance, “U.S. Trade Deficit with China and Why It’s So High,” June 14, 2018). Here is a breakdown of two-way trade, by product type, during 2017:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Comparing American Apples and Chinese Oranges

A stickier issue, where more significant measures need to be addressed, is how China undercuts American companies by acquiring U.S. technologies. China acquires American-owned technologies too easily. President Xi and the Chinese government do not see it this way. They call the trade policy they practice a “successful policy.” China has clearly applied the doctrine of relativism – namely that knowledge, truth, and morality exist in relation to culture, society or historical context defining their idea of “fair trade.”

President Trump has already moved ahead with tariffs against the EU, Canada and Mexico, so he isn’t bluffing. U.S. equity markets are sensing that he isn’t about to blink on China, either. Canadian tariffs on U.S. goods, in response to U.S. tariffs on steel and aluminum, went into effect July 1. The initial $34 billion tariff on Chinese imports would be followed up by tariffs on another $16 billion in Chinese goods, with the potential to apply as much as $250 billion in total against China.

China plans to retaliate with tariffs of its own on $34 billion of U.S. goods and agriculture. This initial salvo has investors on high alert since the first tariffs enacted open the way for an escalation of further tariffs, assuming neither side budges. Making this situation more tenuous is that this week has the July 4th holiday coming on Wednesday, meaning that markets could endure more volatility leading up to Friday as trading volume tends to be lighter surrounding any mid-week holidays.

On the other hand, let’s assume that President Trump and President Xi don’t want to go down the road of mutual economic destruction, so they will come to terms on trade. Most Wall Street chief investment officers are in this camp and for the most part it makes incredibly more sense than the alternative.

Leading up to this past weekend, there was a prevailing tone of neutral-to-mild optimism that neither the U.S. nor China will actually allow the threatened tariffs to be triggered this Friday, July 6. But since there hasn’t been any movement by either government from their current positions, it now appears that the U.S. will go ahead and place tariffs on $34 billion of Chinese goods this Friday.

It would be a huge positive if the U.S. and China could reach a deal by Wednesday or we could see some sell first, ask questions later volatility heading into the weekend. The idea of an all-out trade war while the emerging markets indexes are correcting only exacerbates the notion of global growth slowing in the second half of 2018, while also stoking fears of inflation if we have to pay more for imported goods.

Because the U.S. and China view fair trade through two very different sets of lenses, I think the best investors can hope for are new measures that show tangible progress in lowering the deficit to alleviate the threat of a full-blown trade war. This would be in the form of lower and fewer tariffs by both sides with the mutual goal of targeting a lower U.S./China trade deficit. This is the more realistic scenario that I see unfolding, and it would be quite bullish news for stocks heading into the second quarter reporting period. Neither side has to blink first. Both can come to amenable terms so that China’s leaders can save face while the chart of the U.S. trade deficit improves dramatically over time.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. *All content of “Income Mail” represents the opinion of Bryan Perry*


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