Tariffs & Trade Tensions

Posted by Tim Doyle | May 21, 2019

On May 10th, trade tensions between the United States and China escalated with the US raising tariffs from 10% to 25% on $200 billion worth of Chinese goods. The current administration is also contemplating tariffs on all Chinese imports ($540 billion). China retaliated by announcing plans to impose tariffs on $60 billion worth of American products.

 

In our Q2 Market & Economy Report, we stated that trade tensions between the US and China were a primary concern leading into the remainder of 2019. This stance has not changed, so this is intended to offer some perspective on the current trade tensions between the world’s two largest economies.

 

When looking at impact, it is important to note that exports make up roughly 8% of GDP for the United States and 19% of GDP for China. By comparison, exports in Japan, the UK, Canada and Mexico are 15%, 17%, 26%, and 38% of GDP, respectively. It may be surprising to some that China’s exports (as measured as a percentage of GDP) are in line with countries and regions like the UK, Japan and much of the Eurozone.

 

Technically speaking, China is more reliant on the US for export activity than the other way around, but the US may be overestimating a perceived weakness in China’s position. China is the 2nd largest economy in the world based on Nominal GDP of $12+ trillion and the largest based on GDP (PPP/Purchasing Power Parity) of $23+ trillion. Comparatively, the US has Nominal GDP & GDP (PPP) of roughly $20.5 trillion. China’s GDP growth has slowed from 6.8% in early 2018 to about 6.4% in Q1 of 2019. Still, China’s Q1 GDP number was slightly above market expectations due to growth in industrial output and strengthened consumer demand.

 

The current tensions between the US and China remind me of a story involving my childhood friend, Ben, and his little brother, Matt. Matt was about five years our junior and, as tends to happen with little brothers, he was the recipient of some friendly ‘little brother hazing.’ Matt chased down baseballs, retrieved sodas, and was generally subservient to the whims of Ben and our crew of friends. Years later, when in college, I arrived home for a semester break to find that ‘little’ Matt had suddenly grown into a 6 foot, 200lb young man. Quite literally, the scales had suddenly shifted, and the days of Matt’s subservience and timidity were over. My point is that China is likely no longer the deferential country or economy it might’ve been in 2005, for example, when GDP was $2.2 trillion and exports represented roughly 30% of GDP. President Xi Jinping also has the advantage of being able to play the political ‘long game’, as he essentially has a lifetime appointment. Conversely, the current administration is facing elections in November of 2020. Will President Xi allow these trade tensions to persist until he can potentially find a more cooperative and amenable administration when it comes to trade relations?

 

Now back to the numbers - assume that the new Chinese tariffs flowed directly into the price of consumer goods. This would amount to a price increase of ‘just’ $30 billion ($200 billion x (25%- 10%) in a consumer economy of roughly $14 trillion - or about .22%. Furthermore, it is expected that some of the cost of this tariff increase will be incurred by retailers and importers, further reducing the direct impact on consumers. From a capital markets perspective, these numbers aren’t insignificant, but the true damage caused by these tariffs may not be in the numbers themselves, but in the global economic uncertainty that is caused by a rift between the world’s two largest economies. Lately, we’ve seen volatility in global financial markets, world trade volume has dropped dramatically, and heavy manufacturing countries and regions like Taiwan, Korea, Mexico, and the Eurozone are starting to feel the pinch with manufacturing PMI’s in contractionary ranges.

 

It is impossible to predict how and when these trade tensions will end, but we feel confident that Destiny Capital portfolios are well-positioned to navigate through these uncertain times. After all, these trade developments are no surprise to us. As always, we will continue to monitor any developments and communicate with you as necessary. If you have any questions, your dedicated team is available and ready to serve you.

 


 

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Topics: Economics, Announcements