Macro Battleship with Christopher Wood

Ongoing US monetary tightening is not the only risk facing Wall Street-corrected world stock markets. The past few weeks have seen renewed negative focus on the ‘trade war’ front. First, on May 29 the White House announced 25% tariffs on US$50 billion worth of goods imported from China containing “industrially significant technology”, as well as yet unspecified restrictions on Chinese investments. Second, on May 31, the US imposed 25% and 10% tariffs on steel and aluminium imports from the EU, Canada, and Mexico.

 

Wall Street Globalists vs Trade Hawks

Stock markets were initially unfazed over these opening protectionist salvoes probably on the view that Donald Trump could turn on a dime again. This is certainly possible given that Trump has continued to adopt a ‘good cop/bad cop’ strategy, with Treasury Secretary Steven Mnuchin and National Economic Council Director Larry Kudlow on one side seemingly pursuing a different agenda from White House Trade Council Director Peter Navarro and US Trade Representative Robert Lighthizer on the other.

The divergence in viewpoints was highlighted by press reports of Mnuchin and Navarro publicly shouting at each other outside a Beijing building during their visit to China in May. Interestingly, this was reportedly the first visit ever to China of Navarro, the co-author of the 2011 book Death by China: Confronting the Dragon – A Global Call to Action.

S&P 500

S&P 500

Source: Datastream

Intellectual Property a Key Negotiating Plank

The trade hawks want to target China’s industrial upgrading strategy, known as “Made in China 2025”.

Ultimately, how bad the trade friction gets will depend on which side Trump backs. Is he just using the hawks to increase his negotiating leverage? This may well be the case. But the Trump administration also does seem serious on the intellectual property issue in terms of wanting to see concrete results.

The trade hawks want to target China’s industrial upgrading strategy, known as “Made in China 2025”. The strategy was launched by Premier Li Keqiang in 2015 and targets China’s industrial modernization, including replacing foreign technologies with home-grown alternatives. The programme identified ten prioritized industries that China wants to become globally competitive in by 2025. These include aerospace, information and communication technology, robotics, ocean engineering equipment, agricultural machinery, railway equipment, power equipment, new materials, new energy vehicles, and medical devices. 

The reason stock markets have got more concerned on the trade issue over the past week is that it has looked as though Trump is increasingly siding with the trade warriors. To sum the most recent developments, the US administration announced on June 15 that a 25% tariff will be imposed on US$50 billion of goods from China that contain industrially significant technologies and that Washington will pursue additional tariffs if China engages in retaliatory measures.

China’s Ministry of Commerce responded on the same day in ‘tit for tat’ fashion by announcing tariff measures against the US of the same scale while also withdrawing previous concessions made. In response, Donald Trump on Monday asked the US Trade Representative to identify US$200 billion worth of Chinese goods for an additional 10% tariff, which will go into effect unless Beijing abandons its stated intention to retaliate.

China Imports from the US and American Imports from China

China imports from the US and American imports from China

Source: CEIC Data, US Census Bureau, China General Administration of Customs

Could a Total Confrontation be on the Horizon?

So if the view of the ‘good cop/bad cop’ approach is wrong and Trump is really following a long-term policy of backing Navarro and Lighthizer by targeting China’s “Made in China 2025” policy and actively seeking to undermine it, then a total confrontation is coming. This is because China will not negotiate on its ability to upgrade its economy. This is already a priority of Beijing, and it has become even more of a priority, if that is possible, as a result of the reliance on US technology exposed by the ZTE affair.

China’s internet companies are massively out-investing their American counterparts.

The US Department of Commerce in April banned American companies from selling components to the leading Chinese telecom equipment maker ZTE for seven years for violating the terms of a sanctions violation case regarding shipping American goods and technology to Iran.

But if China is not prepared to negotiate on upgrading, a deal can probably be done on intellectual property, which is another of the Trump administration’s core concerns. This is partly because Beijing will understand that Washington has a case, in part because much of the intellectual property has already been transferred and, perhaps most important, because going forward it looks increasingly likely that China will own much of the intellectual property itself. On this point, an article by a partner in a famous Silicon Valley venture capital firm this week in the Financial Times highlighted how China’s internet companies are massively out-investing their American counterparts (see Financial Times article “China is winning the global tech race” by Michael Moritz, June 18, 2018).

This is why the old view of China demanding transfer of intellectual property in return for market access is probably passé. But targeting ‘Made in China 2025’ is another matter. That is non-negotiable so far as Beijing is concerned given that, with its working-age population having peaked as a result of the 36-year-long ‘One-Child Policy’ (see following chart) and therefore demographics no longer working in its favour, China needs to upgrade its economy if it is to avoid the so-called ‘middle-income trap’.

China’s Working-age Population

China Working Age Population

Source: CEIC Data, National Bureau of Statistics

NAFTA: Nothing to Negotiate if Leftists Win Mexican Election

Meanwhile it is worth remembering that on June 30 the US, in the form of the White House, is due to announce restrictions on Chinese investments in the US. This is unlikely to improve relations between the US and China, though clearly the devil will be in the details in terms of exactly what is announced.

If leftist Andrés Manuel López Obrador wins the upcoming presidential election in Mexico it increases the chance that Trump will withdraw from NAFTA.

There is also NAFTA to consider. Negotiating a NAFTA deal is likely to become harder after the Mexican presidential election on July 1. The likely winner of the Mexican election is the leftist Andrés Manuel López Obrador (see following chart). That increases the risk that Trump will be tempted to withdraw from NAFTA, which came into force on January 1, 1994, before the November mid-term elections. That would certainly send a signal to his base that he is reversing globalization.

Opinion Poll for the Upcoming Mexican Presidential Election

Opinion poll for the Mexican presidential election on 1 July

Note: Poll conducted on 13-15 June 2018. Source: Arias Consultores

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