Dear China, Get Ready For 25pct Tariffs

19-Feb-2019 Intellasia | Forbes | 6:00 AM Print This Post

In two weeks, China will probably be hit with 25 percent tariffs on $200 billion worth of goods. If not by March 1, then after any trade truce endssupposedly 60 days later assuming an extension is still on the table.

The market is way too long on the China truce trade. The Dow jumped over 400 points to settle higher for the eighth straight week on Friday. President Trump may see the gains as a sign that any pause in tariffs is welcomed on Wall Street and, in theory, cast aside the China hawks in his cabinet led by his Trade Representative Robert Lighthiser.

But consider this: On Friday, Trump spoke about the possibility of a trade deal with China during a Rose Garden press conference. The main point of that presser was to talk about his decision to declare a national emergency at the border and fund his border wall without a congressional vote. What was more interesting to the market was Trump’s trade war talk and saying he wants to include House Speaker Nancy Pelosi and Senate Minority Leader Chuck Schumer in on a China trade deal.

“Any deal I make with China, Schumer’s going to stand up and say, ‘Oh, it should have been better.’ That’s not acceptable to me,” Trump said during the press conference. “So I’m thinking about doing something very different…. I’m going to bring Schumer, or at least offer Schumer and Pelosi to come with me, and I’m going to say, ‘Join me on the deal,’” he said.

Schumer and Pelosi are Democratic Party hawks on China. Pelosi was critical of China joining the World Trade Organisation in the late 1990s. China finally joined in 2001. The only thing Schumer and Trump see eye to eye on is China tariffs.

So either this is going to be a lousy deal and Trump is going to tell the market, look it’s not just me it’s all of us. Or this is going to create the bipartisan support needed to keep tariffs locked in on China long after Trump is gone. This seems to be Lighthiser’s thinking.

Trump once again praised tariffs on Friday. He said the government was raking in billions of dollars from Chinese tariffs. Imagine doubling those tariffs from the current level of 10 percent to 25 percent? Once the government gets addicted to that revenue, what is going to stop them from removing it? Big business? No. They have petitioned the government for weeks now for exemptions, to no avail.

Wall Street? No. Wall Street will get used to it after they pick the winners and losers an in the stock market and learn where the companies hardest hit are going to get product instead of China. There will be some serious revaluation going on.

Worth noting for China investors, higher tariffs do not mean that China necessarily suffers great losses. It can allow the market to lower the value of the yuan to make up for that cost. And Chinese manufacturers, having grown exponentially over the last 20 years, can relocate some of their product lines to other Asian countries. This shift has been taking place even before the first shots in the trade war were fired. Chinese manufacturers have been moving apparel shops to Vietnam and Bangladesh, for instance. Some stitch-and-sew work is being moved into India.

“If you get 25 percent tariffs, the Chinese economy will be under more pressure, but that’s a given,” says Jin Zhang, a portfolio manager at Vontobel Asset Management. “Here in the US, companies like GM that have big businesses in China might be in a difficult situation and get beat up by the market. You have to know what you own and try not to own companies that are in the crossfire,” he says. “We are underweight China.”

What else can China do that is of interest to the US while honestly protecting their Made in China 2025 growth strategy and keeping their core economic policies in place?

There is no great deal in the works, as Trump continually hints is in the bag. If there was great deal, he would not want to share that success with Pelosi and Schumer. Meanwhile, the market is continually told by people close to Trump, including Larry Kudlow, that the gap between both sides remains a big one. How is that closing anytime soon?

China’s offer to host Trump in Hainan, a tropical island in south China, was rejected by the White House in favour of a meeting with President Xi Jinping at Mar-a-Lago in Florida. As one investor told me in a casual conversation on Friday: Why go to Hainan only to reject China’s offer? It’s better to bring Xi to the US and say, look, this is what we are going to do.

China may actually be fine with tariffs.

Here’s why.

Assuming sizable distance on key items up for debate, namely subsidies by state-owned enterprises to favourite enterprises, especially in the advanced technology space, if China wants to keep those in place they can. In exchange for keeping that status quo, China gets 25 percent duties.

China has already opened its market to items on Washington’s wish list, namely financial services. This will probably be expanded over time to payment service firms like Visa and Mastercard, another positive for the American services trade with China.

American financial institutions are currently racing to set up shop in mainland China to tap the investor class there and help professionalise the mainland stock market.

As the MSCI Index continues to increase the weighting of Shanghai- and Shenzhen-listed stocks in the massive MSCI Emerging Markets benchmark index, US firms will need equity analysts and other fundamental research on the ground to provide market insights to both Chinese and global clients. This is a very important market for American investment firms. Getting this market to open faster than originally planned, without having to partner with a local firm, can be chalked up as a positive for Trump, even though this move was in the works prior to the trade war.

China has also changed its intellectual property laws, allowing US firms to sue. While they may not get a friendly court judge to rule in their favour, the odds of Washington being happy with that given all theft of IP in the recent past are pretty slim. Companies will have to live with Xi’s pledge to toughen IP legal protections for all firms operating in China, and that’s that. They will probably be fine with that too, seeing how it is something they never had before. It’s a move in the right direction.

We can assume that Xi is not going to make IP laws retroactive, potentially opening the floodgates to American lawsuits against the country’s best domestic companies for wrong doings prior to new laws still in the works.

Seeing how China is unlikely to change the way its state-owned firms operate to appease the US and assuming they have gone as far as they will on intellectual property, the only thing the US can do is keep tariffs as they are, or tell the Chinese, Look, we don’t like the role your state firms play in the market and we are not happy with your IP laws, so we are going to punish you with a 25 percent duty. And we might even put tariffs on more products as we see fit. The end.

China doesn’t have to do anything other than continue talks with the US about market access, in hopes to alleviate the burden of some tariffs on some sectors. But in the meantime, the Communist Party doesn’t have a deadline to make Trump happy. For that, the price is 25 percent. Take it or leave it.

Either the tariffs stay as they are, or they go up. It doesn’t take a Harvard M.B.A. and 10 years at Goldman Sachs to figure that out. But tariffs won’t come down, especially broadly. Over time, sectors or product lines might get a reprieve as trade talks work themselves out.

“The return of ‘tariff man’ and the bizarre invitation to Schumer and Pelosi to share responsibility for the outcome of a Xi summit are suggestive of a president leaning towards 25 percent tariffs on March 1,” says Bryan McCarthy, chief strategist for Macrolens, a boutique investment research firm focusing on China.

The market will sell off the second investors reach the tipping point on this and see more tariffs as the likely outcome.


Category: China

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