When covering a topic like the US-China “trade war,” new developments can occur at any moment, so please bear with us if something significant hits the wires between the publication of this blog post and any breaking news.
At its core, the trade war between the United States and China is represented by a huge (read: "yuuuge") imbalance between what the United States imports from China, and what China imports from the United States. In calendar year 2018, that difference amounted to a trade surplus of roughly $320 billion in favor of the Chinese.
While that's certainly a large number, it takes on new meaning when one considers the trade statistics between China and some of its other larger trading partners. After the United States, the top trading partners with China by country include: Japan, South Korea, Vietnam, Germany, India, the Netherlands, and the United Kingdom.
Of those seven countries, China actually has a trade deficit with three of them (Japan, South Korea, Germany) - which means in those cases China actually imports more in goods from those three countries than they import from China.
Looking at all seven of China’s largest trading partners (not including the US), the net trade imbalance is on average about $34 billion - which means the overall trade imbalance between China and its other largest trading partners is dwarfed by the imbalance with the US ($320 billion).
It would be easy to suggest that this difference was due to the fact that the United States has a much larger population than those other countries, except for the fact that India is included in this list - with a population of over 1.3 billion people. China enjoys a trade surplus of about $50 billion with India, which is far below the $320 billion surplus it enjoys over the US.
Now let's take a brief look at America's trade imbalances with the rest of the world. After China, the next largest trade deficits for the United States are with Mexico ($73 billion), Japan ($72 billion) , Germany ($66 billion), Vietnam ($40 billion), Ireland ($38 billion), and Italy ($32 billion).
On the surface, these numbers appear more palatable than the deficit with China, but one also has to consider that a trend does emerge - the seven other countries with the biggest trade advantage over the US possess much smaller populations (as compared to China). The populations of these countries are: Mexico (130 million), Japan (126 million), Germany (83 million), Vietnam (95 million), Ireland (5 million), and Italy (60 million).
That means the overall trade deficit in per capita terms (calculated as total trade deficit divided by total population) stacks up as follows:
When considering the sheer size of China (population) as compared to other top trading partners of the United States, the trade deficit with China now appears far less egregious. It also makes one wonder if the trade relationship between the United States and Ireland doesn't deserve a little more attention (and investigation).
This short analysis tells us that China isn’t necessarily the worst offender in terms of net trade imbalance over the United States. Sure, the absolute deficit is “yyyuuge,” but in per capita terms, there are six other countries enjoying an even bigger net advantage.
So why has China been singled out? In this case, there are a number of other factors that the Americans feel put them at a disadvantage when “trading” with world’s second-biggest economy, encompassing government subsidies, the protection of intellectual property (IP), and the regulations of foreign enterprises in mainland China, to name a few.
The intellectual property issue was emphasized clearly through the recent arrest of a top Huawei executive in Canada (the US is currently trying to extradite that person to the lower 48). Authorities in the United State claim that Huawei stole intellectual property from a US corporate partner, among other allegations.
The reason this development is so pertinent to the trade war is because one major point of conflict in the conflict is the draconian requirement placed upon foreign entities operating in China, which effectively forces these business to share IP with local partners.
The above example also helps illustrate how the current demands of the United States (and many other Western nations) fall outside the scope of normal “trade,” and capture structural components of Chinese economic policy which is often viewed as anti-competitive (and even illegal based on international trade law). It could be argued that the Chinese should have already instituted many of these changes when they were accepted into the World Trade Organization (WTO) back in 2001.
Looking at this topic from a broader perspective, one can see how the US is using trade (and more specifically tariffs) to try and persuade the Chinese to finally implement policy initiatives which many probably expected would already been in place at this late stage in the game. The big question now is what exactly the United States will accept during the negotiating process (i.e. the concession making process).
Recent reports from the negotiations suggest that the Chinese have offered to increase their purchases of goods from the United States in an effort to help shrink the absolute trade imbalance over the next 5 years. While that’s certainly a positive step, whispers from the meetings also suggest the Chinese have been less open to making structural changes to their economy, especially at gunpoint (i.e. under the threat of escalated tariffs).
While anything could happen before the current negotiating window expires (on March 2nd), there appear to be three likely outcomes that could be announced in the near-to-middle term.
One of the probable outcomes is that the United States decides to accept a deal that is far less comprehensive than their original demands. This type of agreement would probably stipulate that the Chinese increase their purchases of US goods over a set period of time until the trade imbalance is reduced to an acceptable level, or erased altogether. Such an agreement would probably be littered with milestones, monitoring, and various enforcement mechanisms (i.e. the threat of new tariffs).
A second possible outcome is that no agreement is reached by early March, and both sides agree to extend the negotiations for another 30/60/90 days.
The next most likely outcome is that no agreement is reached, President Trump gets frustrated with the process, and slaps all remaining Chinese imports with tariffs (another $200 billion in goods) as he indicated he would do at the outset of the negotiations.
This latter scenario has two parts, because one could see how this could occur with negotiations still proceeding, and one could also see how this path could be taken with a total break-down in talks (i.e. negotiations are suspended).
While It’s hard to assign a probability of likelihood to the above scenarios, it’s even more difficult to accurately predict how international markets would react to any of them. It’s also hard to envision a comprehensive deal being struck (covering every point of contention by the United States), but that eventuality can’t be ruled out completely.
Referring back to the list of countries with the largest trade advantage over the United States in per capita terms, one has to wonder if another country (or countries) on that list may at some point fall into President Trump’s crosshairs (I’m looking at you, Ireland). Whether that happens after a deal is struck with China, or ever, is similarly hard to predict.
Given how active the Trump White House has been on the topic of international trade, one safe bet appears to be the likelihood that another wrinkle (including the ensnarement of another US trading partner) emerges in the not too distant future.
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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