After negotiating in "good faith" for roughly five months, the United States and China broke their so called "trade truce" and raised tariffs against each other in early May.
The United States moved first when President Donald Trump announced via Twitter that the planned increase in tariffs against the Chinese (which had been delayed for months) would become effective on May 10th - purportedly because trade negotiations had been moving too slowly (among other complaints).
Days later, China followed suit by raising tariffs on more products imported from the United States.
The awakening of the trade war beast shook international equity markets, with indices from across the globe nosediving on news that tensions between the US and China were once again rising. One reason investors were shunning risk is because an escalation in the trade war is viewed as an impediment to global growth.
The degree to which the trade war will actually impact the world economy is much debated, and rightfully so.
President Trump himself weighed in with his own opinion on the trade war, suggesting only days after he raised tariffs against the Chinese that it was a "little squabble." This wasn't long after the President suggested that the United States government was profiting greatly from the tariffs because the Chinese were paying so much money into the country's coffers.
Hopefully, the latter assertion by the President was a slip of the tongue, because it's US companies (and arguably consumers) that pay any and all incoming tariffs. That's what a tariff is - a tax paid by an importer of the good (i.e. an American company).
The pain for the exporter of the good (i.e. the Chinese company) comes from the fact that their products are now relatively more expensive, making them theoretically less attractive. Tariffs can catalyze switching - so instead of buying from the Chinese, an American business might instead buy the same product from a domestic supplier (boosting the US economy), or from a foreign company exporting duty-free (i.e. tariff free) to the United States.
Given that the trade war has now escalated another notch, it certainly makes one wonder about the relative severity of the conflict, and where it might be ultimately headed.
The problem is that perceptions of the trade war vary greatly, because the wide range of actors in this particular drama view it through a myriad of different lenses. There's also a vast gulf between the winners and losers.
Given that the US economy is still expanding, the average American (if there is such a thing) probably hasn’t been impacted severely at this point in the conflict. It could be argued that Americans are paying a bigger price due to the American boycott of Iranian oil, which has added significantly to prices at the pump (due to tightened supply).
Looking at an example from the trade war "winners circle," American manufacturers of steel have been mostly pleased with the increased tariffs on Chinese steel. These same companies support an extension of the tariffs, at least until the best possible deal is negotiated with China.
Since the start of the trade war, tariffs added to the cost of imported Chinese steel have arguably done their job - making American steel relatively more competitive (i.e. attractive) in the domestic supply chain. The dumping of cheap Chinese steel on the US market had been pressuring American manufacturers for a long time, and the relief has been palpable.
However, for every winner in a trade war such as this one, there's usually a loser, too. Case in point, one of the biggest losers from the current trade war with China has been the American farmer.
The thing is, when China went to the drawing board to identify possible responses to President Trump’s aggressive tariff initiative, they clearly incorporated a political element into their brainstorming. It's well known (even in China, apparently) that President Trump received a lot of votes from rural America in the 2016 Presidential election. Exhibit A is the fact that Trump won the electoral vote, but lost the popular vote.
The Chinese clearly believed they could put additional pressure on the American President by boycotting purchases of agricultural products from the United States. Aside from impairing the incomes of American farmers, the action could potentially create a rift between the President and his primary base of voters. Ultimately, that friction could force the President to abandon the trade war, or at least conclude it with a less-than-optimal agreement.
Some data related to the trade war may help drive this point home.
First, soybean purchases by the Chinese from American farmers dropped from 36 million metric tons in 2016 all the way to 8.3 million metric tons in 2018, according to Bloomberg. That's pre-trade war versus post-trade war, for those keeping score at home.
Second, it was widely reported last year that farm bankruptcies were at (or near) 10-year highs in the United States. This statistic takes on even more gravity when one considers that the increase in farm bankruptcies occurred during an expansion of the US economy.
Imagine where the farmers would be if another recession materialized?
Third, the front-month futures price for a bushel of soybeans dropped to $8.03 on May 13th of this year - a 10-year low. To put that in context, it's estimated that the average cost to produce a bushel of soybeans in America is around $8.50. That type of economic equation simply isn’t sustainable, and helps explain the rise in bankruptcies.
Because farmers have been singled out by the Chinese, and are taking on a disproportionate amount of pain, the Trump administration organized a bailout for farmers last year, and is considering expanding it in 2019.
However, this aid may be too little, and too late.
In a recent article from the Journal Sentinel in Wisconsin, journalist Rick Barrett highlighted estimates by the Wisconsin Farmers Union that provide further insight into how the aid offered to farmers last year would be akin to trying to put out a forest fire with a thimble of water.
In that example, Barrett indicates that a 55-cow dairy farm in Wisconsin might have received a total of $725 in aid, against estimated farm losses of between $36,000 and $48,000.
Make that far too little, and far too late.
Another interesting pattern to keep an eye on is the exchange rate between the US Dollar and the Chinese Yuan. Over the past several years, this exchange rate has oscillated between roughly 6 and 7 Yuan per US Dollar. Since the start of the trade war, the Yuan has tended to depreciate quickly against the Dollar whenever news breaks that negotiations are going poorly.
Whether it’s a coincidence, or some other mechanism at work, that conveniently makes Chinese products relatively less expensive. It also theoretically makes the pain of the tariffs slightly less burdensome.
No matter your ultimate opinion on the trade war, the one thing that nobody can deny is that a breakdown in negotiations (such as the one observed in May) have often catalyzed movement in the financial markets. Movement which most traders likely view as an opportunity.
If you share that perspective, then you may be interested in a recent episode of Closing the Gap: Futures Edition which focuses specifically on agricultural futures. After all, with soybeans trading recently at 10-year lows, there may be a compelling case to trade them.
As outlined on the show, soybeans can also be paired with corn, to reduce naked exposure. And we hope you’ll take the time to review the complete episode covering this topic when your schedule allows.
We look forward to hearing from you!
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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