Stocks are to some extent a very good measuring rod for any policy changes. They have been on a roller coaster since Trump takes on changing global trading rules. Investors have perceived the US administration declarations of proposed blanket tariffs on Chinese goods as the beginning of a trade war between the US and China. China retaliated and proposed similar duties on the US goods. However, would these proposals materialised and really evolved into a trade war? What could be the impact on industries, especially steel, and trade?
The recent trade conflict is not the first time…
The current trade frictions have been started by the US President Donald Trump, proposing a further 25% tariffs, the equivalent of $50 billion on the Chinese goods. In response, on April 4, China released a tariff list of 25% on $50 billion’s US imports, including soybeans, automobiles and aeroplanes. On April 6, Trump reiterated that by considering adding a further $100 billion in tariffs on goods imported from China. The retaliation continued, and the Chinese Ministry of Commerce and the Foreign Affairs indicated that they would also adopt new measures. However, on both sides, official statements also showed some degree of restraint and tried to diffuse the situation.
Mr Trump’s experience as a politician is very different from traditional US politicians. It is highly likely that he wants to use the trade friction to negotiate on other deals. The history of the US-China trade relationship shows a clearer picture of the current situation.
In 1989, the US added China to the list of observing countries of “Section 301”. In 1990, the trade volume between China and the US still reached around $11.77 billion. On April 1991, the United States Trade Representative (USTR) announced to have listed China in “Section 301”. The main conflict was the patent protection of chemical products and drugs. In mid-December 1991, the US listed total $1.5 billion punitive taxes on Chinese products. On the same day, China responded with a $1.2 billion list of US goods, which was equivalent to 17% of China’s direct exports to the US in that year. Finally, China and the US achieved an agreement in January 1992 and withdrawn their taxation lists.
In 1994, the US added China as a special investigation country under “section 301” again. USTR started an investigation for six months and gave a 100% punitive tariffs on $2.8 billion’s Chinese goods. It was equivalent to 1/7 of China’s exports to the US in 1994. The Chinese government quickly responded by announcing that it would also issue a list of counter-retaliation. After nine rounds of negotiations, both countries made concessions and signed the second intellectual property agreement in February 1995, which is called the “Sino-US Trade Agreement.”
In 1996, the USTR issued an annual report accusing China of not implementing the 1995 agreement seriously and added China as a “special country” and claimed that if China did not take measures, the US would impose 100% punitive tariffs on Chinese products, worth $3 billion. China also announced a list with 100% special tariffs on US products, suspended the imports of audiovisual works, the administrative protection of US pesticides and pharmaceuticals and the approval of US trade affiliates and representatives in China. After consultations, both China and the US reached an agreement and signed the third “China-US Agreement on Intellectual Property Negotiations”.
The most severe issue developed in 2005. The US Senate passed a proposal requesting that the exchange rate of RMB must rise within six months. The proposal stated that if Beijing did not agree then, the US would impose a punitive tariff of 27.5% on all Chinese exports to the US (which had reached $125 billion in 2004). After three years of negotiation, China launched a managed floating exchange rate system for the RMB.
This brief history shows a strong similarity to the current trade friction. Accordingly, Trump administration wants to use the $50 billion’s tariff for achieving other goals as well. The possible targets will be analysed below, but they are connected to Trump plans: “Bring jobs to America” and “open China’s market further”. These achievements would support Trump’s midterm elections at the end of 2018.
…but this time the negations would be tough
China is much stronger economy than before. For instance, in 1979 when diplomatic relations between China and the US were established, Sino-US trade volume was only $2.5 billion. This compares to $580 billion in 2017, an increase of 232 times. China’s GDP in 1980 was about $306 billion, and the US was $2.8 trillion. However, in 2017, China’s GDP was more than $12 trillion and the US over $19 trillion. China has become a much stronger player now.
Currently, the US domestic condition is at a relatively slow pace. Between 2008 and 2016, the US GDP grew at an annual average of 1.3%, while Chinese GDP experienced a growth of 8.4% per year, during the same period. Similarly, the US government debt burden has become much worse. Since 2011, the US government debt exceeded $14 trillion, and by last year, it surpassed $20 trillion, which is more than its GDP.
Secondly, traditional American industries such as defence and agriculture, are facing serious problems. They cannot compete against the low-cost Chinese products, while its defence industry has limited buyers due to its high price. One of its main agriculture products is genetically modified soybeans for which China is the largest buyer.
This time China has more options than just the physical trade. It can target the US service industry. In extreme cases, which we believe are highly unlikely is to dump the US debt financing or devalue yuan.
Given the above facts and figures, Commodity Inside understands that the US and China are likely to have various rounds of negotiations and both sides will make some compromises. The US administration is likely to achieve four objectives which are: Reduce the Chinese trade surplus by $100 billion this year, improve the protection of the US’ intellectual property rights, further open the Chinese financial and E-Business markets and stop Chinese subsidies for “Made in China 2025” industries.
What measure would China take?
Indeed, China would not accept all of the US demands, though it is likely to make some concessions. The overall US trade deficit reached $566 billion in 2017, of which China accounted for $375 billion, or over half of the US trade deficit. The US wants to slash the China deficit by $100 billion which we do not know how feasible it would be for China. It seems unlikely that China can reduce the trade surplus by $100 billion, but will accept a certain amount of reductions through combinations of various approaches. For example, the Chinese government can agree to increase RMB exchange rate further or buy more US natural gas.
Another critical issue would be the access to Chinese financial and E-business market. Currently, foreign ownership in Chinese bank or insurance company is limited to 25%, so it is possible to increase this limit. However, China is highly unlikely to accept cease subsidies for “Made in China 2025”.
Implications for the Chinese steel industry
Commodity Inside China analyst Yuefeng Wang writes “It is likely that some results of the negotiation can be achieved before the US midterm election by 2018. The final list of tariffs can only be concentrated in 10 industries related to “Made in China 2025”. Although China is the largest iron ore importer and steel producer, its steel industry will not be affected greatly.”
However, Commodity Inside expects that the steel market will continue to witness volatility during the upcoming months of negotiation. During this period, the Chinese government is likely to support domestic demand further and will keep eliminating outdated steel capacity. The Chinese steel exports to the US are a very tiny part of its total global exports. So, we are not anticipating any direct implications of 25% US tariffs on the Chinese steel industry.