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Trade War: After the Kabuki Dance Comes Real Deal Making

Summary: Fears of a global trade war have roiled the markets, as major economies and trade partners have announced their own counter-tariffs against the United States. As dramatic as it all sounds, the reality is that nobody on any side of the multilateral bargaining table wants tariffs, not even the U.S. administration which sees tariffs as a bargaining tool. Recent moves suggest the real deal-making is about to start.

The Trump administration’s recent push for tariffs on everything from technology to commodities is revving up global discussions of a trade war. However, what is less clear is how much bargaining power the US holds, as well as who will feel the tight squeeze of protectionism.

China

Following President Trump’s threat in April to slap 25% tariffs on $50 billion worth of Chinese imports to the United States, negotiations have begun in an effort to dissuade protectionist trade policies from either side. In the meantime, China has threatened reflexive retaliation against $50 billion of American exports to the country if the US imposes any duties.

However, things seem to have taken a turn for the better as China has offered to purchase nearly $70 billion worth of U.S. farm, manufacturing and energy products if America abandons the threatened tariffs. While this is still well below the $200 billion reduction in the US trade deficit with China that Trump is aiming for, it could be a huge first step. Such a deal would be contingent on the cancellation of any planned tariffs on Chinese goods, slated to begin shortly after June 15th.

China’s offer would primarily benefit Farm Belt states by guaranteeing larger purchases of American soybeans, corn and other agricultural products. To do this, China would ease certain regulations to boost its imports of those goods. China could potentially increase annual U.S. soy imports to more than 40 to 50 million metric tons. The Chinese team also promised to get state-owned companies to buy more U.S. natural gas and coal. The offer underscores how commodities have shifted from being seen as a potential casualty of the trade conflict to a possible beneficiary of Beijing’s pledge to import more American goods.

A significant complication in trade talks for the two nations, however, has been Chinese telecom company ZTE Corp. Originally, The US Commerce department banned American companies from selling products to ZTE due to a 2017 finding that it had violated US sanctions by illegally shipping US goods and tech to Iran. The company was so dependent on America, importing 25% to 30% of all its equipment from the US, that the ban caused a temporary shutdown of the smartphone giant. Trump now seems open to lifting the ban on the condition that ZTE pays $1.4 billion in fines. The ZTE situation is significant because it could serve as a barometer to measure how the Trump administration is feeling about the broader trade negotiations.

Given these recent diplomatic moves by each sides, it seems hostility may be ebbing and real deal making could be on the way.

Europe

The Trump administration has already chosen to go forward with steel and aluminum duties against producers in the European Union. The US hit EU exports with a 25% tariff on steel and a 10% tariff on aluminum in a bid to assist the US steel industry.

The EU is already striking back, however, planning to target €2.8 billion ($3.4 billion) of annual US imports with punitive tariffs, beginning in July. The list of US products to be targeted covers everything from peanut butter, to pleasure boats and motorbikes. Brussels officials have said the duties have been calibrated to inflict equivalent economic damage on the US that the EU will suffer because of the Trump administration’s steel and aluminum restrictions.

This stalemate, however, may be offset by the EU’s request for exemptions from U.S. sanctions on Iran. While the US removed itself from the Joint Comprehensive Plan of Action (colloquially the Iran Nuclear Deal) last month, the EU has pledged to defend the agreement, protect European companies negatively impacted by the U.S. decision, and offer alternate financing for Iranian investments. If the US denies an exemption, the EU will attempt to skirt the sanctions by activating its blocking statute, a never-before used measure that would order EU firms not to comply with U.S. sanctions. However, the bloc’s own lending arm, the European Investment Bank has replied that it could not ignore U.S. sanctions on Iran.

The EU is in the process of bringing this case to the World Trade Organization, but as in China, it seems the US will continue to hold greater leverage in negotiations going forward.

North America

Finally, looming trade tensions are beginning to press America’s neighbors as the same tariffs on steel and aluminum applied to the EU are also hitting Canada and Mexico. Both nations are already knee deep in NAFTA renegotiations with the US and each other that have been stalled for months.

Canada retaliated similarly to Europe, imposing their own levies on as much as C$16.6 billion ($12.8 billion) worth of U.S. imports. Canada’s own tariffs of 25% on steel and 10% on aluminum will aim to match U.S. penalties on a dollar-for-dollar basis, based on export values. Canada has filed a challenge to US tariffs with the WTO, alongside the EU.

Mexico, following Canada’s lead, stuck tariffs of 25% on certain cheese products, steel and Tennessee whiskey while imposing taxes of 20% on pork, apples and potatoes. The country also said it will complain to the WTO.

Once again, though, the US may hold an advantage with NAFTA being their “ace in the hole”. Following White House National Economic Council Director Larry Kudlow’s statement that President Trump is “seriously considering” splitting North American Free Trade Agreement talks into separate processes for Mexico and Canada, Mexico’s Peso slid as much as 1.4%, trading at a 15-month low. The Canadian dollar did not fall as far, but it has shown similar weakness in the face of a NAFTA dissolution.

As dramatic as all of the trade war rhetoric seems to be, it may not actually hurt global growth all that much. The World Bank estimates the global economy will retain synchronization, growing 3.1% this year. This is unchanged from its forecast in January and matches the pace of growth seen in 2017, the strongest year since 2011. If nothing else, this could strengthen the US’s case even further to push its protectionism for the time being.

What investors should take away from all of this is that the administration sees tariffs as a bargaining tool. Nobody on any side of this multilateral bargaining table wants tariffs, not even the US. Trump’s real goal is American job creation via a reduction of the US’ trade deficit, which has just hit a seven month low, and proliferation of American exports. The President has routinely touted a desire for GDP numbers in excess of 3% and even 4%, but long-term tariffs would inevitably hamper this. The administration wants to put the ball in its court, and it is willing to trade off some short-term hits for long-term gains.

It will take some time for the real effects of tariffs to materialize, but investors seeking exposure to companies that are insulated from the trade war can invest in the iShares Russell 1000 Pure US Revenue ETF (AMCA), which focuses on companies that derive most of their revenue from the U.S.

We’ve also summarized the following articles related to this topic…

 

Trade War: Mexico Strikes Back, Levying Tariffs on U.S. Pork, Steel, Whiskey

The country will slap tariffs of 25 percent on certain cheese products, steel and Tennessee whiskey while imposing taxes of 20 percent on pork, apples and potatoes, according to a resolution published in the Official Gazette early Tuesday. While other World Trade Organization members are also considering retaliating by targeting iconic American products — such as bourbon whiskey and Harley-Davidson motorcycles — the escalating tensions between Mexico and the U.S. may further complicate the renegotiation of the Nafta trade accord.

The peso sank to its weakest in more than a year earlier today on concern the U.S. may leave the North America Free Trade Agreement and try to negotiate two separate free trade deals with Mexico and Canada. The Mexican currency slid for a fourth day on Tuesday, dropping 1.4 percent to 20.3488 in morning trading in New York, the sharpest retreat among major currencies. The nation’s peso-denominated bonds due in June 2027 fell for a seventh day, driving yields three basis points higher to 7.89 percent.

Mexico is set to elect its next president on July 1 and Andres Manuel Lopez Obrador, a leftist firebrand who has argued for more reliance on domestic production, is firmly in the lead with a margin of as much as 20 percentage points. B

 

Trade War: ZTE to reopen after $1 billion fine, new leadership

ZTE has signed a preliminary deal that could allow the company to resume operations. The deal includes a $1 billion fine against ZTE, plus $400 million in escrow to cover any future violations. ZTE promised to replace its board and executive team in 30 days. It would also allow unfettered site visits to verify that US components are being used as claimed by the company.

ZTE’s dispute with the US government stems from allegations that the Chinese company sold technology to North Korea and Iran in defiance of US sanctions. Last year, ZTE settled the case with the US government, promising to pay $890 million in fines and punish dozens of ZTE executives who orchestrated the illicit technology sales. But according to Trump administration officials, ZTE gave many of the wayward executives their full 2016 bonuses and then lied about it to the US government.

So the US went nuclear on ZTE, imposing a seven-year ban on US companies selling technology to the Chinese firm. The company is heavily dependent on US components for its smartphone business. ZTE phones include chips from Qualcomm and the Android software stack from Google. So for the last month, ZTE has been desperately looking for a way to get back into business. It has enjoyed the backing of Chinese President Xi Jinping, who has been negotiating with Trump over a broader trade agreement. ARSTech

 

Trade War: China Offers to Buy Nearly $70 Billion of U.S. Products to Fend Off Trade Tariffs

China offered to purchase nearly $70 billion of U.S. farm, manufacturing and energy products if the Trump administration abandons threatened tariffs. In weekend talks in Beijing, Chinese negotiators led by Liu He, President Xi Jinping’s economic envoy, presented a U.S. team headed by Commerce Secretary Wilbur Ross a package that includes Chinese companies buying more U.S. soybeans, corn, natural gas, crude oil, coal and manufactured goods.

President Donald Trump has pressed China to commit to reduce the $375 billion U.S. merchandise trade deficit with China by $200 billion. Chinese officials are arguing this could go a long way toward meeting that target. Throughout the negotiations, Mr. Liu made clear to Mr. Ross that the offer would be void if Washington proceeds with its plan to impose tariffs on $50 billion of China-made products.

China’s offer would benefit the Farm Belt states that helped Mr. Trump win the election in 2016. By promising to buy more American soybeans, corn and other agricultural products, China pledged to ease certain regulations to boost its imports of those goods.

The Chinese team also promised to get state-owned companies to buy more U.S. natural gas, though it could take some time for American firms to ramp up production. By potentially boosting Chinese imports of U.S. coal, Beijing is targeting states like Pennsylvania and West Virginia that are key to the U.S. midterm elections. WSJ

 

Trade War: Looking Past Worries on Emerging Markets and Trade, World Bank Sees Synchronized Growth Intact

The World Bank estimates the global economy will grow 3.1% this year, unchanged from its forecast in January and matching the pace of growth seen in 2017, itself the strongest year since 2011. Some analysts had begun to wonder whether an era of synchronized growth, in which all major economies were simultaneously growing since last year, is already at an end. While the World Bank sees a number of economies slowing—and projects global growth will slow slightly in 2019 to 3% and 2020 to 2.9%—it forecasts the synchronization will stay largely intact.

A special chapter on corporate debt shows businesses in emerging economies have boosted their borrowing to the same level as companies in advanced economies, with both borrowing about 90% of GDP. That is largely driven by China, but not entirely. Even for emerging markets excluding China, corporate debt to GDP has risen by 15 percentage points since 2006. The borrowing has been heavily in dollars. The primary risk, the World Bank argues, is companies with high debts invest far less in their future than those with low debts. The same applies for countries overall. Burgeoning debts around the world, and tightening monetary policy, mean risks of financial crisis cannot be dismissed. WSJ

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