Ep. 2 US-China Trade War: Background
In this podcast, Jack discusses the big story in China this year—the country’s trade war with the United States. Jack explains why the world’s two largest economies are now at odds over trade and also makes some predictions as to how the Trade War might turn out.
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Excerpt: “With $500 billion going from China to the United States, and only $130 billion coming the other way, it will be difficult to resolve through tariffs alone.”
***
EPISODE TRANSCRIPT:
Doug: One topic that I am sure is on everyone’s mind these days is the trade war between China and the United States. What are your thoughts?
Jack: This is the big story this year, and it’s one that’s been building for some time. The background is that the United States is the largest market for China’s products, and every year, China exports approximately $500 billion of products to the United States. However, going the other way—from the United States to China— is only $130 billion of products. There are many reasons for the large trade imbalance, such as the lower costs in China, but China is now an important part of the global supply chain, and many of the country’s largest exporters are U.S. companies that ship products back home. The $370 billion annual trade deficit that the United States has with China is the immediate cause for the dispute.
However, there are other contributing factors. For example, cyber theft and coerced technology transfers have created important intellectual property (“IP”) issues that confront all U.S. companies doing business in the country. The U.S. Trade Representative (“USTR”) has estimated that intellectual IP theft by Chinese companies, as well as government actions, policies and practices that coerce American companies into transferring their technology and intellectual property to domestic Chinese enterprises, cost U.S. companies between $225 billion and $600 billion every year.
Exacerbating the IP issues is the government’s “Made In China 2025” initiative, which essentially is China’s plan for surpassing the United States and Europe technologically in key industries within ten years. And finally, the vast overcapacity that China has created in basic industries such as steel, aluminum and cement have depressed prices and caused disruption around the world.
While President Trump has been criticized for starting the Trade War with China, his response is that the United States and China have been in a trade war for the past thirty years, and it’s a war that the United States has been losing. Through the threat and imposition of tariffs, Trump wants to reduce the trade deficit, as well as force Beijing to address IP issues.
On March 22, President Trump announced that the United States would take steps to reduce the trade deficit and protect American technology and IP by imposing tariffs on approximately $50 billion worth of Chinese imports. Tariffs on $34 billion worth of products went into effect on July 6, and tariffs on $16 billion went into effect on August 23. China responded to each step by imposing tariffs on an equal amount of imports from the United States. Where we sit today is that each country has tariffs on $50 billion of goods imported from the other country.
Doug: What’s your analysis of the impact of the Trade War so far?
Jack: Given the fact that China exports so much more to the United States than the United States ships to China, it seems to me that this is a big challenge for China—the numbers are simply not in its favor. While China has responded in tit-for-tat fashion to the tariffs that have been imposed so far, it will eventually run out of room. With tariffs on $50 billion of goods from the United States, China only has an additional $80 billion of imports on which it can impose tariffs. Meanwhile, Trump has said that he is prepared to put tariffs on all $500 billion of goods from China and has a lot more room. It’s also in China’s interest to end the dispute as soon as possible. The longer it goes on, the more companies will re-think their global supply chain.
As measured by the stock market and the currency, the dispute has had a disproportionately detrimental impact on China. Since March 22 when Trump made his announcement, stocks on the Shanghai Stock Exchange have declined by 18 percent, and the renminbi, China’s currency, has depreciated by 8 percent against the dollar. Meanwhile, stocks in the United States have increased by 7 percent, and the dollar has appreciated by eight percent over the same period.
Doug: What do you see as the outcome? If this is difficult for China, what can the country do to resolve the dispute?
Jack: With $500 billion going from China to the United States, and only $130 billion coming the other way, it will be difficult to resolve through tariffs alone. China does have other ways to respond, but none come without cost to the country.
For example, some have suggested that China could devalue the renminbi to at least partially offset the tariffs. However, causing, or allowing, the yuan to depreciate further will exacerbate inflation pressures in the country. In 2017, China imported $1.8 trillion of goods and is a large importer of energy, agricultural products, raw materials and the basic commodities that find their way into all areas of the economy.
Others have suggested that China can put pressure on the U.S. financial system by selling some of the one trillion dollars of U.S. Treasuries that it holds. If selling U.S. Treasuries has its intended effect, though, interest rates in the United States will go up, and with the United States considered to be a safe haven, even more capital will flow into the U.S. capital markets, most likely to the detriment of China and its currency and stock market.
Finally, some have said that China could make life more difficult for American companies doing business in the country. Again, there is a cost to China of doing so. At the end of last year, China had $1.5 trillion of accumulated Foreign Direct Investment (“FDI”) in the country, and Hong Kong had an additional $1.9 trillion. By comparison, the United States had $4.1 trillion as of that date. China is one of the largest recipients of FDI in the world, which brings management and technology along with capital into the country. Actions against U.S. companies would also give pause to companies from other countries looking to expand in China.
At the same time, there are a number of measures that China can take to resolve the dispute. A few well timed grain or energy purchases would help reduce the deficit and would be well received. Likewise, a program to curb hacking by state run organizations, and a continued relaxation of foreign ownership restrictions as a way to ease complaints about coerced technology transfer, would also be positive steps.
Doug: Talk about forced technology transfer. You dealt with this issue in auto components, didn’t you? How did that play out?
Jack: It’s quite simple. When a foreign company does a joint venture (“JV”) in China with a Chinese enterprise, the JV is registered in China and is a Chinese company. Under the rules, the local company has to own the technology, so when a foreign company transfers technology into a China JV, the technology is then owned by a Chinese entity. That’s what is meant by forced or coerced technology transfer.
Obviously, if the foreign company can set up a wholly owned company in China, and is not required to do a JV, this issue goes away because the foreign company is then transferring technology to an entity which it owns in its entirety. China has already been taking steps in this direction. On July 28, China reduced its “Negative List” of industries where foreign ownership is prohibited or restricted from 63 to 48. Under the latest changes, restrictions in the finance, transportation, professional services, auto, ship and aircraft manufacturing industries will end. For example, there has been a rule in China that has required the international car companies to do a JV in China, and that has prohibited them from owning more than 50 percent of an auto manufacturing facility in China. That regulation is now going away.
Doug: When you started in the auto business in China, auto components was the only industry where foreigners could have 100 percent ownership, now it’s down to just 49 industries that are off limits. China needs to chip away at this. Is that what you are saying?
Jack: One correction. When I started in China, auto components was the only industry where foreigners could have majority ownership. Wholly owned companies were not allowed at that point. It wasn’t until the late 1990s that foreigners could set up wholly owned enterprises in China. I believe that Motorola was the first foreign company to set up a wholly owned company.
Until wholly owned industries were permitted, foreigners were relegated to minority interest in most industries. In some industries, like insurance, foreign investment was limited to 25 percent ownership.
Doug: What do you see coming out of this—large purchases of food and energy by China; more industries taken off the Negative List; tariff reductions? Do you see anything else as far as demonstrable steps?
Jack: Yes, I believe that a portfolio of measures will ultimately be part of a compromise. Because a Trade War with the United States is a tough one for China to win, there is some hope that the dispute will end quickly. Andy Rothman, who is the China strategist for Matthews Asia and who lived in Shanghai for many years, has speculated that China may reach out to the United States at the meeting of the United Nations General Assembly in New York in September. I have known Andy for many years; have learned to trust his judgement; and tend to agree with his analysis.
Doug: Knowing how important saving face is in China, I wouldn’t be surprised if this isn’t portrayed as a more general overhaul, portrayed as a more general development of the economy.
Jack: You are correct. That is the way it will be pitched, and to be fair, that is the way China has been heading. Once this dispute is resolved, look for China’s stock market to take off.
In this podcast, Jack discusses the big story in China this year—the country’s trade war with the United States. Jack explains why the world’s two largest economies are now at odds over trade and also makes some predictions as to how the Trade War might turn out.
***
Excerpt: “With $500 billion going from China to the United States, and only $130 billion coming the other way, it will be difficult to resolve through tariffs alone.”
***
EPISODE TRANSCRIPT:
Doug: One topic that I am sure is on everyone’s mind these days is the trade war between China and the United States. What are your thoughts?
Jack: This is the big story this year, and it’s one that’s been building for some time. The background is that the United States is the largest market for China’s products, and every year, China exports approximately $500 billion of products to the United States. However, going the other way—from the United States to China— is only $130 billion of products. There are many reasons for the large trade imbalance, such as the lower costs in China, but China is now an important part of the global supply chain, and many of the country’s largest exporters are U.S. companies that ship products back home. The $370 billion annual trade deficit that the United States has with China is the immediate cause for the dispute.
However, there are other contributing factors. For example, cyber theft and coerced technology transfers have created important intellectual property (“IP”) issues that confront all U.S. companies doing business in the country. The U.S. Trade Representative (“USTR”) has estimated that intellectual IP theft by Chinese companies, as well as government actions, policies and practices that coerce American companies into transferring their technology and intellectual property to domestic Chinese enterprises, cost U.S. companies between $225 billion and $600 billion every year.
Exacerbating the IP issues is the government’s “Made In China 2025” initiative, which essentially is China’s plan for surpassing the United States and Europe technologically in key industries within ten years. And finally, the vast overcapacity that China has created in basic industries such as steel, aluminum and cement have depressed prices and caused disruption around the world.
While President Trump has been criticized for starting the Trade War with China, his response is that the United States and China have been in a trade war for the past thirty years, and it’s a war that the United States has been losing. Through the threat and imposition of tariffs, Trump wants to reduce the trade deficit, as well as force Beijing to address IP issues.
On March 22, President Trump announced that the United States would take steps to reduce the trade deficit and protect American technology and IP by imposing tariffs on approximately $50 billion worth of Chinese imports. Tariffs on $34 billion worth of products went into effect on July 6, and tariffs on $16 billion went into effect on August 23. China responded to each step by imposing tariffs on an equal amount of imports from the United States. Where we sit today is that each country has tariffs on $50 billion of goods imported from the other country.
Doug: What’s your analysis of the impact of the Trade War so far?
Jack: Given the fact that China exports so much more to the United States than the United States ships to China, it seems to me that this is a big challenge for China—the numbers are simply not in its favor. While China has responded in tit-for-tat fashion to the tariffs that have been imposed so far, it will eventually run out of room. With tariffs on $50 billion of goods from the United States, China only has an additional $80 billion of imports on which it can impose tariffs. Meanwhile, Trump has said that he is prepared to put tariffs on all $500 billion of goods from China and has a lot more room. It’s also in China’s interest to end the dispute as soon as possible. The longer it goes on, the more companies will re-think their global supply chain.
As measured by the stock market and the currency, the dispute has had a disproportionately detrimental impact on China. Since March 22 when Trump made his announcement, stocks on the Shanghai Stock Exchange have declined by 18 percent, and the renminbi, China’s currency, has depreciated by 8 percent against the dollar. Meanwhile, stocks in the United States have increased by 7 percent, and the dollar has appreciated by eight percent over the same period.
Doug: What do you see as the outcome? If this is difficult for China, what can the country do to resolve the dispute?
Jack: With $500 billion going from China to the United States, and only $130 billion coming the other way, it will be difficult to resolve through tariffs alone. China does have other ways to respond, but none come without cost to the country.
For example, some have suggested that China could devalue the renminbi to at least partially offset the tariffs. However, causing, or allowing, the yuan to depreciate further will exacerbate inflation pressures in the country. In 2017, China imported $1.8 trillion of goods and is a large importer of energy, agricultural products, raw materials and the basic commodities that find their way into all areas of the economy.
Others have suggested that China can put pressure on the U.S. financial system by selling some of the one trillion dollars of U.S. Treasuries that it holds. If selling U.S. Treasuries has its intended effect, though, interest rates in the United States will go up, and with the United States considered to be a safe haven, even more capital will flow into the U.S. capital markets, most likely to the detriment of China and its currency and stock market.
Finally, some have said that China could make life more difficult for American companies doing business in the country. Again, there is a cost to China of doing so. At the end of last year, China had $1.5 trillion of accumulated Foreign Direct Investment (“FDI”) in the country, and Hong Kong had an additional $1.9 trillion. By comparison, the United States had $4.1 trillion as of that date. China is one of the largest recipients of FDI in the world, which brings management and technology along with capital into the country. Actions against U.S. companies would also give pause to companies from other countries looking to expand in China.
At the same time, there are a number of measures that China can take to resolve the dispute. A few well timed grain or energy purchases would help reduce the deficit and would be well received. Likewise, a program to curb hacking by state run organizations, and a continued relaxation of foreign ownership restrictions as a way to ease complaints about coerced technology transfer, would also be positive steps.
Doug: Talk about forced technology transfer. You dealt with this issue in auto components, didn’t you? How did that play out?
Jack: It’s quite simple. When a foreign company does a joint venture (“JV”) in China with a Chinese enterprise, the JV is registered in China and is a Chinese company. Under the rules, the local company has to own the technology, so when a foreign company transfers technology into a China JV, the technology is then owned by a Chinese entity. That’s what is meant by forced or coerced technology transfer.
Obviously, if the foreign company can set up a wholly owned company in China, and is not required to do a JV, this issue goes away because the foreign company is then transferring technology to an entity which it owns in its entirety. China has already been taking steps in this direction. On July 28, China reduced its “Negative List” of industries where foreign ownership is prohibited or restricted from 63 to 48. Under the latest changes, restrictions in the finance, transportation, professional services, auto, ship and aircraft manufacturing industries will end. For example, there has been a rule in China that has required the international car companies to do a JV in China, and that has prohibited them from owning more than 50 percent of an auto manufacturing facility in China. That regulation is now going away.
Doug: When you started in the auto business in China, auto components was the only industry where foreigners could have 100 percent ownership, now it’s down to just 49 industries that are off limits. China needs to chip away at this. Is that what you are saying?
Jack: One correction. When I started in China, auto components was the only industry where foreigners could have majority ownership. Wholly owned companies were not allowed at that point. It wasn’t until the late 1990s that foreigners could set up wholly owned enterprises in China. I believe that Motorola was the first foreign company to set up a wholly owned company.
Until wholly owned industries were permitted, foreigners were relegated to minority interest in most industries. In some industries, like insurance, foreign investment was limited to 25 percent ownership.
Doug: What do you see coming out of this—large purchases of food and energy by China; more industries taken off the Negative List; tariff reductions? Do you see anything else as far as demonstrable steps?
Jack: Yes, I believe that a portfolio of measures will ultimately be part of a compromise. Because a Trade War with the United States is a tough one for China to win, there is some hope that the dispute will end quickly. Andy Rothman, who is the China strategist for Matthews Asia and who lived in Shanghai for many years, has speculated that China may reach out to the United States at the meeting of the United Nations General Assembly in New York in September. I have known Andy for many years; have learned to trust his judgement; and tend to agree with his analysis.
Doug: Knowing how important saving face is in China, I wouldn’t be surprised if this isn’t portrayed as a more general overhaul, portrayed as a more general development of the economy.
Jack: You are correct. That is the way it will be pitched, and to be fair, that is the way China has been heading. Once this dispute is resolved, look for China’s stock market to take off.
