Until recently the “trade war of words” seemed a lot like the wolf in “Little Red Riding Hood.” There was a great deal of huffing and puffing. Market pundits assumed all would end well with no real damage to either side.
Negotiations appeared to be working well as of early June 2018 with China offering to buy more US goods. American and Chinese officials were making progress to avert a trade war. China pledged to increase its purchase of American goods, to lift existing barriers making it easier for United States firms to sell and operate in China, according to a senior Trump administration official.
By mid-June, the atmosphere changed with a new intensity in the negotiations as China’s position became less amiable. The potential tariffs on Chinese goods sold in America could be as large as all Chinese goods sold here last year!
Ignore rhetoric to the contrary. Trade wars will affect US corporations, particularly those who export to China and those who rely upon low-cost imports from China.
This will increase the inflation rate which happens to support the Federal Reserve’s objective for raising interest rates. If you exclude crude oil and housing, inflation has been rising at a slow pace this year. Oil and housing exclusions are good for academic modelling, but we live with their costs. Oil products affect costs from farm production, manufacturing and transportation of goods to the gas pump. Higher housing costs make current homeowners happy while frustrating first time buyers. Whether caused by the Fed or a trade war, ramping up inflation will impact all of us.
Many professionals are hoping for a last-minute gentlemanly resolution. This seems increasingly unlikely. In corporate America, we hammer out negotiations to make a deal. Once done, we go on with the business as it is restructured. However, China’s culture has a major problem with “saving face.” This is especially so when it is happening in front of the entire financial and political world.
China has announced retaliatory tariffs. US companies will not absorb all the cost of the tariffs China imposes or the US imposes on Chinese imports sold by US companies. Amazon, eBay and other online stores along with any US firm that buys or sells Chinese products will be affected. Consumers will watch prices rise.
The impact of a trade war is pervasive and extensive. Once started, trade wars typically escalate and can last for a very long time. China is much more economically dependent on America than vice versa. However, it could be a year or two before their GDP is impacted by plant closings and rising unemployment. When the pain is great enough, someone will cry “uncle.”
Few of us understand the depth of today’s integrated global production systems. We expect this to at least impact technology, banking, farming and the construction industries. Probably, many more.
Escalating implementation of tariffs will cause economic damage causing the Fed to reduce growth forecasts. This trade war may well be the catalyst that awakens a sleeping bear and knocks the market out of its trading range to much lower prices. As investors, our focus cannot be on the pros or cons of a trade war. We must focus on the potential damage to our portfolios and maintain a disciplined sell side process.