The real, true trade war
We’ll know in a few days if President Trump forgoes added tariffs on a remaining $300 billion in Chinese exports. Deutsche Bank thinks China has more to lose near-term if he goes with them—55% of Chinese exports use imported parts, compared to 35% in the existing $250 billion group already subject to tariffs. The bigger question is what might happen beyond trade. The Huawei case illustrates tariffs are not the only weapon. As China sets up a list of "unreliable entities" in response to the countries aligning with the U.S. against the telecom and networking equipment maker, the impact of a potential "technological decoupling" on the global supply chains is difficult to analyze and predict. But China appears to be digging in for a prolonged battle. It’s ramping up domestic infrastructure spending and taking other stimulus measures to goose growth. It’s also stockpiling gold reserves. According to the World Gold Council, its first-quarter gold purchases were the highest in six years. Much like President Trump, China President Xi has a lot on his plate, and recent scenes out of Hong Kong don’t help the current geopolitical climate. Worries regarding Hong Kong’s continued presence as an international financial hub as well as its sustained special status under U.S. law continue to mount.
Unlike the Russian approach during the Cold War, in which students studying abroad were used to spread Soviet ideology, the U.S. is concerned about Chinese students in the U.S. helping their country gain an upper hand in science and technology. China in 2008 began a program to entice students and academics (including foreign-born) who are studying abroad to return home, bringing their newfound knowledge with them. With nearly a third of all American Nobel laureates born outside of the U.S., many in Congress and the White House fear an increasing number will take China up on the clarion call. According to the U.S. Embassy in Beijing, “the U.S. intelligence and law enforcement communities have identified an increasing number of instances in which foreign intelligence services co-opt academics, researchers and others to conduct activities on behalf of foreign governments during the individual’s stay in the United States.” In 2018, the National Institutes of Health warned over 10,000 U.S. academic institutions about threats to biomedical research from those possibly linked with foreign governments. Seeking to better protect military technology, a Pentagon task force created by former Defense Secretary Mattis is instilling more rigid reporting rules upon those who receive defense research grants. U.S. lawmakers also are weighing legislation limiting Chinese academics’ access to study here.
To be clear, these increasingly stringent requirements have not come about as the trade talks have broken down; they've been simmering below the surface for at least the last decade, the Institutional Strategist reports. They represent just some of the concerns the Trump administration and Congress—both Democrats and Republicans—have about the theft and loss of intellectual property by Chinese authorities and enterprises. As the two sides continue to square off, the disruption to the global supply chain is evermore concerning. Foreign supply chains account for nearly a third of the value added by trade globally and in the U.S.; in China, it’s 40%. The worsening trade situation is being blamed for pushing Germany and Europe closer to recession, slowing U.S. manufacturing activity and undermining growth in China, where imports are down 4% year-to-date (YTD) and exports up only 0.4% YTD vs. 13% a year ago. It's also causing increasing unease in the tech world. Foxconn, a major supplier to Apple, says it will build all the iPhones destined for the U.S. outside of China if it has to. We have noted before that in the broad scheme of things, the amount of tariffs on goods and services is fairly small relative to the overall size of each economy, the two largest in the world. But what if our administration insists that any good sold to a U.S. citizen must be manufactured within our shores, or if Xi decides to make it very difficult for U.S. multinational affiliates to do business in China? The real, true trade war would rock global economies and markets.
- It’s all about low inflation Citing uncertainties, policymakers indicated they’re ready to cut as soon as next month. Notably, the Fed slashed its inflation forecasts—it doesn’t see core PCE prices reaching 2% until 2021. Powell again made clear the Fed will do what it takes to reach that target, a sign it could cut rates even if growth and trade improve. The more muted outlook helped send 10-year Treasury yields below 2%, their lowest level since Trump was elected.
- The consumer isn’t uncertain Bloomberg’s Consumer Comfort Index last week rose to its highest level since early March, led by a jump in its state-of-economy component. Separately, weekly measures of retail sales by the International Council of Shopping Centers and Redbook reflected continued robust spending, in line with Fed comments that the consumer represents a favorable underpinning for the economy.
- Housing gets a spring lift May existing home sales surprised, rising 2.5% off an upwardly revised April. Mortgage applications have surged to multiyear highs, and builders remain relatively upbeat, with a pickup in both housing starts and permits boding well for homebuilding activity. On a 3-month average basis, starts are at their highest level in more than a year.
- More signs of a U.S. manufacturing slowdown Its deterioration was reflected in this month’s New York and Philly Fed surveys of regional activity, both of which surprised substantially to the downside. The former contracted for the first time since 2016 and the latter stalled, posting its second-lowest reading since 2016. Markit's initial take on June activity dropped to its lowest level since September 2009.
- More signs of a global manufacturing slowdown Despite slight improvement, Markit’s June survey of eurozone factories showed activity continued to contract, with the April-June quarter representing the sharpest 3-month decline in six years. A similar survey of Japanese manufacturers found June activity was at its weakest in three years.
- And hints of a broader U.S. slowdown After three straight monthly gains, Conference Board leading indicators fell flat in May, in part on the month’s sharp sell-off in stocks. The year-over-year rate of change also was unchanged at 2.5%, its slowest pace since December 2016. Separate surveys by the American Trucking Associations and Cass Information Systems found freight shipments declined in May, while Markit's June survey indicated manufacturing's weakness may be starting to bleed over into services.
In the bond world, the U.S. beats China hands down Foreigners own just 4% of Chinese government bonds, vs. 32% of U.S. Treasuries. The biggest holder of Chinese government bonds are domestic banks, and their ownership share has been rising over the past decade. In the U.S., domestic pension funds and insurance companies are the biggest owners of U.S. government bonds.
China’s contribution to climate change? Completed in 2012, China’s Three Gorges Dam is massive, capable of holding 42 billion tons of water. According to an article earlier this year in Interesting Engineering, “[a] shift in mass that size does affect the Earth, increasing the length of a day by 0.06 microseconds.” Yardeni Research wonders if anyone, including Alexandria Ocasio-Cortez (D-N.Y.), has considered the possibility that this phenomenon may be the cause of climate change.
Fake news To stir up anti-U.S. sentiment as trade talks bogged down, China drew focus to the harassment of Chinese nationals by U.S. authorities while airing a number of patriotic programs on state television. Its Culture and Tourism Ministry also issued a widely noted travel alert, highlighting the frequency of “shooting, robbery and theft” in the U.S.