The U.S. electorate in November 2016 elected Donald J. Trump as the 45th president. In his election campaign, he struck a distinctly protectionist tone on foreign trade, and among other ideas, singled out China as one of the main factors behind a widening U.S. global trade deficit and diminishing manufacturing and economic activity in the States.
The arguments behind Trump's stance on trade and China may be controversial, but it seems likely that his tenure in the U.S. presidency will lead to alterations in the trade relationship between China and the U.S. and possibly in trade patterns globally.
The Evolution Of China As A Global Trade Player
From the 1960s to the present, China has made a dramatic transition from a mostly agrarian and pre-industrial society to major player in world trade. After its communist takeover and the formation of the People's Republic of China in 1949, China was largely dependent on trade and relations with its communist partner, the Soviet Union. But in the '60s, in an effort to escape from the influence and dominance of the Soviet Union, China opened trade with some partners outside of the communist bloc, most notably its capitalist Asian neighbor Japan.
By the '70s, China had normalised relations with other non-communist partners, including Canada and West Germany. A further turning point in Chinese relations with Western nations came in 1972, with the visit of U.S. President Richard Nixon to China and discussions on opening of relations between China and the U.S. Trade between the U.S. and China jumped from US$5 million in 1971 to US$800 million in 1973. In the ensuing period, China weaned itself further from dependence on trade with communist bloc nations to where a majority of its trade is now conducted with non-communist countries around the world.
An additional and very important development in Chinese foreign trade was trade reform and liberalisation begun under the leadership of Deng Xiaoping in 1978 following the death of former Chairman Mao Tse-tung. With these reforms, China loosened central government control of trade and allowed the expansion of foreign trading rights.
In the 1980s, this movement was expanded to allow for foreign investment and even rights of wholly owned foreign companies to operate within China in some sectors. With this, foreign trading rights expanded from fewer than 100 state-approved entities in the 1970s, to more than 35,000 companies by 2001. Another important push in the direction of trade liberalisation direction was China's request to enter as a member in the World Trade Organisation (WTO).
Foreign companies were attracted both by the abundant labor and low costs of operating in China in addition to the prospect of selling to China's massive consumer market (more than 1 billion citizens). The move simultaneously opened prospects for Chinese exports to WTO member nations around the world. But it also subjected China to a set of trade practice restrictions and possible penalties to which it hadn't been subjected previously.
The Current State Of Chinese Trade
With the expansion of its trade into the global market, China grew from the 7th largest economy (worth US$305 billion) beginning in 1980, to the second-largest (worth more than US$11 trillion) in 2016. From the time of China's economic reforms in 1978 to the present, the country has grown at an annual pace of near 10%.
China is currently the second-largest economy globally behind the U.S. Also, China is the U.S.'s second-largest trading partner and its third-largest export market. In 2015, China sold US$483 billion in goods to the U.S., an amount more three times greater than US$116 billion the U.S. sold in China. Globally in 2015 China exported US$2.3 trillion and imported US$1.7 trillion, posting a trade surplus of US$600 billion in the period.
In his campaign pledges during the 2016 presidential election campaign, Donald Trump made several proposals that would specifically affect trade relations with China. Among these include labeling China as currency manipulator to subject it to possible tariffs and taxes, U.S. withdrawal from the Trans-Pacific Partnership, instructing the U.S. Trade Representative to bring trade cases against China, within the U.S. and at the WTO to challenge China's alleged unfair subsidies to its industry, and apply tariffs to Chinese goods consistent with Section 201 and 301 of the Trade Act of 1974 and Section 232 of the Trade Expansion Act of 1962.
Possible Impacts of Trump's Proposals On Trade
There has been much speculation about the possible impacts of the Trump administration's proposed actions against China on trade, but it is not yet clear if they will be implemented as proposed.
Label China As Currency Manipulator
As part of his campaign promises, Donald Trump said that he would instruct the U.S. Treasury to officially label China as a currency manipulator so that the U.S. may take punitive actions. While this threat sounds like it carries weight, it may be more bark than bite.
The U.S. Treasury has used this tool in the past, most notably against Japan and Taiwan in the 1980s, and also against China itself in the 1990s. The mechanism would not necessarily lead to immediate trade penalties—it might be considered an illegal action under world trade rules—but rather to a series of negotiations with the country in question to try to adjust the currency policies in question.
Analysts point out that during the last round of such negotiations with China in the 1990s, the talks did lead to adjustments in China's currency policies. However, the nation's currency nonetheless remained weak thereafter despite the changes.
The trends of China's currency, meanwhile, may be under greater influence from the threat of a credit bubble and slowing growth that could put downward pressure on the value of the renminbi regardless of U.S. efforts at coercion.
Bring Trade Cases Against China
In addition to other nations, the U.S. has mounted challenges to Chinese trade policies. These include challenges to its farm support on grains, and its export duties on raw materials that aim to make manufacturing cheaper in China than abroad.
Of the 28 cases between the U.S. and China at the WTO since the Asian nation joined the organisation in 2001, the U.S. has won the majority. The efficacy and economic returns of taking China to the WTO, however, may be doubtful.
The country has showed itself willing to go without enforcing some of its own internal trade regulations and outright ignore some WTO rulings, concluding that due to the size and attractiveness of its economy its opponents will be unwilling to impose trade sanctions even when authorised. Subsequent rulings against China could prove to be a test for the nerve of the Trump administration in staring down an important global trade player.
Apply Tariffs To Chinese Goods
Trump's advisers during the presidential campaign alleged that besides manipulating its currency and providing illegal export subsidies, China does the following:
- Engages in "massive" intellectual property theft to avoid research and development costs.
- Fails to enforce worker safety standards and environmental regulations in order to cut costs.
Trump's trade advisers have calculated that because of these practices, overall, the renminbi has been undervalued by 45%. As a remedy, Trump has proposed a 45% import tariff on Chinese goods coming into the U.S. Under the Trade Act of 1974 and the Trade Expansion Act of 1962, Trump would have the authority to raise tariffs on the Asian country's goods, but likely at a lower rate than suggested.
China, meanwhile, is seen responding to possible U.S. moves by cutting imports from manufacturers such as Boeing, Apple, GM and Ford. However, proponents of elevating tariffs note that China sells three times more to the U.S. than it buys. Trade with the U.S. accounts for about 18% of China's exports and about 4.5% of its GDP, while trade with China accounts for 7% of all U.S. exports, equivalent to about 1% of its GDP. Considering this, they note that China's economy could be affected much more by the policy change.
Withdraw The U.S. From The Trans-Pacific Partnership
Donald Trump pledged that if he was elected, the U.S. would abandon the Trans-Pacific Partnership (TPP) trade deal. The TPP is a major trade agreement deal that has been negotiated between the following 12 countries in the Pacific region:
- New Zealand
The deal has been agreed upon by the governments of the countries that participated in the talks, but it still must be ratified by their respective legislatures. Negotiations were completed in 2015 and the framework for the deal was released in November of that year.
The accord would call for tariff reductions for most goods and services traded between the countries, covering about 18,000 tariffs. The deal would also involve a collective consumer market of around 800 million people. The countries involved in the deal account for nearly 40% of global trade, but trade with the U.S. is a sizable amount of that (more than 60% of the total the TPP accord's total GDP).
Tariffs on most goods like farm and industrial products would be eliminated immediately after the accord is ratified. However, tariffs on some goods deemed sensitive would remain initially and be eliminated over time. Certain goods and services are not included.
Trump and his aides have described the TPP as a potential "backdoor" for China to expand trade not only to the U.S. and North America, but also to the economies of many U.S. trade partners. This is in part because the TPP is considered to be a "docking agreement," so other countries could be added without the approval of Congress.
India, China and Korea have expressed interest in joining the TPP. The agreement was initially conceived, at least in part, as an effort by several Pacific region countries to boost trade in their region and economies without the direct influence and intervention of China in trade. China was not included as an early member in the agreement.
For this reason, the withdrawal of the U.S. from the TPP may serve as "shot in the foot," allowing for the further encroachment of China and its goods as competitors in the markets of key U.S. trade partners in the Pacific region. Thus, in this particular instance, implementation of Trump's campaign proposal may have the opposite effect of what he aims for in the protection of U.S. trade interests locally and abroad.
Policy Impact On Stocks
Like most trade-related measures, the implementation of trade-restriction measures against China proposed by Trump would likely have a diffuse impact on stocks. Principally, they could be expected to have an impact on companies doing direct business in and with China.
These could include U.S.-based companies such as General Electric, Apple Computer, Nike and Tesla, among others. Similarly, Chinese companies relying on business in the U.S. could also be hurt. This would include companies such as Alibaba, Baidu Inc., Netease and JD.com, among others.
In addition to direct relationships between the U.S. and China, the trade shift would likely have impacts on shares of companies in other regions, with some benefitting. Those include companies in Europe, Southeast Asia and the Pacific region, South America and Africa. This could include large non-U.S. companies like Airbus, Volkswagen, Samsung, Arcelor, JBS foods, Tata and others.
Policy Impact On Currencies
The direct impact on currencies of trade policy changes in relation to China should be measured against other factors, including global economic growth patterns, inflation and monetary policy decisions. However, it's likely any shifts in international trade flows would also produce some changes in currency levels over time. The dollar climbed against a broad range of currencies immediately following Trump's election win, while China's renminbi fell to an eight-year low.
That trend may be reinforced, should the U.S. opt to implement some of the policies suggested by Trump. The result could be the renminbi staying at the lower end of its range as U.S. trade flows are steered less directly toward China. There is little evidence, however, to suggest that any of the manoeuvres suggested by Trump would influence China to alter its currency policy.
China has maintained the renminbi linked to the dollar in a controlled trading band and has made few large alterations to the policy in recent years. This has occurred despite vocal complaints from successive U.S. administrations and other governments that the Chinese currency is undervalued.((Retrieved 30 November 2016 http://www.economist.com/news/finance-and-economics/21644205-devaluing-yuan-would-do-china-more-harm-good-currency-peace)
There may be impacts on the currencies of other regions, depending on their positioning with either the U.S. or with China.((Retrieved 30 November 2016 https://www.bloomberg.com/news/articles/2016-11-15/trump-trade-snub-set-to-boost-china-s-bid-for-its-own-asia-pact)
The currencies of countries whose goods eventually substituted Chinese or U.S. goods in either market could be expected to strengthen. This may be particularly true for currencies of other nearby economies such as Korea and Japan, which maintain steady trade relations with both the U.S. and China.
The election of Trump, who advocated for protectionist policy during his presidential campaign, could have significant repercussions for trade between the U.S. and China. Specifically, he has called for labeling China as a currency manipulator, bringing more trade cases against China at the WTO, applying import tariffs to Chinese goods and withdrawing the U.S. from the TPP.
The measures proposed imply a sharp re-alignment and curtailing of trade flows between the two countries. However, the practical implications of implementing them suggest that they might be applied to a much lesser degree than hinted during the heated debate of the U.S. presidential campaign. Further, the Trump administration's urgency to impose greater restrictions to U.S.-China trade may be influenced, and possibly lessened, by the evolution of global economic factors going forward and even by diplomatic negotiations between the nations' governments.
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Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…