Monday, August 19, 2019

Why the US China trade war is happening

China has been making serious progress to becoming a world class economy financially and militarily. Donald Trump appears to recognize this and has launched a Trade War against China. Gary Shilling explains this dynamic in his new post on bloomberg.

The escalating trade war between the U.S. and China has reached a fever pitch, with financial markets seeming to lurch on every new development no matter how insignificant. That’s understandable, but what investors need to know is that in a world of surplus goods and services, the buyer has the upper hand.

Sure, both sides are under considerable pressure to reach a deal. President Donald Trump faces re-election next year, and the longer the trade disruptions drag on, the bigger the potential for a steep stock market selloff and the deeper the recession I think the U.S. economy has already entered. Xi Jinping, China’s de facto president-for-life, is strapped with a slowing economy, with the 6.2% rate of expansion reported for the second quarter probably double the truth. Also, some Communist party elite fret over Xi’s power and his provoking the U.S. and other countries with aggressive military expansion and the heavy-handed Belt and Road program.

Nevertheless, the basic issue is China’s challenge to the U.S. for global supremacy and the importance of technology in this struggle. China’s growth has depended on Western equipment and cheap local labor to produce inexpensive goods that could be freely exported to North America and Europe. With slower growth in the West and muted demand for everything, including imports, that game is over. So, too, is Chinese growth through infrastructure spending. The result has been excess capacity, ghost cities and a huge increase in debts.

So China must turn to domestic growth, but with the earlier one child-per-couple policy, the labor force will be shrinking for decades. Hence the need for technology-driven productivity. But China is only starting on domestic technology development and therefore desperately needs help from the West. For years it has been demanding the transfer of technology as the price of Western firms doing business in China. Trump seems well aware of China’s long-run game plan and determined to retard it.

Meanwhile, the slide in China’s economy will intensify as Chinese and foreign producers accelerate their shift to even-lower-cost Asian countries that are out of the line of the U.S.-China trade war fire. These include Vietnam, India, Malaysia, Taiwan and Thailand. Already, the direct and indirect effects of the trade spat have dropped China from being America’s largest trading partner to third place behind Mexico and Canada. U.S. bilateral trade with China fell 14% in the first half of 2019.

Declining imports from China have been offset by purchases elsewhere. U.S. imports from Vietnam leaped 33% in the first half. In June, exports to the U.S. from South Korea, Taiwan, Japan and Singapore rose by a combined 9% from a year earlier, using a three-month moving average, while their exports to China fell 9%. Singapore’s shipments to China plunged 23% in May from a year earlier, the fourth drop in five months. Much of those imports are components that China assembles for final export to the West.

But despite Trump’s hopes, manufacturing is not returning to the high-cost U.S. Manufacturing output dropped 1.1% in June from its December peak, and the Institute for Supply Management’s manufacturing index fell again in July, this time to its lowest level since 2016.

Rising costs in China have encouraged manufacturers of apparel, footwear and other low margin consumer items out of China in recent years, but now the departure of electronics and other high margin products are troubling Beijing. And Chinese leaders are aware that once these operations leave and labor is trained and supply chains established elsewhere, they are unlikely to return.

Foxconn, which assembles Apple’s iPhones and iPads, mostly in China, is considering shifting production elsewhere. It has plants in Brazil, Mexico, Japan, Vietnam, Indonesia, the Czech Republic, the U.S., Australia and other countries. Only 25% of its manufacturing is outside China, but Young-Way Liu, the head of Foxconn’s semi-conductor business group, recently said the company’s manufacturing capacity outside China is adequate to supply Apple and other customers with products for the U.S. market, and that production could be expanded at facilities worldwide “according to the needs of our clients.”

Meanwhile, Apple is asking suppliers to consider moving final assembly of some products out of China. This would involve a third of production for some devices, including iPhones, iPads and MacBooks, and destinations under consideration include other Southeast Asian countries. Nintendo is shifting some output of its Switch video game console to Southeast Asia from China. Japan’s Sharp, which is controlled by Foxconn, said in June that it planned to move personal computer production to Taiwan and Vietnam from China.

So, while China suffers from the departure of high margin production, the U.S. will still enjoy low-cost imports from other Asian countries—and emerge from the trade war on top.  But the long-term gain to American consumers that follows the short-term pain of the trade war may be limited by China’s determined challenge for world domination.