US-China trade war: What will happen to tariffs in March?

USA businesses that buy Chinese goods are adventurers.  They go to the other side of the world to secure supplies of low-cost products for their customers. They brave all sorts of challenges ranging from quality (whether it meets their expectations), price (whether they really got the best price), cost of freight (which is always changing), speed (both of samples and delivery); and even weather (worrying about production delays or storms affecting their sea-going vessels).

Uncertainty is part of their environment and they just acquired another big concern: tariffs.  This was unexpected and unwelcome.  It is a potential game changer that may force them to alter their whole supply chain strategy. In March, they will know if the trade war will ease up or if it will get worse.

Since 1978,US imports from China have grown over 4,000 fold, from c.$100 million to over $446 billion.   It did not happen smoothly or predictably. During this period, I have observed many game-changing events, notably: the setting up of formal diplomatic relations in 1979; China getting PNTR (“Permanent Normal Trade Relations”) in 2000; its entry into the WTO (World Trade Organization) in 2001 and the end of the MFA (Multi Fiber Agreement) quota system in 2005.

Now we have a trade war and the big question is: what will happen in March?

My prediction is that it will get better, that the new 25% tariffs will not be imposed, and that previous tariffs will be reduced over time.

I don’t have a crystal ball and this particular situation has many moving parts but bear with me: close observation yields enough data to venture an opinion.

My prediction is based on logic.  Many argue that it is very difficult to predict what either President Trump or President Xi will do.  Agreed. But the reality of what each of them face in their own country can inform us on what they should do.  It is possible to understand the impact of an ongoing trade war on each country, it is possible to evaluate what risk/reward ratio each leader is contemplating and so, logically, it is possible to deduce what they will do about it.

Both leaders are proud and forceful and neither wants to be seen as backing down.   But they are also confronted by the need to address their different realities. And preventing a trade war suits both of them.

Profound convictions:  Trump’s attitude towards China is not new. In September 2011, he tweeted: “China is neither an ally or a friend – they want to beat us and own our country.” He sees China as a competitive business machine that has taken advantage of the USA for too long.

Xi Jinping, on the other hand, believes China’s time has come, and he has reasons to believe that he may be right. And that if he stands firm he will get his way.  These convictions have set both leaders on a collision course.

How it started – and kept going: In February 2018, Trump slapped 30% tariffs on solar panels and washing machines (clearly targeting China) and in March, he imposed tariffs on steel and aluminum (not just China). China retaliated by slapping tariffs on 128 US products.  And off we were.

In July, the USA imposed the first round of punitive tariffs, invoking China’s trade and intellectual practices.  More came in August, with China retaliating in September with a tariff focus on soybeans. Finally, in December, a 90-day truce was reached in Buenos Aires.

During the 10 months between February and December 2018, both sides had the opportunity to observe events and reactions and verify their assumptions – many of which proved to be incorrect.

USA
The USA “can’t lose a trade war with China”.
Yes, the deck is stacked in favor of the USA, but in the end, everyone loses a trade war.

The USA economy is strong.
But will it stay strong after the tax-cut effects wane?  And will it stay strong if China’s economy tanks and the global economy weakens?

The Republican party controls both houses of Congress. 
But, political winds are shifting. The Democrats took the house back.

Businesses support the trade war.
Actually, businesses don’t like the trade war.  Wild stock market gyrations proved it.

China
Trump will blink and change his mind.
That was not a safe bet. 

“The enemy of my enemy is my friend.”
Not really.  Although Trump also started a trade war with Europe, the Europeans did not rally and unite with China against the USA. 

Only about 25% of Chinese exports go to the USA, so a trade war will not have a big effect on China’s economy.
Technically correct, but in reality the Chinese economy is sputtering.  And even if only part of it can be attributed to the trade war, why exacerbate a problem if you can fix it?

Opinions and social mood matter and can be controlled.
China was careful to prevent anti-USA sentiment, but how long can they do this if the trade war continues and the economy worsens? 

Quick conclusion: These sobering facts create an incentive on both sides to try and fix the problem before it gets worse.

What must happen: China will have to bend and fix their trade and IP policies. (They have already started doing so.) The USA should avoid gloating and agree to a progression of positive steps.

Why it will happen: Because the domestic situation of each leader matters more to them than an international spat. There will be some give and take, and China will have to do most of the give, but both sides will present this as a win.

Risk/Reward ratio:

China 
Risk: The trade war has a direct impact on the Chinese economy.  Moreover, the perception of a trade war has an unwanted impact on markets and business confidence.  And that affects the Chinese economy more than Xi Jinping wants.

Reward: Stability and a chance to nurture the economy back to good health. In the short term there is not much of an economic downside for China to concede to the USA and change its trade and IP policies.  In the long run, it may actually benefit China to be seen as a fairer marketplace.

USA 
Risk: Continuing the trade war will impact the US economy, even if the impact is less than in China.  If the USA economy falters, if unemployment increases, Trump will be confronted by re-election risks in 2020 and big legacy risks later.

Reward: The end of the trade war, which will be portrayed as a win, will benefit Trump and will allow him to concentrate on other issues.   China’s support for his North Korea initiative may also be a side benefit.

Conclusion: The trade war created a huge disruption, and that disruption highlighted problems that needed fixing.  At the onset, the USA and China were on a collision course, but after ten months the real impact on respective economies became evident and attitudes changed.  It should be clear to both sides now that continuing the trade war has a lot more downside than upside. Logic dictates it is time to make a deal.

The outcome in March depends on what complicated people decide. Culture, language, different evolution and political backgrounds will make the task of the negotiators complex and difficult. Much can and will go wrong, clearly no-one can predict the result with any level of certainty.  But I believe common sense will prevail.  I believe that, in this equation, when all is said and done, cooperation will be seen as a better outcome than ongoing disruption.

 

By Michael De Clercq