Equity markets today showed President Trump the consequences of not striking a trade deal with China, in the worst day since January. I’m sticking to the advice I offered yesterday, perhaps a bit prematurely: Buy Chinese stocks on the dip.
US markets fell across the board. All the major indices, from the tech-centered NASDAQ to the domestically-oriented, small-cap Russell 2000 fell over 2% before clawing back a bit of the loss late in the session.
Only 36 stocks in the S&P 500 showed gains. Semiconductors, casinos, and farm equipment showed losses of around 4%, not surprising given their sensitivity to China or Chinese trade. But selling was indiscriminate. What the market is telling President Trump is that the whole economic growth story is in play.
A trade deal is in the interest of both parties, but a trade deal that looks too easy is in the interest of neither party. Presidents Trump and Xi are calculating men with a complex relationship to their domestic constituencies.
The US leader affects a rough and spontaneous exterior. But it is useful to recall – as Newsmax founder Chris Ruddy observes – that Trump kept a reality show viable for an unheard-of fourteen seasons by studying his ratings in depth and taking swift preemptive steps to correct any weaknesses. This side of Trump, the calculating and detail-oriented television entrepreneur is more relevant than his much-commented “art of the deal” grandstanding during negotiations.
If the United States imposes a 25% tariff on $500 billion of Chinese imports, the economic consequences will be nasty for both sides. That’s $125 billion in additional costs to US consumers – very little of what China exports to the United States can be replaced by domestic production. Consumer electronics, toys, clothing, furniture and household appliances comprise most of China’s exports to the US, and consumers won’t like the consequences.
Chinese inputs also support American manufacturing, especially the smaller firms who account for most of the 450,000 manufacturing jobs that the US economy added since Trump took office.
Trump will brag about a 3.2% GDP growth rate during the first quarter, but he knows that the US economy is more fragile than the headline number indicates and that the economic consequences of a trade war could cost him the election.
But Trump will face complaints by Senators Chuck Schumer and Bernie Sanders that he wasn’t tough enough on the Chinese. He can’t afford to make it seem easy. His own political credibility requires cliff-hanger negotiations and a concluding fight scene worthy of a Marvel Comics movie.
Sanders, who polls show is the second-most-likely Democratic candidate to challenge Trump in 2020, began the attack on Trump April 29, denouncing the president for failing to label China a currency manipulator and for allegedly failing to stand up to Beijing.
“We need a president who will actually fight for American workers, keep their promises, and stand up to the giant corporations who close down plants to send jobs overseas,” Sanders wrote.
China’s economy, for that matter, bounced back during the first quarter, but the Chinese leadership does not want to rely on monetary stimulus and infrastructure spending for very long. It is committed to de-leveraging and reform of state-owned enterprises. China’s internal stimulus depends disproportionately on the property sector, which already is overbuilt in some cities.
Economic reformers in Beijing have long been frustrated with the state-owned enterprises, which constitute a formidable political constituency opposed to internal economic transformation. Trump may be doing Xi Jinping a favor by giving him a political rationale to cut subsidies to SOE’s, something which he wants to do in any case.
Intellectual property protection benefits some Chinese companies at the expense of others. Huawei now files more patents than any company in the world, and together with ZTE holds nearly 40% of all patents involving 5G technology.
It is cheaper to imitate than to innovate, and it is not surprising that China grew during the past forty years by adopting Western technology by means fair or foul. The future of the Chinese economy, though, lies in innovation. China’s greatest international success to date is Huawei, now the corporate champion in game-changing 5G technology.
America’s intensive diplomatic efforts to exclude the Chinese firm from the global rollout of 5G failed only because Huawei has a better product, and even close American allies such as the UK fear being left behind. The lesson that Beijing will have taken from the Huawei affair is that China’s prestige, power and economic growth depend on its most innovative companies, not on stagnant state-owned enterprises.
In short, what we observe is entirely consistent with the rational self-interest of Trump and Xi, and the logic of their self-interest dictates a trade deal. The scenario requires a swoon in equity prices, and the market graciously obliged today.