China Trade War Could Cost the US Big – The Hidden Dangers

If you are following the stock market, you have likely read a lot of headlines about the US and China trade war.

News outlets have made it a battle between the US and China people.  This creates a dangerous division between two mutually beneficial trading partners.

However, the most important narrative is being ignored.

The fact is that US and China trade war could hurt the US just as much.d

 

China Trade War – Surplus for Both Sides?

Using the phrase China trade war sets a tone of battle, one that represents one side is winning at the expense of the other.

Looking at the numbers below, you will see that in 2017 China exported $505.47 BN in goods to the United States.  At the same time, it imported just $129.89 Billion.

Overall, this is a surplus of $375.5 BN US dollars.

But does this mean that China is winning the war?  That is a very complex relationship which needs further explanation.

China Trade War - Trade Balance with the US

China Trade War – Trade Balance with the US

 

China Trade War – What Did the US Gain?

The trade surplus for China means the US was in a deficit to the same extent. However, the deficit produced is the result of importing Chinese made goods.

In the United States, consumer spending accounts for nearly 80% of the total GDP.  It is not a big secret that Western society is one of consumption.

US is taking advantage of lower cost manufacturing, to keep prices lower and more attractive to the US citizen.

Lower prices are the single biggest benefit to the United States.

Imagine paying an extra 40% on every dollar you spend for American made goods?  Be honest, would you do it?  More importantly, would you be able to afford it?

Price increases of 40% would effectively mean your purchasing power (income) drops by the same amount.

This matter escalates further when you look at the chart below.

Median household income in the United States has not increased, after adjusted for inflation, since 2,000!

You can now start to appreciate the need for lower prices for consumers, since most are not receiving a raise that outpaces inflation.

 

China Trade War - Median Household Income

China Trade War – Median Household Income

 

China Trade War – What has China Done with Their Surplus Wealth?

This is where things get very interesting, as this information is not circulated in traditional news outlets.

Prepare yourself, you are about to have a light bulb moment.

The US government sells treasuries (bonds) to foreign countries to raise cash to operate the government.  These infusions of cash are used to pay Medicare, fund the military in the US, and run the entire country.

In return for this inflow of foreign money, the US government pays an interest to treasury bond holders.

So who is providing the most amount of money to fund the US government?

Take a look at the US Treasury chart below:

China Trade War - US Treasury Holdings

China Trade War – US Treasury Holdings

 

Where Does China Get so Much Money From?

Are you surprised to find out that China is the largest investor in US treasuries?  China owns $18.7 billion worth of bonds.

Where is this money coming from?

The proceeds form their trade surplus of course.

When China sells goods to the United States, they receive US dollars back for the transaction.

If China was to sell these US dollars, the currency would depreciate.  Instead, China re-invests the proceeds of the trade surplus back into the United States, funding the operation of the entire government.

 

China Trade War – What is the Long Run Impact?

It is important at this point to mention that no one is disputing the fact that China has taken advantage of numerous situations in this relationship.  However, one must also realize that they have also provided many benefits through the US trade relationship.

The relationship is not perfect, and it could benefit both sides to re-negotiate more favorable terms.  The main reason is because a mutually beneficial relationship is the only one that will last.  It is clear that the United States are not happy.

But are aggressive tariffs the answers?

Here is a thought experiment for you. Ready?

This is what could happen if tariffs are imposed and held for a longer period of time:

  1. China’s economy is already slowing down, and their stock market is down over 20%
  2. China now needs money to keep market liquidity and stability
  3. China starts selling US dollars, pushing the US dollar price lower
  4. US dollar selling pushes the Chinese Yuan higher, collapsing exports even more
  5. Foreign companies start to exit the dollar as the drop accelerates
  6. US consumers now need to pay more lower value dollars to purchase international goods which are now more expensive in dollar terms
  7. Less consumption leads to contracting sales, lower economic growth
  8. US companies layoff employees to cut costs
  9. US government loses their biggest treasury buyer, China, now needs to pay more interest to attract investment to fuel the budget
  10. But the economy is contracting, so there are no buyers
  11. China is in recession by this time, starts selling US treasuries to raise cash
  12. Banks do not lend money as easily to US companies, interest rates explode
  13. Stock market crashes
  14. End result – escalating cycles pushing both US and China into a deeper and deeper recession

Who wins in the China trade war?

China Trade War – What is the Trump Administration Goal?

I think the goal of Trump and his team is to motivate China to sit down and re-negotiate trade terms.

However, the tactics used are a very dangerous method.

Simply stated, tariffs will eventually trigger a global collapse.

A 25% tariff is an immediate increase in prices to US consumers, while hitting Chinese companies by the same extent.  Most Chinese companies run on low margins and pass down this efficiency in the form of low prices.  They will not survive 25% tariffs – not even close.

China is a country of pride and responds to aggression with aggression.

In grade school we called this a pissing contest.

 

China Trade War Conclusion – The Danger of the Unknown

How this ends, no one knows – but we are in the middle of a very high stakes poker game that few people understand the true dangers of.

I am very closely watching trade balance data, US treasury holdings and the Chinese Yuan rate fix.

The market is very nervous about this trade war, and you can see this in the institutional position reports.

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