There is no doubt about it. The US and China are in a full-blown trade war. And as a result, investors have seen the return of market volatility over the previous few days. Last Thursday, President Trump unexpectedly announced a 10% tariff on another $300 billion of Chinese goods and products, effective September 1st. Purportedly, this was after China agreed to purchase large quantities of agricultural products from the United States but never did so.
In response to the 10% tariff, China devalued the yuan to fall below its 7-to-1 ratio with the US Dollar. A weaker Yuan means that the 10% tariff has less of an impact on goods imported into the United States. As expected, the Chinese government denied manipulating its currency.
For the most part, the US equity markets have been unscathed by the longtime US-Chinese trade war. The bond markets have felt its impact, and certainly, the currency markets have as well. While there have been single-day losses, the market quickly recovered.
Pain On Both Sides
While both countries are feeling the pain of this trade war, it is clear that China has more to lose. Before this began, China already faced several challenges, including the transition from cheap manufacturing to a higher-end producer of goods, political instability due to events in Hong Kong and Xinjiang, and a 27-year low economic growth rate (6.2%, not too shabby). A trading war with it’s biggest exporter does not help solve their economic problems.
The US, of course, started the trade war in March 2018 in response to intellectual property theft. However, the US producers and consumers have begun to feel the pain of this dispute. Farmers are experiencing a drop in soybean exports, and US consumers are likely to see higher prices as retailers tariffs pass along the higher prices.
No End In Sight
It looks like this trade war will not end any time soon. The trade war is escalating into a currency war. On this battlefield, it may seem that the country with the cheaper currency wins, but it usually leaves both countries in worse shape.
The only way that either country could justify a trade war is if the result is a favorable trade agreement. This can only occur if a country has enough bargaining leverage to negotiate such a deal. And the longer this trade war continues, the more allowances a country will have to win to make up for the previous damages caused. Essentially, the longer this plays out, the more likely a resolution won’t occur.
It is worth noting that the United States appears to have more leverage as the US accounts for 18% of China’s exports while the US only accounts for 8% of China’s imports. However, China has the luxury of waiting for a new President. If a Democrat wins in 2020, a resolution is much more likely to occur.
Bottom line, we may only be in the 4th inning of this conflict. So don’t hold your breath.