The US is officially in a tit-for-tat trade war with China. On June 18, President Trump stated the following:
“On Friday, I announced plans for tariffs on $50 billion worth of imports from China… However and unfortunately, China has determined that it will raise tariffs on $50 billion worth of United States exports… Therefore, today, I directed the United States Trade Representative to identify $200 billion worth of Chinese goods for additional tariffs… If China increases its tariffs yet again, we will meet that action by pursuing additional tariffs on another $200 billion of goods.”
It doesn’t get much more tit-for-tat than that. In response, the Chinese Commerce Ministry stated that: “China will take actions to defend its interests” and that if the US releases a new tariffs list, then China is fully prepared to respond with “qualitative and quantitative” tools. According to Chinese analyst, Bill Bishop, those “qualitative” measures may include more inspections, production delays, administrative penalties, encouragement to use non-US products and a nasty nationalist backlash against the US and its goods.
In Montaka’s December 2017 Quarterly Letter, we flagged a key risk for 2018 was a break-down in the relationship between the US and China. This has been a key source of market volatility this year and we now expect the situation to get worse before it gets better. Why?
In the days following President Trump’s announcement of new potential tariffs on Chinese imports, the White House Office of Trade and Manufacturing Policy released a damning and inflammatory report, titled: “How China’s Economic Aggression Threatens the Technologies and Intellectual Property of the United States and the World.”
This report is well-researched with 163 references to external sources of research; many from Europe and many from publications made prior to Trump even taking Office. The report appears mostly (but not entirely) fair and highlights numerous ways in which China effects IP transfer from other countries.
One paragraph gives an accurate flavour for the tone and content of this explosive report:
“Chinese industrial policy seeks to ‘introduce, digest, absorb, and re-innovate’ technologies and intellectual property (IP) from around the world. This policy is carried out through: (A) State sponsored IP theft through physical theft, cyber-enabled espionage and theft, evasion of U.S. export control laws, and counterfeiting and piracy; (B) coercive and intrusive regulatory gambits to force technology transfer from foreign companies, typically in exchange for limited access to the Chinese market; (C) economic coercion through export restraints on critical raw materials and monopsony purchasing power; (D) methods of information harvesting that include open source collection; placement of non-traditional information collectors at U.S. universities, national laboratories, and other centers of innovation; and talent recruitment of business, finance, science, and technology experts; and (E) State-backed, technology-seeking Chinese investment.”
Now, irrespective of whether or not one agrees with the contents of this report, what appears undeniable is the notion that the Trump Administration is readying for a serious fight with China. And this report follows the strongly worded 2017 Report to Congress of the US-China Economic and Security Review Commission, published last November, which we have reviewed and has received bipartisan support in the US.
As a result of these actions we are observing in the US, we now believe the probability that the Trump Administration backs down in the near-term is low.
So, will Beijing back down instead? We also believe the probability is low, at least in the near-term. Our reasoning is part cultural and part political. As many readers will know, the Chinese place a high value on “saving face”. Backing down to a perceived bully like President Trump is the opposite of this and will therefore be culturally unpalatable.
Perhaps more substantively, the National People’s Congress voted in March to end term limits for President Xi Jinping. President Xi is planning for decades ahead, a period over which he effectively cannot be contested or questioned. President Trump, on the other hand, has until November this year when the Democrats could potentially regain control of the House of Representatives. Should the Democrats take control of the House, we can all but be assured that the President’s freedoms to pursue his aggressive style of diplomacy will be materially restricted. President Xi knows this and will surely opt to wait it out, rather than back down.
All of this points to likely escalation over the coming four months. And this raises the prospect for heightened volatility in equity markets. We have positioned Montaka’s portfolio accordingly. Montaka’s net market exposure is less than 40 percent. This should greatly assist in protecting the downside should equity markets fall; and we remain ready to pounce on new bargains as and when they present themselves.
Andrew Macken is Chief Investment Officer with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.