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Trade Turmoil Between the U.S. and China: How Might It Affect the U.S. Economy?

Author

Paul Buongiorno

Date

June 2019

Trade tensions between the United States and China have been simmering for decades, but recent escalations have upped the stakes and grabbed headlines. Investors are nervous about the effect of tariffs on economic growth, corporate profits and price inflation for certain products.

While resolving trade issues is in the interest of both U.S. and China, the trade war is unlikely to be resolved in the near term given the hardened stance of the two countries. The fallout of a protracted trade war could impact the U.S. economy. However, it is likely to be more painful for China.

We believe a cautious approach is warranted for investors as they continue to gauge companies’ domestic and global growth prospects.

How did we get here and where will it all lead? Here’s our take:

The Rift: The U.S. has been trying to negotiate a new trade deal with China for months. Talks broke down earlier last month, and the Trump Administration responded by announcing an increase in tariffs from 10% to 25% on $200 billion in goods from China, with big tariff hits on telecom equipment and circuit boards.

The Administration also said it was preparing to impose a 25% tariff on an additional $325 billion worth of goods that are not already subject to levies, most of which are consumer goods. This has set off alarm bells at U.S. companies that rely heavily on sales of Chinese-made consumer products.

China responded that it will increase tariffs from 10% to 25% on about $60 billion worth of U.S. goods.

The best prospect for easing tensions and a new deal could come this month, when President Donald Trump meets with Chinese President Xi Jinping at the G20 Summit in Japan, an event that will bring together governments and central bankers from 19 countries and the European Union.

The Stakes: The U.S. and China together represent one-third of the global economy, so a prolonged U.S.-China trade dispute could pinch global growth.

Total U.S. exports to all countries are $2.5 trillion, representing 12% of gross domestic product (GDP), while imports represent $3.1 trillion, or 15% of GDP. The net trade deficit—driven largely by heavy imports of consumer goods and autos/auto parts—is equal to 3% of GDP.

China is the largest trading partner of the U.S. and represents 12% of the total U.S. trade. The U.S. runs a trade deficit with China of about $420 billion, importing $540 billion worth of goods and exporting $120 billion.

For the U.S., the largest imports from China are machinery ($270 billion), furniture and bedding ($35 billion), toys and sports equipment ($27 billion) and plastics ($19 billion). The largest U.S. exports to China are machinery ($27 billion), aircraft ($18 billion), optical and medical instruments ($10 billion) and autos ($9.5 billion).

The Impact: The Trump Administration’s latest tariff escalation with China could reduce gross domestic product by about 15 basis points (bps), or 0.15 percent. However, if the Administration follows through with the plan to impose a 25% tariff on an additional $325 billion worth of goods, the GDP could be reduced by more than 50 bps on an annualized basis if the tariffs were to remain in place over the course of a year. This would add up to a 70 bps cumulative hit from all imposed and threatened tariffs since they began in April 2018.

Beyond the primary impact, we will likely see a decrease in U.S. consumer spending power, lower business profits, or a combination of the two. For U.S. businesses, a rise in tariffs and trade tensions could affect capital expenditures and dampen consumer and business confidence, which raises additional concerns about the longevity of the current economic growth cycle. New tariffs also could affect the currencies of both countries, further affecting trade and the economy in general.

While the impact on U.S. GDP is notable, China has more to lose. The estimated impact to China’s GDP is about 1% of GDP over the course of a year, according to Strategas, or 1.5%, according to Bloomberg.

The Mitigating Factors: Even with tariffs in place, there are ways that both countries can soften the blows to their respective economies. The U.S. will continue to benefit from lower personal and corporate taxes, as well as from lower interest rates, which should boost housing. China, meanwhile, has been showing signs of recovery and has the ability to add more stimulus for its economy.

Keep an eye on U.S. CEOs, who will likely seek to diversify their supply chains to reduce their dependence on China. To wit, over the past two weeks, there have been several companies that have announced that they are actively seeking new sources of supply. Also, it’s worth noting that the current rift with China could pay off if the U.S. succeeds in reducing piracy of intellectual property, one of the most significant sticking points over the years. Long term, those could be positive developments.

Our Conclusion: A prolonged trade war with China could take a meaningful bite out of the economy, bringing some combination of reduced consumer spending, business profits and capital expenditures. How big will that bite be? It remains to be seen.

President Trump and President Xi may be able to strike a new deal in Japan at the G20 Summit later this month. However, until the trade war is resolved, the situation merits a cautious approach for investors, especially when it comes to large-cap U.S. equities and global equity indices. Investments that are less sensitive to trade war tensions and have attractive current valuations are worth consideration. Among these are mid-cap U.S. equities, energy infrastructure and Opportunity Zone funds.

Paul Buongiorno is a Managing Director of Tiedemann Advisors LLC. Tiedemann Advisors is an investment advisor. The information presented herein is intended as an illustration of the services offered by Tiedemann. Such services may not be suitable for all individuals. This information is intended to serve as the basis of a discussion with a Tiedemann professional and does not constitute, and should not be construed as, the provision of tax, accounting or legal advice or investment recommendations. You should consult with your tax or legal advisors prior to entering into any planning or trust arrangements. Economic and market forecasts presented herein reflect our judgment as of the date of this presentation and are subject to change without notice. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals and objectives, risk tolerance, investment time horizon, tax situation and other relevant factors. These forecasts are subject to high levels of uncertainty. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Asset allocation does not guarantee a profit or protection from losses in a declining market. Investments in securities involves significant risk and has the potential for partial or complete loss of funds invested. Investments, when sold, may be worth more or less than the original purchase price.

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