Trade War: Part Deux

Back to the future... The blame game turns into a 'financial war'... Trade War: Part Deux... Good for politics, bad for the economy... A 40% drop in GDP?... This happened in the Great Depression, too... How it all plays out...

We've heard this one before...

Trouble is brewing between the U.S. and China on trade.

It may seem like half a lifetime ago, but it was just in mid-January that the U.S. and China signed a "phase one" deal to suspend their 20-month "trade war."

China promised to buy $200 billion worth of American products by the end of 2021... while the U.S. reduced tariffs on some Chinese goods, and also removed China from a list of "currency manipulators."

Today, though... one pandemic later... it's back to the future for a new and expanded trade war.

This chapter could involve a lot more than trade...

I (Kim Iskyan) think it could make the "First Trade War" feel as quaint as the good ol' days of shaking hands with a stranger or cheering on your favorite team in a crowded stadium.

In recent months, the tensions have simmered... and at other times been boiling. And the two sides have taken two steps back without one going forward.

The hard-fought "phase one" deal has hit some significant roadblocks, just based on the logistics and supply and demand factors involved with the pandemic. It's in danger of never coming to fruition.

Though China remains committed to the deal – in fact, it has been buying tons of soybeans from the U.S. over the past few days – American exports to the country may only total $57 billion this year.

And in the meantime, as Stansberry NewsWire editor Scott Garliss reported earlier this month, the markets have been getting roiled again over renewed, testy U.S.-China relations and public posturing...

Specifically, U.S. and Chinese officials have been trading accusations over who is to blame for the origination and spread of the coronavirus. And now, it has escalated well beyond epidemiological talking points and conspiracy theories.

We've waded back into trade-war territory...

The U.S. government is considering new tariffs and sanctions on China. It's encouraging companies to move production and other operations out of China – all as part of a rapidly escalating effort to "punish" China for the virus.

It looks like the blame game could turn into a 'financial war'...

As the Financial Times explained yesterday...

President Donald Trump has ordered the main federal government pension fund not to invest its portfolio in Chinese companies, which his administration says pose a serious national security risk to the U.S.

The White House is talking about the Thrift Savings Plan – a $600 billion U.S. federal pension fund for government employees and military members – that is set to start tracking an index that includes Chinese stocks later this year for investors who want international exposure.

The president doesn't control the fund, but his message is clear: The U.S. government wants to frame the flow of investment into China (and the shares of Chinese companies) as a danger to American business, economic, and political interests and objectives.

It may be just a matter of time before other U.S.-based money managers feel pressure to take similar measures.

How would Fidelity Investments or BlackRock (BLK) feel to be the target of an early morning presidential tweet because they hold a position in Chinese tech giants Alibaba (BABA) or Tencent (TCEHY)?

And this could be just the start of 'Trade War: Part Deux'...

The Economist reported last week...

News outlets reported the fanciful idea, floated by sources in the administration, that the White House was considering cancelling part of the country's $1.1 [trillion] in debt obligations to China [which are U.S. Treasurys held by Chinese investors and the government], to "punish" China for the pandemic.

Here, it's important to note that casino and hotel businesses controlled by Donald Trump declared bankruptcy six times between 1991 and 2009...

The point is... Trump, the businessman, viewed the nonpayment of debt as a tool in his business strategy and negotiation arsenal.

I think the 'nuclear option' of defaulting on U.S. Treasurys is unlikely...

It would destroy investors' faith in the trustworthiness of the U.S. government, make it much more expensive for the U.S. government to borrow money, and undercut the status of the U.S. dollar as a reserve currency.

That it's being discussed at all, even if just as a negotiation ploy, is alarming – and may lead China to reduce its holdings in U.S. Treasurys as a precautionary measure.

The trade war ended back in January because it was threatening economic growth in both countries, and becoming a political liability for both Trump and Chinese President Xi Jinping.

Now, though, it suits the leaders of both countries – who are both under pressure domestically over the fallout of the coronavirus – to crank up the engines of war again, against an actual physical enemy.

In the U.S., rattling China's cage is good political business...

According to a recent poll by think tank Pew Research Center, 26% of Americans are positive about China – while 66% are downbeat on the country. In 2017, Americans were split evenly on their views of China.

Our colleague and True Wealth editor Dr. Steve Sjuggerud recently wrote that anti-China sentiment is good for the "talking head" media business, too.

So you can bet that U.S.-China relations will be a major theme of the upcoming U.S. presidential election...

We can easily see presumptive Democratic candidate Joe Biden and Trump one-upping each other on who's better placed to put China in its place... and things getting personal.

The thing is, the global economy – and the U.S. economy, in particular – can't afford another war...

Financial, trade, or otherwise... between the world's two largest economies.

During the first trade war – which "ended" right as the virus started to break out in full force in China – U.S. consumers were among the biggest losers.

According to a May 2019 report by the New York Federal Reserve, the trade war cost the typical American household $831 per year (an estimate that didn't reflect tariffs imposed later in the year). Moody's Analytics estimated that the trade war cost 300,000 jobs in the U.S.

Of course, those figures are pocket change in the context of the current economic environment... with 33 million U.S. jobs now lost since the start of the COVID-19 pandemic.

The St. Louis Fed is expecting a gross domestic product ("GDP") decline of around 40% in the second quarter.

And we're starting to see the "second order" effects of the pandemic, beyond the health and the obvious economic impacts...

Grocery prices are jumping, and oil companies are going out of business...

Grocery prices jumped 2.6%, on average, across the U.S. last month. That might not sound like much, but when most other growth is at zero or negative – and the U.S. is experiencing meat shortages – even a seemingly small rise in the weekly food bill for every American (including the one in five who don't have a job) can quickly add up to a big budget hit.

And in another sector, the oil company bankruptcies are mounting... Chesapeake Energy (CHK) is the latest to issue a dire warning about its debt, a trend we've warned would unfold even before the pandemic struck.

What's happening now – exploding unemployment and economic collapse – is similar to the Great Depression...

Back then, tariffs were boosted in an effort to protect American industry.

Sound familiar?

Specifically, the Smoot-Hawley Tariff Act passed in June 1930. In response, other countries put up their own trade walls.

With the benefit of hindsight, there's no question that higher tariffs deepened and extended the economic decline... making what could have been only the Really Bad Depression into the Great Depression.

What's more, the American political system isn't well-equipped to fight China.

What the clash of cultures means for business...

Remember... China has been around for a lot longer than the U.S. – and knows how to play the long game (that is, it has patience) in a way that's completely foreign to the American political (and economic) system.

We talked about this theme in Monday's Digest with respect to the U.S.'s response to the virus as a whole, when we quoted noted investor Paul Tudor Jones.

Most American businesses plan, at most, in terms of decades. And politics happen in chunks of four years, centered around the U.S. presidential cycle.

In China, centuries are the currency of time. And leaders come and go when they please, rather than according to the calendar.

How it all plays out...

Trump is focused on reelection in November, while Xi is Chinese president for life... The latter can afford to ride out bumps along the road.

Meanwhile, China's breakneck economic growth of the past few decades – and in coming years – means that it's a statistical inevitability that the country will take the place of the U.S. as the world's largest economy in the next decade or so.

As the balance of economic power shifts, so will the terms of any negotiation in the trade war...

What would have worked for the U.S. before – like tariffs or banning Chinese tech companies from doing business – will not work when China's global economic footprint eclipses that of the U.S.

That's the long game.

In the short term, let's hope that Trump and Xi read their history... and don't make a bad situation worse.

A New Threat to the Markets?

True Wealth Opportunities: China analyst Brian Tycangco discusses more on the U.S.-China relationship and its impact on the global economy in this video interview with our colleague Jessica Stone...

To watch this video, click here. And remember, to get all of our free videos as soon as they're posted, be sure to subscribe to Stansberry Research's YouTube page right here.

New 52-week highs (as of 5/12/20): General Mills (GIS), KraneShares MSCI All China Health Care Fund (KURE), Lonza (LZAGY), and Victoria Gold (VGCX.TO/VITFF).

A rare, quiet mailbag today. How do you think the U.S.-China trade war will play out? Share your thoughts – and anything else on your mind – with us at feedback@stansberryresearch.com. As a reminder, we cannot provide personalized investment advice, but we do read every note.

Regards,

Kim Iskyan
Singapore
May 13, 2020