Investor Insights

US-China Trade Conflict: Common Misconceptions

Published: May 17, 2019Updated: May 17, 2019

By: Stash Graham

Considering recent events, we felt it wise to provide a brief overview on some of the misconceptions that people may be having about the recently escalated trade conflict between the United States and China.

  1. China is paying the United States cash for the tariffs

While Larry Kudlow, Trump’s top economic adviser, did not do himself any favors with the President, he was correct. In his Sunday Fox New Appearance, Mr. Kudlow contradicted the President over who pays for the tariffs. Over the preceding few weeks, the President’s tweets has made it seem as if China is paying the United States.

Mr. Kudlow is correct that the American small business and consumer are the entities paying the tariffs. Fox News anchor Chris Wallace needed to push him a little to get the response that all investment professionals and business executives knew already. Simply how the mechanisms of tariffs work, it would be impossible for China to pay the US directly. The interview finished with the economic advisor saying that “both sides will suffer on this.” This statement could not be more true.

2. The American consumer spending ability is currently impaired due to the new 25% tariffs

The American consumer might be stretched (see record high nominal auto loan delinquencies, growing credit card write offs, etc) but it is NOT specifically due to the recent tariff escalation.  In fact, the American consumer has not seen a material increase in a lot of goods, since the tariffs started last summer. Over the last year, the business community has been spending billions of dollars in capital to build up inventory. This abnormally high inventory needs to be sold down (to consumers) before the higher ticket price items will come ashore. We project it will still be a few months before consumers see meaningful changes in the cost of goods. Lastly, which industries should you expect higher prices first? Industries that partake in highly competitive markets. In highly competitive markets, prices should match costs, so a tariff that increases costs for a business, will increase costs for a consumer.

3. The American consumer is taking the brunt of the US-China trade conflict

While the American consumer has really yet to see the full brunt of tariff escalation, the American supply chain system has come under pressure and has spent the better part of the last year trying to create alternatives. These other options are expensive and time consuming. Imagine being a US based auto manufacturer, whose plant needed 2-3 auto parts from China. These auto parts are on the tariff list and is the only place right now that makes it around the world with ready supply.

Does the manufacturer increase spending in the short term and go into the capital reserves to buy a massive amount of inventory to front run the increased tariff? Does the supply chain manager pay the additional cost there by hurting margins? And does it later plan to offset that lost profitability by decreasing expenses elsewhere (see cutting US based labor force)?  This does not even mention that businesses could possibly build infrastructure spending millions (or billions depending on the company and situation) and wait for the infrastructure to complete over the next couple of years. If the late 1980s were any guidance, the new supply chain infrastructure would probably be built in another low cost, cheap labor country like Vietnam, not the United States. All of these questions and considerations are currently being dealt with among all of the American based conglomerates that probably in your investment portfolio.