June 4, 2019. By Mark Barry:

For over a year the United States and China have been engaged in a contentious trade dispute, as the United States has taken a more assertive approach in an attempt to address what it views as unfair Chinese trade practices. Namely these practices include large-scale theft of intellectual property, forced technology transfers, industrial subsidies to SOEs (state-owned enterprises), and various barriers to market access for US companies operating in China. Negotiations between the two sides had been ongoing for several months in an effort to reach a comprehensive trade deal, and in late April we heard positive messages from US and Chinese negotiators that a deal was in sight.

However, negotiations fell apart quickly in mid-May, with the US announcing they will increase tariffs on $200B worth of Chinese goods from 10% to 25% and would look to raise tariffs on all the remaining imports from China (which total about $300B). Accounts vary on the cause of the breakdown, with the US side claiming that China significantly revised the text of the deal at the 11th hour, while the Chinese later responded by stating that the US kept adding additional unreasonable demands to the agreement. While the truth may lie somewhere in the middle, it appears that when the draft agreement was circulated amongst the higher ups in the CCP (Chinese Communist Party) they balked at several items, chiefly proposed changes to Chinese law (as related to intellectual property protections) and enforcement mechanisms for the deal. This then resulted in the dramatically revised version of the text that proved to be a non-starter for the US.

US-China Trade War Timeline of Key Events

Source: Goldman Sachs Asset Management

With the collapse of negotiations, the US-China relationship has deteriorated with both sides digging in to their respective positions. The Chinese state media apparatus has ratcheted up its nationalist rhetoric and President Xi Jinping gave a speech telling the country to prepare for a new Long March. Meanwhile the US has put Chinese tech titan Huawei on the Commerce Departments export blacklist – this is a major escalation in the dispute as it curbs Huawei’s ability to purchase US hardware and software which would have a severe negative impact on the company. Major US companies such as Intel, Qualcomm, and Google have already moved to cut off deliveries to Huawei and in the case of Google their apps and Google Play store will not be usable on any Huawei phones. While China has not yet retaliated for the US blacklisting of Huawei, they have hinted at potential actions such as the halting of rare earth shipments to the US.

While the breakdown of trade negotiations has rattled financial markets, the selloff has not been overly excessive, and it appears investors are simply backing away from previously inflated expectations for a comprehensive trade deal (which we did not share). The markets’ relatively sanguine reaction will likely give President Trump confidence to push forward with tariffs and avoid signing a deal that doesn’t address the primary US complaints. However, these tariffs will have a negative impact on both economic growth in both the United States and China, and while the direct hit to GDP may seem tolerable at face value, it is likely to be exacerbated by additional indirect effects.   

Source: Goldman Sachs Asset Management

The next development in this saga will be the planned meeting between President Trump and Xi Jinping on the sidelines of the G20 meeting June 28-29 in Japan. At this point unfortunately it appears the best we can expect from this meeting is a ceasefire; it is highly unlikely a comprehensive trade deal is agreed to by the end of June. The two sides have left the door open to continue negotiations, as averting a full-blown trade war is in everyone’s best interest, but as of right now a comprehensive trade deal does not seem within reach. We will be watching closely for any signs of détente in the coming weeks, but the US-China trade dispute is part of a larger geopolitical competition between the two powers, and even if some form of trade deal is eventually signed the US-China relationship will remain as a source of volatility for the financial markets into 2020 and beyond.