Something Will Be Done, But No 'Global' Trade War In The Cards

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by: Michael Chandler

Summary

The trade deficit for 2017 was approximately $566 billion, $375 billion was with China alone.

Of the $566 billion trade deficit, China, Canada and Mexico make up $464 billion.

In my opinion, a negotiated resolution in these three countries hardly constitutes a “global” trade war.

Tech companies particularly have an enormous price to pay because many are required to give their Intellectual Properties to the Chinese Government before they can do business there.

I have stated in recent articles I believed there is little chance the administration takes us into a full-fledged global trade war. Today, I will explain my rationale, but before I do let’s discuss our current trade deficit and clearly define the advantages of its reduction or elimination.

The trade deficit for 2017 was approximately $566 billion. Keep in mind we had like-size trade deficits going back several decades. Our trade deficits have gone basically parabolic since NAFTA approval, as shown in the chart below.

See the source image

This chart clearly shows not only the increase in a trade deficit but a period where the US lost most of its manufacturing to cheaper labor and lower corporate tax rates abroad. Post NAFTA, you can see where our trade deficit went from $200 billion to well over $800 billion in an 11-year timeframe. For the last 12 months, that deficit is $566 billion.

As you can see, there are several trade agreements which we entered since 1979, many of which set the stage for the massive increase in trade deficits. These trade agreements allowed for corporations to move their companies or at least their manufacturing abroad. You certainly cannot blame the corporations for moving to those countries where they had lower costs of production to include labor.

To add to the attractiveness of lower labor costs, US tax rates have been approximately 10% higher than most other developed countries. Since 1991, the US corporate tax rate has been between 35 and 39%, whereas the rest of the developed world has been somewhere between 25 and 29%. Therefore, corporations moved to become globally more competitive. Once abroad they could export their manufacturing goods back to the United States, creating an enormous and growing trade deficit.

See the source image
Now here is where it gets interesting!

Of the $566 billion trade deficit over the last 12 months, $375 billion came from China. In fact, our trade deficit with China has steadily increased from $318 billion in 2013 to where it is today. Most of the remaining trade deficit came because of NAFTA.

See the source image

It appears to me a resolution of trade issues between the United States and China combined with a friendlier US-based NAFTA agreement would solve most of this trade deficit.

Those of you that are iPhone owners or iPad owners need to turn your phones over and see where they are manufactured. 95% of all iPhones and iPads are assembled in China. My second point is that 70% of all cell phones of all types are assembled in China.

Furthermore, according to the New York Times the cost to manufacture an iPhone in the United States is $65 more than manufacturing it in China, where it costs an estimated $8. With this kind of difference in labor costs as well as tax advantages, it becomes difficult for Boards and CEOs not to move manufacturing abroad.

However, many Tech companies, particularly, have an enormous price to pay because many are required to give their Intellectual Properties to the Chinese Government before they can do business there.

Although piracy and counterfeiting remain issues in China, the two newer forms of siphoning off foreign IP value are theft - often cyber theft - of extraordinarily valuable trade secrets and know-how, and the technology transfers required of American and other foreign companies as a condition to doing business on Chinese soil.

China has been notorious for stealing IP and producing like products. On May 15th, 2016 Newt Gingrich was quoted as saying “The Chinese last year probably stole $360 billion in intellectual property from the United States.” The $360 billion figure is based on a federal estimate, though experts caution that the true number is impossible to know. It could be higher. His numbers were verified by William Evanina, director of the Counterintelligence and Security Center. In fact, Evanina suggested the $360 billion represented losses from cyber-hacking alone!

As you can see we have reason to take a strong stand on trade with China.

The goal of Trump’s new trade measures is to persuade Beijing to stop strong-arming U.S. companies into surrendering technical secrets in return for market access.

Qualcomm (NASDAQ:QCOM), which got 65 percent of its annual revenue from China last year, is among scores of U.S. companies that have handed over technical secrets in ostensibly voluntary transactions that critics say were anything but.

In 2016, the San Diego-based developer of advanced computer chips committed to license its proprietary technology to a joint venture controlled by the provincial government of Guizhou.

In addition, just last week the Administration proposed a 7-year ban on the sale of technology components to China from the US. This suggestion certainly fell on open ears.

China’s ZTE Corp. blasted the U.S. government decision to impose a seven-year ban on its purchases of crucial American components, calling the move "extremely unfair" and "unacceptable."

Just a few weeks back, the administration disallowed the sale of Broadcom to Qualcomm because of Qualcomm’s China connection. The administration's justification was based on National Security.

This is of great concern to many technology companies, not just Apple (NASDAQ:AAPL).

My guess is with trade negotiations going on with China, Apple is a little bit concerned, as well they should be. The recent pressure we have seen on Apple stock may be partly due to Apple having all its apples in one basket i.e. China!

I made a statement in my opening paragraph that I did not believe there would be a full-fledged global war on trade. Here is why!

China - $636 billion traded with a $375 billion deficit.

Canada - $582 billion traded with an $18 billion deficit.

Mexico - $557 billion traded with a $71 billion deficit.

Japan - $204 billion traded with a $69 billion deficit.

Germany - $171 billion traded with a $65 billion deficit.

Of the $566 billion trade deficit, China, Canada and Mexico make up $464 billion. As I’ve indicated previously, it appears an agreement in NAFTA is forthcoming. This should be announced in the next few weeks.

China, on the other hand, will be more difficult. Keep in mind the cost of doing business in China is giving up intellectual properties to the government. China is dependent upon these companies selling them components made throughout the world. From that perspective, you may be able to build a case for somewhat of a more global trade war.

Most of these companies that are manufacturing these components are doing so from Asia. All these companies doing business in China are losing their intellectual properties by being forced to hand them over or by outright theft.

The elimination of the theft of intellectual properties would be a huge advantage to all these global companies. Therefore, in many ways the ongoing trade negotiations with China could be a windfall for all companies doing business in China.

Many of the countries participating in the Trans-Pacific Partnership are developing countries throughout Asia and all would love to do business with the United States under the TPP. Assuming through negotiation we could eliminate China’s manipulation of currency as well as the issues regarding intellectual properties, I believe reentry into the TPP could be a reality.

In summary, there are only a handful of countries that account for nearly all our trade deficits. China, Canada, and Mexico account for 82% of our current trade deficit. A resolution of the trade issues surrounding these countries could go a long way to turning around our trade deficits. It would help increase our exports as well as support bringing manufacturing jobs back to the United States.

Clearly, there is a lot at stake and it won’t be easy.

In my opinion, a negotiated resolution in these three countries hardly constitutes a “global” trade war.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.