U.S. And China: As The World Turns

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by: Michael Chandler
Summary

The International Monetary Fund estimates tariffs imposed on China could shave 1.5% off their GDP. Here in the US, the reciprocal tariffs could shave .50% to 1% off the US.

In a recent report, J.P. Morgan estimates the cost of the iPhone would increase 14%, should these tariffs be implemented.

The biggest issue may not have anything to do with the current tariff battle or even the trade deficit. It may very well have everything to do with IP theft.

It seems like a month ago we were 95% sure there would be a trade agreement with China. We were wrong, and it now appears this could escalate and extend many months before coming to some sort of conclusion.

The International Monetary Fund estimates tariffs imposed on China could shave 1.5% off their GDP. Here in the US, the reciprocal tariffs could shave .50% to 1% off the US gross domestic product.

I think Alan Greenspan hit it right on the head when he stated this morning on an interview on FBN that there would be a clear winner but both countries would lose. He went on to say that tariffs are an excise tax which, directly or indirectly, will be passed on to the consumer.

Currently, the US imports $535 billion worth of goods and services from China. 25% tariffs have been placed on $200 billion of those imports. The President has warned that the remaining $335 billion of imports could be subject to the same 25% tariff. In this potential second tranche of tariffs, we find telecommunication and technology among the sectors subject to this second levy.

50.1% of the world’s supply of cell phones are exported from China. Nearly all the production for Apple’s (AAPL) iPhone is exported and assembled there too.

In a recent report, J.P. Morgan estimates the cost of the iPhone would increase 14%, should these tariffs be implemented. The iPhone XS would increase from $1000 a unit to $1142. This is simply one example of what Alan Greenspan was referring to when he said there would be a drag on the US consumers' purchasing power.

It is important to remember that $535 billion in imports from China is a small percentage of a $21 trillion economy. Nonetheless, it can, and will, cost the American consumer.

Many believe China has offset much of the first tranche of tariffs by allowing their currency to fall in value against the dollar. Over the past 12 months, the Chinese yuan has drifted up from 6.37 to 6.88 yuan per dollar. Keep in mind that this devaluation of the currency harms consumers in China. You see, they experience imported inflation as a result.

It’s no wonder President Trump has been urging the Federal Reserve to cut rates. On Wednesday, he encouraged the Fed to match Chinese rate cuts going forward. His objective is designed to offset any further devaluation of the Chinese currency.

China exports more than $2.2 trillion per year, and currently, is the largest exporter in the world. They import $1.7 trillion. The US imports 18% of China’s exports, which contributed to a $419 billion trade deficit for the US with China in 2018.

One of this administration’s goals in its current trade talks is to eliminate this trade deficit. With the Chinese per capita GDP-PPP approximately $15,308, and the US per capita GD-PPP exceeding $59,000, it is easy to conclude that the lower labor cost in China has been enticing for US companies. Apple, like many companies, has moved its manufacturing to China as a result. Another objective of the current administration’s trade policy has been to entice some of these companies to bring their production back to the United States.

In a recent research note from Bank of America, it was concluded that the cost of an iPhone would increase by 20% if Apple were to move its manufacturing back to the US. Keep in mind, according to J.P. Morgan, the increased cost in the iPhone due to tariffs is 14%. Therefore, tariffs placed on China alone would not be enough to incentivize the company to move its production back to the United States.

On the other hand, it might very well entice many of these companies to leave China and move to other emerging markets with similar labor cost and no tariffs.

As you can see, no one wins the tariff war. Ultimately, the consumers will end up holding the bag.

The biggest issue may not have anything to do with the current tariff battle or even the trade deficit. It may very well have everything to do with IP theft and national security.

Just this morning, the President signed an executive order giving the commerce secretary the ability to halt international companies from selling their products in the US. Furthermore, those US companies selling components to suspected foreign companies involved with IP theft and national security issues may also be blocked.

The President’s target here is Huawei. Huawei is the second-largest producer of cell phones in the world. Samsung (OTC:SSNLF) is the largest, followed by Huawei and then Apple. Huawei has had a history of IP theft and is currently under investigation by the DOJ for violating trade sanctions imposed on Iran.

Huawei is a leader in the rollout of 5G Wi-Fi technology. This new technology is ten times faster than the current 4G technology used today. The company does business with approximately 80 countries. 6.6% of its business is here in the US. Its focus is on bringing Internet capabilities to rural areas. The company has a substantial presence in Latin America and Africa.

It’s a well-known fact that Huawei is influenced by the Chinese government. The security concern is that as the company rolls out its 5G networks, they could easily be hacked by the Chinese government. The US does not stand alone in its concerns, as Huawei is currently blocked from Australia, New Zealand, and Japan. Germany has accepted its 5G platform, but England, among other European countries, is considering blocking it too.

As I mentioned, only 6.6% of Huawei’s revenues come from the United States. Therefore, blocking the company's goods and services would not have a considerable impact on Huawei, or at least it would be able to overcome such a loss.

The big issue is the fact that it is dependent upon 33 US companies for their components, including the likes of Qualcomm (QCOM) and Intel (INTC). Blocking Huawei's access to the parts produced by these 33 companies could very well bring the second-largest cell phone producer in the world to its knees.

China was swift to respond to the executive order signed by the President. They indicated they currently had no plans for further trade talks going forward.

It seems like a month ago we were 95% sure there would be a trade agreement with China. We were wrong, and it now appears this could escalate and extend many months before coming to some sort of conclusion.

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.

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