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Trade war endgame?

17 May 2019

3 minute read

Further tit-for-tat tariffs between the US and China have spooked markets that were perhaps prematurely spending the gains from an expected agreement. This week, we explore the potential for a deal still to be struck and what the world and its capital markets might look like if it isn’t.

Who's it for? Confident investors

What you’ll learn:

  • The latest developments in the US-China trade dispute
  • Why a solution is yet to be found
  • The likely outcome and what investors should do

The temperature is rising again in the global trade arena. Further tit-for-tat tariffs between the US and China have spooked markets that were perhaps prematurely spending the gains from an expected agreement. This week, we explore the potential for a deal still to be struck and what the world and its capital markets might look like if it isn’t.

The latest

On Friday of last week, the US went ahead with a scheduled increase of tariffs on $200bn of Chinese goods from 10% to 25%. Furthermore, the administration is now threatening tariffs on the remaining $300bn (approximately) of Chinese imports. The Chinese themselves have retaliated with their own set of tariffs.

What is the hold up?

China is baulking at the continuing US insistence that China amend laws (not just regulations) relating to the transfer of intellectual property (IP). On the US side, there is considerable resistance to the Chinese demand to roll back all tariffs as soon as a deal is struck.

We have argued in the past that China may actually benefit from bowing to US demands on the treatment of IP. There is plenty of evidence to suggest that innovation is unlikely to sustainably flourish without stronger and more evenly enforced IP laws – innovators tend to have less incentive to innovate if they suspect their successes could be easily appropriated by someone else.

Many in the Chinese administration still rue the fact that China effectively ‘missed out’ on the first industrial revolution of the early 18th century and see this as key to explaining the ‘century of humiliation’ that followed. In order to avoid a repeat period of domination (and humiliation) by foreign powers, it is therefore essential that China operates at the commanding heights of the goods and services at the centre of today’s own industrial revolution – from robotics to artificial intelligence.

To this end, the last few years has seen an increasing drive, by both fair means and foul, to acquire and absorb technology from other countries and companies. Of course, China wouldn’t be the first country to follow this path. The US was famously acquisitive in the early stages of its surge to the top table of the world’s powers.

Can a deal be found?

Tariffs hurt both economies. The bill will be footed by consumers and businesses and eventually governments via lower tax receipts. On the US side, the administration can probably take some solace in the fact that they don’t have to face the electorate until next year, but also that this is an issue that garners strong support across the political spectrum – this is not just a President Trump issue. For China, there is some scope to support economic activity, but it will hurt nonetheless. We still suspect a deal is likely.

In most negotiations, one tends to find that the easiest issues are thrashed out first, to build confidence and a degree of trust before the thornier, more apparently unsolvable issues are tackled. Both sides likely want a deal, but also need to present a win to their domestic audiences. President Trump will likely find a deal that lacks changes to Chinese law difficult to sell.

The world economy still looks good enough to bet on for the long term, even if the West’s answers to this apparent crisis seem to lack a bit of imagination at the moment.

The longer term answer?

For investors, it may not matter so much who ‘wins’ when all is said and done. The fruits of innovation tend to eventually be shared around the world’s corporate sector. We would urge investors to look through to the other side of this trade skirmish, and the likely accompanying turmoil. The world economy still looks good enough to bet on for the long term, even if the West’s answers to this apparent crisis seem to lack a bit of imagination at the moment.

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You should only be thinking about holding these investments for at least five years as they’re designed for the long term.

All of these investments can fall in value as well rise; you may get back less than you invest.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice. If you’re not sure about investing, seek independent advice.

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