China Tariffs: Big Overtime for Lobbyists, Small Share of Total Imports

Editors’ note: Our political commentary is non-partisan by design. We assess politics solely for its potential market or economic impact, and we believe political bias blinds investors and raises the risk of error.

President Trump generated a bunch of overtime for lobbyists and Treasury officials on Thursday, announcing plans to levy tariffs on around $60 billion (or $50 billion, according to White House aides) worth of imports from China and adopt new restrictions on Chinese investment in the US. Ostensibly, the move is retaliation for what the administration describes as “unfair” trading practices, including China’s subsidizing key domestic industries, putting byzantine restrictions on inbound foreign investment and forcing firms to hand over trade secrets in order to do business there. But reducing the allegedly “out of control” trade deficit also seems to be a primary aim. Now that Trump has signed the relevant executive order, we enter a 15-day public comment period, during which businesses can weigh in on which of the 1,300 product categories under consideration for tariffs should be on the final list. Meanwhile, the Treasury gets 60 days to figure out those investment restrictions. For its part, China is pledging both to speed up market liberalization, potentially addressing many of Trump’s concerns, and retaliate with tariffs of its own. So there is much trade-war chatter, with many blaming Thursday’s market volatility on these tariffs. Yet in our view, it is premature to draw firm conclusions. Given the number of moving parts and broad opposition to these tariffs from many US businesses, congressmen and administration officials, it is entirely possible these tariffs could end up as watered-down as the steel and aluminum tariffs. Also, when put in proper scale, these tariffs are actually very small. Patience, as always, is key for investors.

At the risk of delving into sociology and triggering people’s political biases, we think it is worth noting that the Trump administration has a tendency to start negotiations with bombastic threats, then slowly moderate to something resembling a conventional Beltway approach. “I will build a border wall and make Mexico pay for it,”^[i] for example, largely morphed into “let’s continue the Bush and Obama administrations’ policies of heightened border security, forget adding fencing in illogical places like impassible mountain ranges, respect private property rights, and have Congress appropriate federal funding for security as needed, consistent with standard procedures.” “Repeal and replace the Affordable Care Act” largely turned into “patch it where needed if Congress can agree on it, and if they can’t, oh well.” Yuuuuuuuuuuuuuuuuge tax cuts turned into watered-down tax tweaks and added tax code complexity. Oh, and those sweeping steel and aluminum tariffs? They are now “tariffs for everyone except Mexico, Canada, Australia and everyone who is presently talking to us about exemptions, which includes the EU, South Korea, Argentina and probably Brazil.” (For those scoring at home, that list includes five of the largest sources of US steel imports.) As others have noted, these all match the negotiating strategy Trump described in that 1980s literary classic, The Art of the Deal.

Based on these precedents, we believe it is fair to consider today’s announcement the starting position. The next 15 days are the negotiating period. During this period, big and small businesses alike will turn their metaphorical garden hoses on this proposal, in an effort to water it down as much as possible. In one letter, 46 industry lobby groups covering just about all of the economy have registered their official opposition. They will be busy. So will many lawmakers, particularly Republicans who don’t want to face campaign trail pushback about higher consumer goods prices offsetting tax cuts. Chinese Premier Li Keqiang might reiterate his pledge to slash tariffs, improve foreign competition in the service sector and improve intellectual property protections. He might unveil the practical details everyone has been waiting for since he first previewed this at the Communist Party’s annual confab this month. There is a lot of room here for the administration to dilute the tariffs while also claiming victory—just as they seem to be doing now with the steel and aluminum levies. Alternatively, lawmakers could band together and pass a bill to reclaim the trade authority they ceded to the executive branch several decades ago.^[ii] (And pigs might fly, but you never know.) 

We aren’t here to comment on the wisdom of trying to use protectionist threats to goad trading partners into dropping their own barriers. Nor are we going to weigh in on the moral and philosophical questions surrounding China’s habit of wrangling source code, specs, diagrams and other trade secrets from foreign firms trying to do business there. But given markets’ general preference for free trade, free-flowing capital and genuine competition, we happen to believe China and the entire world would benefit if China eased its rules for foreign investment and dropped some tariffs. There is a reason America and Europe moved on from mercantilism a couple centuries ago. While it is impossible to know how this story concludes, we think it would be too myopic not to consider all possible outcomes—including a somewhat less mercantilist China.

“Wait and see” can be a frustrating tactic, especially when headlines are screaming. But consider it this way: Markets discount widely known information. Expectations for $60 billion in tariffs and corresponding retaliation from China are probably baked into prices now. If Thursday’s volatility is any guide, investors are generally unhappy with this possibility. But as markets look forward, they move most on the gap between expectations and reality. Compared to what people evidently fear today, even watered-down tariffs would be a positive surprise. Heck, even simple math might be a positive surprise: $60 billion amounts to just 2% of total 2017 imports. That is … not a lot. If China retaliates in kind, they would apply further tariffs to just 2.6% of the US’s total 2017 exports.^[iii] That is also not a lot. Seems to us like there is a lot of room for negative sentiment to catch up to a more benign reality.

Or, think about it from our old pal Ben Graham’s perspective: As he famously quipped, markets are voting machines in the short term and weighing machines in the long term. Today, investors frantically hitting “sell” after Trump’s announcement voted their dislike. And the S&P 500 fell -2.5%.^[iv] Only when the details of this become clear can markets start the process of weighing them and scaling the likely impact on economic growth and corporate earnings. So instead of reacting to other people’s reactions after a bad day, is it not more prudent to take a deep breath and wait for more actionable information?

History has repeatedly shown investors who react to headline news shoot themselves in the foot. Your gut instinct might disagree with this statement, but last we checked, guts are incapable of seeking perspective and additional facts—not to mention analyzing those facts. Analysis takes time, and it is one of an investor’s best, most faithful allies when headlines are screaming and markets are gyrating. If careful analysis does eventually suggest there is a high likelihood of a trade war causing a bear market, there will likely be other opportunities to adjust portfolio positioning accordingly. For now, though, based on all available information and the very small scale of these tariffs, we think we simply aren’t at that point or anywhere close to it.