Geo Political Economics

[cdrom]

The Unintended Consequences Of The China Trade War

https://www.forbes.com/sites/kenrapoza/2019/06/26/the-unintended-consequences-of-the-china-trade-war/#436947ce6ba0

Every war has collateral damage. When it comes to the China trade war, the long-term dominance of the U.S. is one of them.

Consider this: Many people in the world have a smartphone. Judging by the bestselling phones in the world, they run on two operating systems. One is made by the Cupertino, California-based Apple. The other is made by Mountain View, California-based Google. Two companies. One state. One country. They control the smartphone market worldwide.

When China buys soybeans from Brazil, they pay for it in U.S. dollars. Most of the cars on the road in Beijing are American brands.

Russian president Vladimir Putin once said in an interview with Hollywood filmmaker Oliver Stone that when the Soviet Union collapsed, the new government believed the U.S. was their friend. Mostly all of their government computers run on American-made software. Surely, that is changing now.

President Trump might not last the entirety of this trade war. He might not see it through to the end, which in Washington terms means a decoupling from China as the go-to manufacturing center.

But what Trump did was sew a sense of uncertainty with Washington that got countries thinking. Be it China or Germany or Russia—why be so dependent on the U.S.? Especially with respect to core technology like the one powering all-essential smartphones and computers.

“It’s going to be an interesting next 20 years to see if this little snowball at the top of the mountain falls apart or keeps rolling down the hill and gains so much momentum that you can’t stop it anymore,” says John Scannapieco, a shareholder in the Nashville office of law firm Baker Donelson and co-leader of their Global Business Team advising both U.S. and foreign companies on trade matters.

“People are starting to say, ‘Wait a second, should I still rely on these folks?’ The trade war from our side is primarily about decoupling China from the U.S. supply chain. I get it. But these policies that Trump is pursuing also gives the rest of the world an argument to decouple from the U.S.,” Scannapieco says.

China will undoubtedly take the lead on this. How far of a lead is anybody’s guess: a few feet forward, or a country mile? No one knows yet. To listen to China, they are light years behind the U.S. in technological innovation.

China’s leading telecommunications system manufacturer, Huawei, is no slouch. They are on par with the U.S. in terms of 5G development. But they need U.S. hardware to complete the task.

Their Android-powered smartphones are now the No. 2 selling smartphone in mainland China, ousting Apple from that spot.

Huawei faces restrictions in buying American-made microprocessors for its equipment. So Huawei is now rolling out their own operating system for smartphones, a move that will further erode Apple’s market share in China. And Google’s Android, led by Samsung phones.

All Beijing has to do is wave its magic wand and mandate all government employees to have phones with the Huawei OS and soon midlevel companies like Xiaomi and smaller players like Vivo and Oppo would issue phones on the Huawei OS in addition to Android.

In Europe, countries are trying to figure out ways to avoid U.S. sanctions on Iranian oil.

Russia is trying to approximate with China and figure out a way to seriously increase trade in each others currencies instead of dollars in preparation for a worst-case scenario that has Washington cutting them off from dollars someday.

“The unintended consequence will be a three-track world, with a generalized return to heightened state intervention,” says Kim Catechis, head of global emerging markets for Martin Currie, an Edinburgh, Scotland-based wealth management firm.

If decoupling from China also means decoupling from America, then three distinct camps could be carved out of the ashes of globalization: a U.S.-led one, dominant in the Americas, a China-led one dominant in Asia, and an “Old World Order” of increasing economic and political interdependency limiting cross-border investment.

For many years now, at least since the end of World War II, the U.S. led the world in soft power. Everyone wanted McDonald’s, Coca-Cola, Disney, Hollywood and American music.

Over the years, that soft power has eroded a bit only thanks to the inclusion of other sources of content (think Pokémon, for instance) and the personal tastes of a well-traveled, global middle class.

But on many key issues, namely core technology, the U.S. is as indispensable as China is in its role as the world’s assembly line. The trade war threatens to undercut the U.S. position, chip away at its dominance.

China plays the starring role in the erosion of U.S. market share in mainland China and throughout Asia. But European and Japanese companies should not be discounted. There is more disdain in Europe for companies like Google and Facebook than there is for Huawei and Alibaba. The trade war only exacerbates that disdain.

“The world is moving toward another extended period of political and economic divergence, with some similarities to the original Cold War, but in many ways more invasive and more dangerous,” thinks Catechis.

The longer-term impacts and the degree to which value chains and decision-making processes are permanently disfigured appears to be underappreciated by investors.

Ask anyone serving multinational, American clients—a law firm, a consultancy—and they will all tell you that when the trade war began last summer, no one was talking about leaving China. Then September 2018 came, and Trump slapped 10% tariffs on $200 billion worth of China sourced imports. Still, most thought it would blow over.

The Yangshan port in Shanghai. Investors have not been able to decipher what decoupling from China means from the marco perspective. There are just too many companies involved.ASSOCIATED PRESS
By October of last year, Trump and China’s president Xi Jinping announced a cease fire on tariff hikes. They would talk it out for 90 days. Tariffs that were supposed to go to 25% were on hold. Everyone pretty much thought that this was as bad as it would get for tariffs.

Then May came. Trump hiked tariffs to 25% as promised. Now nearly everyone is thinking about moving. Many in the market are assuming tariffs on $300 billion more Chinese goods.

“One of our clients who had 100% of their manufacturing sourced through a contract manufacturer in China, and when we first engaged them last fall about this they said, ‘Don’t come and talk to me about changing my supply chain, because we spent a lot of time setting it up and it runs efficiently, and we don't want to break anything unnecessarily,’” says Brian Dunch, the global trade services leader at PwC. “That has completely changed now,” he says. “Now the discussion is: How do I do this?”

That’s not an anomaly.

To think China is considering the same, either by moving parts of their manufacturing to Southeast Asia or even to Mexico, is a fool’s errand at this point.

To think that if Trump was to get reelected, and the trade war were to escalate, that countries in Europe wouldn’t consider the same is like putting your head in the sand, trying to look for rainbows and unicorns in the clouds.