“One day, she’ll start sending you mixed signals, and you’ll get mad because she finally learned how to play your game.” – Unknown
“Hold out baits to entice the enemy. Feign disorder, and crush him.” – The Art of War by Sun Tzu
“A slander is like a hornet; if you cannot kill it dead at the first blow, better not to strike at it.” – Henry Wheeler Shaw, 19th century American humourist who used the penname Josh Billings
The United States is the only western country that continues to apply the death penalty to this day. Capital punishment is used as legal penalty across 31 American states and by the US federal government and the US military. The Bill of Rights – the first ten amendments to the US Constitution that were adopted in 1789 – included as part of the Eighth Amendment the prohibition of cruel and unusual punishment. Following the Bill of Rights, punishments such as drawing and quartering, public dissection, burning alive, and disembowelment were recognised as cruel and unusual punishments and consequently outlawed by the Supreme Court.
Capital punishment also survives in the People’s Republic of China till this day. Cruel and brutal practices in serving the death penalty were also abolished in China but much later than they were in the US. One practice used by the Chinese was particularly barbaric. Far more barbaric than any practice that may have been used in the US even prior to the passing of the Bill of Rights.
The ancient Chinese practice known as lingchi – more commonly referred to as death by a thousand cuts – was not officially outlawed in China until 1905. Lingchi was a long, drawn out punishment, intended to test how many cuts a person could withstand before dying.
President Donald Trump has this week announced plans to impose tariffs on Chinese imports amounting up to US dollar 60 billion. The plan is based on applying a 25 per cent import duty on a yet to be determined list of Chinese products. Mr Trump has unleashed the firing squad with the intent, according to US officials, of derailing Chinese high-tech ambitions. General Secretary Xi Jinping has identified ten key areas – such as robotics, electric and fuel-cell vehicles, aerospace, agricultural machinery and biomedicine – as part of his “Made in China 2025” initiative. These are the sectors that the Trump Administration aims to attack through the planned tariffs. Mr Trump and his band of trade warriors, not content with import tariffs alone, are also looking to introduce legislation placing new restrictions on Chinese investment into the US in the aforementioned industries.
In hope of rattling the hornet’s nest some more, the Trump Administration granted temporary exemptions – until 1st May – on steel and aluminium tariffs announced earlier this month to a number of US allies, including the European Union, Australia, South Korea, Argentina, and Brazil.
To top it all off, President Trump replaced national security adviser Herbert Raymond McMaster with super-hawk John Bolton.
In response to the US’s plans to introduce tariffs on Chinese imports, China’s Ministry of Commerce said it is planning to place import tariffs on 128 US products representing US dollar 3 billion in imports. Tariffs will be placed on products such as US steel pipes, recycled aluminium, pork, fresh fruit, and wine. To some Beijing’s reaction appears measured, to others it seems meek. In our opinion, Beijing has just made its first cut; it has a thousand more lined up. How many cuts they make depends on Washington.
Ever since Mr Trump abandoned the Trans Pacific Partnership, Mr Xi has taken it upon himself to become the primary advocate of global trade and in turn positioning China to play a greater global role. The measured response is sound politics. Beijing will not want to come off looking aggressive or to take steps that could derail global trade. For seemingly undue aggression from China would push Europe and other American allies to align with the US – something they have thus far resisted in doing.
Investment Perspective
Mr Trump, in our opinion, is not the crazed madman with too much power to wield as some segments of the mass media would have us believe. Instead, we think he has two immediate goals in mind when it comes to China: to shore up his voter base; and to send China the signal that the rules of engagement have changed. The latter goal is something a number of commentators and analysts have pointed to while citing Mr Trump’s interview with Oprah Winfrey in 1988. While we have no reason to doubt that Mr Trump indeed is approaching the situation in the way he described he would to Ms Winfrey three decades ago, we must also accept that the world we live in today is drastically different to the one that existed at the time of that interview. The rise of China is amongst the most far-reaching changes over the last three decades.
Before the rise of China, the US was already running trade deficits – in effect borrowing US dollars – and supporting the internationalisation of leading US companies. These companies invested all over the world and became what today are commonly referred to as multinational corporations. These multinationals used, in effect, US debt to fuel international expansion and generated returns that far exceeded the interest cost the US incurred on its debt. The end result being that the US was able to collect the spread between the return on investment on the multinationals’ international operations and the cost of its debt.
The rise of China has had a profound impact on the above described dynamic. First, it has led to US multinationals earning much higher returns on their international investments. Second, China has as a matter of policy helped reduce the cost of US debt. The end result: the US earned an even juicier spread on its international investments.
As any corporate financier worth their salt will attest to, when such a spread is available to exploit you should continue to add leverage till the point the marginal benefit of additional leverage is zero. And this is exactly what the US did. Wall Street won at the cost of Main Street.
Donald Trump by unleashing a trade war is attempting to reverse this trend. The consequence of which is that the US’s net investment income that has been positive for so long will turn negative. Leverage after all cuts both ways. For his protectionist policies to yield long-term results tariffs may not be enough, however. Mr Trump will need both a much higher interest rate and a stronger US dollar. Given where US debt levels stand and the US Treasury’s borrowing needs for the coming years can the US withstand this policy? We think not.
We do not want to be long the US dollar. Tactical positioning aside of course.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.