Photo Credit: PAS China

President Trump has been promoting a trade war with China. His defenders argue it is time to rebalance what has been a win-lose trade relationship. Although there are positives in getting cheap goods from China that the trade balance can’t capture, it is true that China’s long growth spree should be accompanied by a different approach to international trade.

However, although reluctantly, China seems open to change its posture in the international markets. The Asian giant seems open to import more products from abroad and stimulate its internal market.

The trade war

While I agree that previous US administrations have been too soft on Chinese trade policy, I think that the approach of shooting first and negotiating latter might have many unintended consequences.

Putting tariffs on Chinese goods is not a win-win strategy Inflation should start rising in less than a year. Exports will be affected by higher prices from imports. In China, the problems are similar with one catch – the US dollar strength is Yuan’s weakness. And, that will offset part of the tariffs effect.

The problem lies in what might be a wrong diagnosis. People are emphasizing too much China as the source of the US trade deficit. One might argue the tax reform is the main responsible for the trade deficit. Basically, the fiscal reform results in collecting lower corporate tax revenue, while spending the same, thus broadening the budget deficit. This has propped up the stock market, creating a wealth effect that, usually, results in credit expansion and higher consumption. It is that last item that stimulates imports.

It would be preferable to see the current administration tackling the budget deficit and reducing the debt-to-GDP ratio. If they did that, probably, the import stimulus induced by the budget deficit would be reduced, shrinking the trade deficit. In my opinion, doing both, the tit for tat negotiating approach and reducing the budget deficit, would do wonders for the US economy. It would tackle at once many of the long-term frailties of the economy, strengthening the crisis resistance of the whole country.

Instead, the current administration is opting for fiscal stimulus, inducing a budget deficit in good times. It may even go after an infrastructure stimulus, by asking the Democrat’s help in the Congress. That might end up being the fuel for an inflationary debt crisis in the US.

Takeaways from the trade war

However, before the catastrophe materializes, the sun will keep shining. The US is still the biggest stock market in the world, and there is a huge bias in its favor versus the Chinese market. Therefore, we should expect the USD to keep its strength, and the Chinese market to maintain its weakness.

In my opinion, the current weakness in the Chinese market is a great opportunity to reformulate investment portfolios around the globe by adding emerging market positions. On another note, the current US excesses, and the USD appreciation make me eager to keep gold (GLD) under close watch.