Trade War Explained: Where we are and where we are headed

For years, the United States was the biggest producer in the world. Its industries created millions of jobs in the country and exported most goods to the rest of the world. Under the Bill Clinton administration, US companies started asking for an opening to do business in countries like Mexico and China. They hoped that this will help lower their wages and make huge profits. This came to pass as the administration signed NAFTA into law. NAFTA is a deal that removes tariffs on most goods traded among United States, Mexico, and Canada.

At the same time, the Bill Clinton administration started pursuiding China to change its market structure to allow competition. To do this, the administration negotiated a deal in which the country would become a member of the World Trade Organization (WTO).

More than 20 years afterwards, China has continued to grow and accumulated more than $10 trillion in gross domestic product. Attracted by the huge Chinese market and the cheap labour, companies like Procter & Gamble (P&G), Clorox, and Nike moved their production there.

The result for all of this was that the US was now importing more goods than it exported. When this happens, it leads to the trade deficit to widen. A trade deficit is a simple term that subtracts the exports from imports.

The role of Donald Trump in Trade War

As all this was happening, Donald Trump was building his empire in New York. He was observing the widening trade deficit and writing about it in paid advertising in New York Times. In 2016, he became president and spent the first one year doing the tax reform. In these reforms, he advocated for large corporate tax cuts with the goal of returning the companies that disappeared to the US.

During the second year of the presidency, he started to focus more on trade. The first action was to place a tariff on imported washing machines. He then moved swiftly to put tariffs on imported steel and aluminum. Shortly afterwards, he announced that the US would add tariffs on Chinese goods worth $60 billion. After a few months, he added tariffs on more Chinese goods worth more than $200 billion. China responded swiftly and announced that it would impose tariffs on US goods worth $60 billion.

As you have observed, the US is able to impose more tariffs on Chinese imports because it imports more. In 2018, the country imported goods worth more than $557 billion and exported goods worth just $137 billion. However, the goods that China imports from the US are very sensitive to the US market.

After meeting with XI in Argentina, the president announced a ceasefire that saw teams from the two countries restart the negotiations. A few weeks ago, these talks broke down and Trump added 15% tariffs on Chinese goods worth $200 billion. The country also added Huawei on the so-called ‘entity list’. Effectively, this was supposed to criple the company because it depends a lot on US suppliers.

Why the US could lose this Cold War

Ultimately, the US is at a disadvantage in this cold war. This is simply because, while China exports a lot of goods to the US, these goods are manufactured by American companies. In fact, very few Chinese companies do business in the US. In addition, most American companies do business in China. As such, the country could effectively block and make these companies suffer. For example, it could ban a country like Tesla that is building a plant in Shanghai in favor of the local electric vehicles.

Another reason why the US will likely lose the trade war is that Trump is considering the next general election. This means that he has a short horizon on the deal. Xi on the other hand has no term limits, which means that he has a long-term view on the talks. In addition, with the US congress and senate being divided, it is highly unlikely that Trump will have any success on trade.

Last week, he turned his attention to Mexico, which is the third trading partner of the US. In a series of tweets, he said that the US will start imposing tariffs on all Mexican goods. This comes as the three countries move to ratify the new USMCA deal. His reason for the current tariffs is to pressure Mexican authorities to do more on immigration. Still, Americans will suffer because of the vast amount of goods manufactured by American companies in Mexico do.

Therefore, as traders, it is important to have the ongoing trade conflict at the back of your mind because of everything that is going on. A single tweet can lead to sharp movements in the financial market. In fact, last week, the Mexican peso dropped by more than 5% after the single Trump tweet.

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