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Tangerine White Paper: U.S. Tariffs on Chinese Imports Raised to 25%

Tangerine White Paper: U.S. Tariffs on Chinese Imports Raised to 25% What’s Happening:  Lots. In early May of 2019, China and the U.S. appeared to be progressing towards finalizing a trade agreement that reports suggested was about 95% complete. At some point those negotiations took a seriously wrong turn, President Trump issued a pair of incendiary weekend tweets, scheduled talks failed to lead to a resolution, and everything just kind of fell apart.

On Friday, May 10, 2019, the Trump Administration raised the prevailing tariff rate from 10% to 25% on approximately $200 billion of Chinese goods. The increased rate applies to the 194-page list of products which were initially tariffed at a 10% rate back on September 17, 2018. There are no new products subject to tariffs at this time.

On May 13, 2019, Beijing announced that it would respond by raising tariff rates on the $60 billion of U.S. imports currently subject to tariffs. The rates will be raised from current levels ranging from 5%-10% to new rates ranging from 20% to 25%. The increased tariff rates on U.S. goods are set to go into effect on June 1, 2019.

The Trump administration responded by reiterating prior threats to impose a 25% tariff on an additional $300 billion in Chinese imports. On Monday, May 13, 2019, the Trump Administration initiated the months' long public notice and comment period required prior to the imposition of new tariffs. If imposed, it would mean that all of the approximately $540 billion in Chinese goods sold to the U.S.market would be subject to tariffs.

In the meantime, both sides continue to talk tough while expressing hope that a deal could be forthcoming. Unfortunately, hope is not a strategy, and there is no obvious path forward to an imminent resolution. Both China and the U.S. have professed (with varying degrees of bellicosity) a willingness and ability to withstand a prolonged conflict. Each has compelling reasons to dig in and prepare for a long road ahead.

What Comes Next:  No one actually knows. Anyone who claims to know is lying. There exists an impossibly wide range of potential outcomes that run the gamut from a quick resolution to a decades-long economic cold war.

China is set to raise rates on the existing tariffs on U.S. goods on June 1st. At some point in the next couple of months, the U.S. is likely to impose tariffs on the remaining $325 billion in Chinese imports.

The 25% tariff rate on Chinese imports put in place on May 10, 2019 appears likely to remain for some time, even if some sort of interim cooling off period or limited trade deal is agreed upon in the near future.

Treasury Secretary Steve Mnuchin has said that the sides are “likely” to resume talks in Beijing at the end of May. President Trump is expected to meet with Chinese President Xi Jinping during the G20 summit taking place in Japan in late June. It is possible, though unlikely, that a resolution is reached during those meetings. A more realistic possibility is that the counterparts make some high-level conceptual progress that lays the groundwork for subsequent negotiations. When, or even if, a resolution will be reached is anybody’s guess.

The Impact:  Significant. The S&P 500 dropped about 4.5% between the initial Trump tweets on May 5th and market close on Monday, May 13th. Economists predict a direct economic loss to the U.S. of 0.2-0.3% of GDP as a result of the latest round of increased tariff rates should they remain in place.

Both economies will suffer long and short-term economic consequences. The United Nations Conference on Trade and Development projects that the imposition of 25% tariff rates will lead to a $94 billion reduction in U.S. exports and a $205 billion reduction in Chinese exports.

Industry and consumers on both sides of the Pacific will suffer, with Chinese manufacturers losing market share to increasingly competitive global alternatives and American consumers bearing the brunt of a substantial increase in the cost of goods.

But Tariffs Are Good, Right?  No. Tariffs are not good. They are, in fact, bad. Now, tariffs can be a highly effective tool to create leverage in a trade negotiation. In this instance, tariffs may absolutely prove to be a worthwhile short-term cost incurred in exchange for a long-term gain. There is certainly much to be gained in the long-term here. But no, there is no inherent benefit to tariffs themselves other than as a means to an end.

Ok, But Trade Wars Are Easy to Win:  Apparently not. The U.S. has significantly more leverage in this conflict and has not been hesitant about using that leverage. Alas, here we are, having let slip the dogs of trade war with no clear
victory in sight.

Inflection Point:  There is now no denying that we find ourselves embroiled in a good old fashioned trade war. Both sides are slinging arrows while remaining somewhat restrained in their escalation. So far, the U.S. has increased tariff rates, but not expanded the scope of imports subject to tariffs. China has responded with measured rate increases, while remaining cautious to avoid triggering an escalated response from the United States. No matter how truculent the public statements, it is clear that neither side is eager to ratchet up this conflict. The Trump administration very clearly hopes to avoid roiling a bull market. The real question is whether a shared desire to avoid escalation will allow the sides to find an offramp from a path of mutual destruction upon which they have already embarked.

The next major inflection point will be whether the U.S. follows through on threats to levy tariffs on the remaining $325 billion in Chinese imports. The impact would be significant, as consumer goods would be heavily hit and shockwaves
would reverberate throughout the world of retail. Should that happen (and it very well might), China could respond by dumping U.S. Treasury bonds. Such a response is unlikely, as the impact would be highly self-destructive. However,
if this trade war has shown us anything, it is that both sides appear willing to inflict self-harm in search of a broader victory.

Long-Term Considerations:  The stakes are high and will have long-term implications. In certain respects, the Trump administration is absolutely correct about the imbalances in the existing trade relationship between the U.S. and China. Forced technology transfers, the widespread theft of intellectual property, restricted market access, government subsidies and impotent enforcement mechanisms have created an imbalanced playing field. That imbalance no longer makes sense in light of China’s rising economic standing in the world. In other respects, the administration’s overwrought concerns about trade deficits and a (stated) belief in the benefits of tariffs are misplaced. I have a pretty sizeable and growing trade deficit with my local Trader Joe’s. That trade deficit is unlikely to reverse course any time soon. There is nothing inherently wrong with that.

At the same time, China has a good thing going for it and has a vested interest in keeping the field of play tilted in its favor. Beijing surely realizes that the 2020 Presidential Election looks like a coin flip. China understands that if they can
hold out long enough, they may get a better deal from a new administration that could reap a political windfall simply by “ending the trade war.”

Notably, one of the many negatives of living in an authoritarian single-party Communist state is that the powers that be don’t much concern themselves with the opinions or well-being of the populace. When it comes to withstanding the harmful effects of a trade war, not caring about your population ends up being a serious bargaining advantage for the folks in Beijing.

There are, however, perils to an overreliance on a Fabian strategy of perpetual delay. The risk to China is that the longer tariffs remain in place, the more supply chains will shift to other countries. Once that business leaves China, much of it will not return. Beijing knows this and must be cautious to avoid causing a flight from China manufacturing that would have permanent ramifications.

A New Hope:  On the other side of this conflict lies the potential for a brighter future for both sides. In the long run, China would likely benefit from a more open market and adherence to norms that would bring them in line with other modern market economies. Increased faith and confidence in China would eventually lead to greater investment, innovation, and collaboration with the rest of the world. The U.S. would also benefit from a more even playing field; one that allowed its companies open access to the massive Chinese consumer market buoyed by confidence that American companies could protect their intellectual property. There is a happy ending here. Let’s hope we get to tell it.

Tangerine:  At Tangerine, we believe in taking a belt and suspenders approach. China remains an important part of our short and long-term sourcing strategy. What works well about manufacturing in China works extremely well. That will
not change.

Concurrently, we are expanding our manufacturing base, bolstering investment in alternative supply streams across Asia, as well as North, Central, and South America. Regardless of how or when this trade conflict ends, Tangerine will be better equipped to serve our customers’ needs. The work being done today to diversify and improve our supply chain will pay dividends for years to come.

What we are finding is that developing markets still need time and investment before they will be able to effectively compete with China in certain product categories such as consumer electronics and machinery. However, the impetus to
source outside of China has opened up new manufacturing channels for products like bags, drinkware, and apparel that we expect to remain part of our supply chain on a going forward basis. Those channels will only grow more competitive and sophisticated as capital flows into those countries.

We will continue to keep you abreast of the situation as it develops. More importantly, we will continue to embrace the challenge created by this trade war and transform it into opportunity. It’s kind of what we do.
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