China Strikes Back, U.S. Stock Markets Plunge

US China Trade War

U.S. President Donald Trump may have thought that he hit a good serve with his “small” new tariffs, but China returned his serve right into his face over the weekend.

The trade war between the United States and China has heated up in a big way over the last few days, and the gloves may finally be coming off now. If people thought that Trump’s playing his tariff card on the $300 billion worth of Chinese imports that had yet to be touched was the extent of their worries, where China would then just cave in without much of a fight, they had another thing coming.

The valuation of the Chinese yuan has been a bone of contention on the U.S. side for quite some time, even though we would think that it would be better for the country if the yuan’s valuation was kept down. If you are a net importer, as the U.S. definitely is, then the benefit of your imports being cheaper clearly outweighs the costs of your exports being worth less.

This is true economically at least, but whether this is seen this way politically can be an entirely different story. If the importers, the people essentially, have less political clout than the exporters, then this picture can be skewed and the goal may be to disadvantage the public for the benefit of certain companies.

The U.S. government wants the yuan valued higher simply because it wants to benefit these companies over their consumers. The people don’t realize what is really going on and can even be whipped into a frenzy by people like Donald Trump, where they actually believe that countries like China are stealing from us and we need to fight back against this menace, when it is this view that is the actual menace.

Protectionism strategies do not protect the people, they do not benefit the people, they protect and benefit special interests, which in this case are exporters or companies that wish to export but cannot unless they are provided an advantage. These advantages can be as simple as lobbying other countries such as China to inflate their currencies so that we can sell to them and we’ll get more money back in U.S. dollars for what we sell there.

Meanwhile, if this is successful, this will mean that it will cost us more to buy from the country. Given that the current trade deficit is $418 billion with China, this means that a lot more U.S. dollars will be leaving on a net basis than otherwise would if their currency wasn’t worth so much.

One of the goals of the trade agreement is indeed to look to sway the Chinese to keep the value of the yuan up, and this is a pretty sensitive and issue as well as one seen to be of significant importance, so China pulling back on this support is definitely a big issue.

The Price of our Imports Matters and Matters a Lot

It’s not even that it is a good idea in itself to reduce the trade deficit with China, although doing this in certain ways could help the country, for instance by getting China to allow more American goods to be sold there and having it reduced that way. We do not want to reduce it by tactics such as tariffs or by twisting their arm to keep the value of their currency higher than would be ideal, for both they and us as it turns out, because this restricts trade and results in a less efficient marketplace.

At least some of this misplaced thinking may be by way of misunderstanding, and it very well be that Trump is thinking that he is helping the country with his protectionist goals rather than just looking to help pad the pockets of some shareholders. Even if additional tariffs are temporary, if the goal is to seek a more protected market, that in itself is going to lower efficiency and cause Americans to pay more for things than they would otherwise without this interference.

A lot of this does depend on the current state of trade between countries, as for instance if the U.S. was a net exporter to China, they should want the yuan to be worth more in order to make more profit from these exports. If things are the other way around, like they are now, we should never want this unless we want to hurt our economy, our people, and our country.

China, on the other hand, being a net exporter, wants the American dollar to be higher relative to the yuan so that they can earn more, so a lower yuan in this case is a win/win situation if we use our heads, but we often do not, and let emotion or distorted thinking sway us.

It is never a good idea to look to artificially inflate prices such that people pay too much for something even if the benefactor of these higher prices are our own companies. All we end up doing here, at best, is distributing wealth away from those who have less toward those who have more.

There is plenty of wealth distribution that goes on within a free economy, but it is the sort that benefits everyone with more efficient prices but benefits those who leverage capital more. When we restrict these freedoms, we end up with a smaller pie and there is less to go around for everyone.

When we restrict trade, what happens is that everyone needs to get by on less, from those with the capital to those who are just getting by and cannot enjoy the economic quality of life they would have if not for these barriers and restrictions.

Trump’s new 10% tariffs on Chinese goods, if left to stand, means that people will have to pay 10% more for a lot of things that they buy, and $300 billion worth of goods is a lot of goods and a pretty big piece of overall spending. This does not tax the Chinese, it taxes Americans, surely and directly.

After these new tariffs were announced, people were wondering what the Chinese response to this would be, how they would retaliate in other words. Their response was as elegant as we could have ever hoped for.

The Yuan Going Down is a Good Thing, Even if We Don’t Understand Why

Aside from taxing Americans, one of the other things that these tariffs do is place downward pressure on the yuan. All the Chinese had to do in order to respond is to just let these pressures play out on their own, in other words not take action to keep the value of the yuan up in response, and then watch Trump fall on his face.

They let the value of the yuan slide enough to negate the effects upon price of these new tariffs, and essentially the goods will be made 10% cheaper, so that when the U.S. slaps their 10% tariff upon them, we’ll end up in the same place as before.

It would not be incorrect at all to see this as Donald Trump brandishing his sword, ready to strike his own people with it, and the Chinese parrying this blow and saving Americans from this undignified attack from their own president. This is of course not why the Chinese did this, as it helps China as well and quite a bit, as they collect more U.S. dollars for their goods, but both Americans and Chinese win in this scenario overall.

This does not mean that the matter is now settled though, and far from it. Trump is already accusing China of manipulating their currency, even though the truth is that it is Trump that is trying to manipulate it with these tariffs and he is expecting the Chinese to comply, and has become disappointed that this isn’t happening this time.

U.S. stock markets have been in free fall since the tariff announcement, and the real reason is that these latest developments are indicative of a real war going on and China’s refusing to prop up their currency in the face of all this really takes us a lot further away from a resolution. The fear is that this war may not only continue for a long time but get worse, and with Donald Trump at the helm, these fears are very real.

The devaluation of the yuan actually takes us in the right direction, unless you own stock in a company who exports a lot to China. A lot of companies do, so their stock isn’t exactly going to benefit from this, although the people will, but the people don’t often count for much or even anything when these decisions are made.

This could all end up getting a lot worse now that we’re seeing bigger bullets being used in this war. There’s no telling how much further the market could go down, but the fact that last week was the worst week this year for the markets and we’re already well beyond that point this week after a little over a day speaks pretty loudly.

As last week wound down, we suggested that this may be a good time to step aside from the stock market, and even though we’ve been through a lot of things this year that others have suggested the same thing, this time is clearly different and the bear that people have been afraid of all year has never been so close to us or so dangerous.

We’ve already matched the 6% drop that we saw in the month of May in just 4 trading days, and are already down another percent in after-market trading on Monday. While the news we have now is out, this is the sort of volatility that can easily take on a life of its own and precipitate further declines simply from its own weight, as more and more people see red and join the rush to the exits.

This does not necessarily mean that we’re headed a lot lower, but this latest selloff and the concerns surrounding it are on a completely different scale than anything we’ve seen this year, and the people that are pulling out of stocks right now can’t really be blamed. Our main goal with investing needs to be managing risk, and while you do need the risk to be big enough to attract your attention, this one is plenty big enough to warrant plenty of that.

We may have seen the worst of this already, and markets even have a habit of over-reacting and then settling in to a higher equilibrium once things calm down, but this current situation cannot be counted on to do that necessarily. Keep your eyes on the action and on the door.

Ken Stephens

Chief Editor,

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.