US-China Trade War! What it Means for NZ

We fought for a lot in the West. And we won. We created a social order where any person, no matter their background, could work hard and achieve their potential. They could enjoy a level of reward seldom seen throughout human history.

Unfortunately, we’ve also taken these freedoms for granted. We haven’t had to fight for them for 80 years. And it’s a surprise how fast they’ve eroded.

Within many democratic countries, inequality is rising fast.

Technology means network effects concentrate wealth. Own Trade Me, Amazon, AirBnB or any other substantial network and you get rich.

A fast-growing compliance culture further ensures only larger players survive. You may see an opportunity in business, but more and more industries are so regulated now, you’ll need significant capital to open your door.

Yet the greatest threat to the Western ideal of freedom lies, ironically in free, global trade.

The global trade system is unfair. And up until now, few have been prepared to tackle it.

A local example

For years, a friend of mine built a small factory in New Zealand, manufacturing an innovative home appliance for which there was a strong local market for. Despite growing sales and investment, he eventually had to move on.

Why was that? Well, he had to pay workers a decent wage. At least $17.70 an hour. Normal hours are around 40 per week. Workers take breaks. They do not live on-site. They enjoy freedoms and dignity.

Across the seas in China, minimum wages are growing. But even in Shanghai, where they are highest, they top out at US$348 per month. Extensive overtime is common. And at many plants, workers live on-site to provide a constant stream of labour.

When my friend complains about manufacturing products in New Zealand, he is told, ‘Oh, there’s no competitive advantage to be had in manufacturing here. You have to go offshore.’

At a country-level, we should pursue our competitive advantages. New Zealand has an advantage in dairy production. Simple economics.

But on a wider scale, you cannot compete in trade against countries where workers live on-site, eight to a room, and work for next to nothing. Nor in a wider sphere, where intellectual property may be uplifted and the trading currency pair manipulated.

Leave this open and all manufacturing will move to those more profitable conditions. Once the work moves there, the technology starts to go too. Capital follows. And a changed supply chain changes the game.

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The US versus China trade war

Donald Trump is one of the few leaders to call time on the trade rort.

The finance industry, the left-wing, and all those with vested interests in the status quo oppose him.

When many are winning in a game and a guy comes in and says this game has been rigged — he’s going to be very unpopular. Even if he’s right.

The truth is, most Western countries have become dependent on China as the ‘workshop of the world’. While that workshop has lifted millions out of poverty, it’s not a great long-run situation.

So, you buy a kettle from The Warehouse for $19 and think you’ve got a bargain. You’ve only got that bargain because people worked on a factory line for $1.50 an hour, maybe sleeping on-site.

China itself is trying to move away from sweatshops. A friend of mine who visits China regularly tells me running a factory there has become a lot harder. Your kettle will probably end up being made somewhere else.

The point is, free global trade is not on an anything like an even playing field. To achieve that, you’d need all countries to sign up to minimum global labour standards that are vastly ahead of where they are today.

This may never happen.

So factoring in fair wages into the making of your kettle, maybe it needs to be $99. And that’s probably a price where it can be made local, creating local jobs, reducing the carbon footprint and giving local makers a fairer go.

We’ve been here before

In the 1980s and 1990s, the US faced off against another powerful Asian economic power.

At that time, Japan was manipulating its currency to support its export economy. It subsidised local companies. It erected barriers to imports.

To prevent wholesale loss of the American electronics industry, Washington introduced 100% tariffs. It forced voluntary restrictions on Japan’s auto, steel, and machine industries.

During this time, the value of Japanese assets fell heavily. And from the 1990s until today, the country has grappled with low rates of economic growth. From 1980 until 2018, it averaged annual GDP growth of just 0.49%.

Japan is now focusing more on building economic growth through domestic consumption, which seems to be bearing fruit.

The trade deficit between the US and Japan is now much more manageable. In 2017, exports to Japan from the US totalled $75 billion. Imports from Japan, $143 billion.

Exports to China from the US are only $120 billion. Imports from China, $540 billion.

The gap would suggest China cannot win a tariff war. And if an agreement is not reached in levelling the playing field, it may suffer much more than the US.

Unfair play does not win in the end

If trade negotiations continue to sour, there’s going to be turmoil in the stock markets, especially for businesses exposed to Chinese trade.

This will impact countries like New Zealand and Australia, who depend on commodity exports to China. Although the initial reaction may be one of shock and volatility, the long-term trajectory could create opportunity.

Filling the supply gaps caused by high tariffs means that New Zealand businesses could potentially increase their market share in China. However, this requires flexible production and export capability.

There may be opportunity for Kiwi businesses as the tariffs bite.

I’ve mentioned before that I am a shareholder in Sanford [NZX:SAN]. Sanford exports fish to China. In February, there was a dip in the share price when the company faced delays getting salmon shipments cleared through Chinese ports.

Amidst a trade war, we may see further volatility in Sanford’s price. China is looking at a 25% tax on US seafood. In that case, tariff-free New Zealand seafood is going to appear cheaper.

This could create opportunity for the company. And at the right time — opportunity to accumulate the stock at a reasonable price.

Of course, this is not without risk. Supplying seafood depends on the catch and other factors like the weather.

It will be one of the interesting events in our history as the US confronts China over its trade practices. For now, all we can do is have faith that fairness will prevail.

Fair trade is not always free trade. And here in the West, our value is fairness.

Regards,

Simon Angelo
Analyst, Money Morning New Zealand

Important disclosures

Simon Angelo owns shares in Sanford Ltd [NZX:SAN] via wealth manager Vistafolio.