To The Moon

Background:

1) Trump's Tariffs

• Trump plans to implement a blanket tariff of 10%-20% on all imported goods, with a 60% tariff specifically on goods imported from China.

• According to the Peterson Institute for International Economics (PIIE), the average tariff on Chinese goods was 19.3% in June 2023, compared to about 2.3% in 2018.

• Trump hopes that these tariffs will encourage U.S. companies to reshore their manufacturing operations and protect local businesses from cheaper foreign competition, as the price advantages will diminish once the tariffs are in place.

• In short, tariffs on imports should support domestic businesses by making foreign-made products more expensive.

 2) U.S. May Revoke China’s PNTR Status

• There are growing concerns that the United States may revoke China’s Permanent Normal Trade Relations (PNTR) status, formerly known as Most Favored Nation (MFN) status.

• If revoked, tariffs on Chinese goods are expected to rise significantly.

• Currently, U.S. tariffs on goods from countries without PNTR status—such as Russia, Belarus, North Korea, and Cuba—range from a minimum of 35% to as high as 100%.

When Will Trump Impose Tariffs on China?

• During Trump’s first term (2017-2020), the U.S. only imposed tariffs on Chinese goods in February 2018, despite Trump’s inauguration in January 2017.

• However, it seems likely that Trump will pursue tariff measures shortly after taking office this time.

What Will Likely Happen to China with a 60% Tariff?

1) RMB Depreciation:

• According to MUFG, a 60% tariff on Chinese goods could lead to a 10%-12% depreciation of the Chinese yuan (CNY) to offset the negative impact on China’s exports.

2) Relocation of the Industrial Chain:

• Chinese companies may attempt to move their factories overseas to avoid U.S. tariffs.

• However, this strategy may not be effective, as the U.S. plans to increase taxes on countries that act as intermediaries in re-exporting goods to the U.S.

• Additionally, reshoring could lead to job losses for Chinese citizens.

3) Dumping:

• One extreme measure China could consider is abandoning the U.S. market and instead increasing market share in other countries by "dumping" goods at below-market prices.

• However, this could prompt other nations to impose higher tariffs on China, as such practices would harm local businesses.

In short, China may allow the yuan to depreciate once the tariff is announced. A weaker yuan could be one of the solutions to mitigate the impact of the 60% U.S. tariffs.

Will China Retaliate?

• I reckon China is unlikely to retaliate harshly, given the uneven recovery of its economy. China would not want to risk destabilizing its own economy with a prolonged trade war.

• However, if China chooses to retaliate, it may impose tighter export controls on key "dual-use" technologies and items (those for both civilian and military purposes), including raw materials and metals.

• U.S. agricultural products, such as soybeans and corn, are also prime targets for tariffs.

• In 2023, China was the largest market for U.S. agricultural exports, comprising 17% of the total. It was closely followed by Canada and Mexico.

• For instance, China accounted for nearly 50% of U.S. soybean exports. However, the U.S. is China’s second-largest soybean supplier, with nearly a 30% market share. Brazil holds the top spot as China’s largest soybean supplier, with about a 60% share.

• China may also target American companies operating in China. U.S. companies could face tighter regulations regarding permits, safety checks, and licensing approvals.

• American companies may also face public boycotts, especially if rising Chinese nationalism is triggered by increased tariffs.

• If China retaliates by imposing higher tariffs on U.S. products, American companies may seek to sell their goods in other countries. However, China’s size and market potential would be difficult to replace.

• We can also learn from the change in tone of the congratulatory statements from President Xi to Trump in 2016 and 2024 that China’s retaliation against Trump’s tariffs is unlikely. The statement leans towards China wanting to be a partner and friend with the U.S., rather than seeking to jointly boost global development and prosperity as two world superpowers.

• In Xi's 2016 congratulatory message, he stated that as the world's largest developing country and the largest developed country, China and the U.S. had the responsibility to maintain world peace, stability, and to jointly boost global development and prosperity.

Source: China-consulate Melbourne, Nov 2016

• In Xi's 2024 congratulatory message, he urged the two countries to find the right way to coexist in the new era to benefit both nations and the wider world. Xi emphasized that history shows that China and the U.S. gain from cooperation and lose from confrontation. He noted that a stable, sound, and sustainable China-U.S. relationship serves both countries' shared interests and meets the aspirations of the international community.

Source: Xinhua, 7 Nov 2024

Tariff Impact on Americans:

• The Peterson Institute for International Economics (PIIE) finds that imposing a 20% across-the-board tariff, combined with a 60% tariff on China, would cost a typical U.S. household in the middle of the income distribution more than $2,600 per year.

• The National Retail Federation (NRF) estimates that American consumers’ annual spending power could be reduced by $46 billion to $78 billion due to these tariffs under Scenario A (a blanket tariff of up to 20% on all imported goods) and Scenario B (an additional 60% to 100% tariff on Chinese goods). The increased costs resulting from the proposed tariffs would be too large for U.S. retailers to absorb and are likely to raise prices beyond what many consumers are able or willing to pay.

Source: NRF

Will Tariffs Cause Inflation?

• U.S. importing companies typically pay the tariff tax and often pass the cost on to consumers.

• It is widely regarded that Trump’s tariffs, immigration crackdown, and corporate tax cuts could fuel inflation.

• However, I believe the inflation risk may be overblown. The rise in inflation due to tariffs may not be as significant as factors like supply chain constraints (e.g., COVID), war, and spikes in energy prices.

Conclusion:

• Rather than being concerned about U.S. tariffs and inflation risks, U.S. market participants appear complacent about the short-term outlook for the U.S. economy.

• I reckon Trump does not worry too much about inflation risks induced by tariffs. He likely views energy deregulation as a way to bring down inflation.

• Americans will likely experience wage growth due to the immigration crackdown.

• If American wages have increased faster than inflation, or at least kept pace with it, workers will experience greater purchasing power. As a result, corporate earnings and economic growth are likely to remain strong, even in the face of inflation.

• All in all, I believe U.S. tariffs on Chinese goods will not derail the U.S. economy.

• Instead of focusing on inflation risks, investors are likely to focus on a better economic outlook due to deregulation, wage growth, and corporate tax cuts.

• Currently, research firms have set a 2025 target price for the $.SPX(.SPX)$ ranging from 6,500 to 7,000.