Is the China Trade War as Troubling as It Seems?

As mentioned, the U.S. economy is primarily driven by consumer spending, which accounts for nearly 70% of total GDP. China's economy is primarily driven by exports. In short, China needs to sell. Therefore, when the U.S. (or other nations) increase tariffs on Chinese exports, it causes a slowdown in the Chinese economy because tariffs make Chinese products more expensive for the rest of the world. This strategy is designed to bring China to the table. Has it worked? Absolutely. You see, China's economy has indeed slowed, which has prompted its leaders to discuss a new trade deal.

A Brief Word on Tariffs

Tariffs are not inherently bad. For instance, they can provide leverage between nations in a negotiation. That will become clear in a moment. It's true that without tariffs, the price we pay for many imported goods would be lower. But isn't that a good thing? Yes … but … that would also cause a radical change in the business climate in the U.S. as companies would be unable to compete.

Moreover, a complete absence of tariffs could result in widespread layoffs and business closings, which would have a dire effect on our standard of living. Perhaps more relevant is that the U.S. enjoys a much higher standard of living than the rest of the world. For example, median household income in the U.S. was approximately $61,372 compared to China's $10,964 (CY 2017-USD). Since Chinese workers need less income to survive, labor costs are much lower than in the U.S.

Why is President Trump pounding the desk so hard? The following chart may provide some answers. As you can see, the U.S. is China's best customer. In fact, the U.S. and Hong Kong together import more Chinese goods than the next nine countries combined. Therefore, the U.S. has the most leverage.

Tariffs may be here to stay, but how much is too much? If higher tariffs continue for a short period, the effect will be minimal. If this continues for a longer period, it may result in higher prices for consumers. If that causes a significant reduction in consumer spending, it could result in a weaker U.S. economy. This is basically a game of "who will blink first" or perhaps, "who will need to blink first."

The U.S. Economy

The U.S. economy is strong. Real GDP growth is around 3.0%, unemployment is at 3.6% (a 30-year low), inflation is under 2.0%, and corporate profits are strong. In fact, there are more jobs than workers. To sustain U.S. GDP growth, we need about 100,000 new jobs per month. We have been averaging over 200,000.

Summary

I believe the strong U.S. economy will provide support for stocks until the next recession draws near. Yes, there will be bumps along the way, but I wouldn't expect a major correction yet. Of course, if the trade deal falls apart, stocks are likely to fall, but with the strong backdrop of our economy, it should be temporary. Although that's logical, the stock market is usually illogical. This may be a good buying opportunity. We'll see.