US-China trade war is brewing as trade deficit sticks at $25 billion, asset manager warns

US-China trade war is brewing as trade deficit sticks at $25 billion, asset manager warns
⦁ "We may be brewing up for a trade war," warns Jim McCaughan, CEO of Principal Global Investors.
⦁ Tariffs on Chinese steel imports would be bad for markets and could trigger a wider trade war.
⦁ China maintained its trade surplus with the U.S. of around $25 billion in July.
⦁ A trade war between the U.S. and China is brewing and could be the biggest risk for global investors, a prominent asset manager told CNBC.
⦁ "We may be brewing up for a trade war because of the mistaken way that many policymakers interpret the trade issues. I don't believe that the U.S. trade deficit is as big a problem as many say," said Jim McCaughan, CEO of Principal Global Investors, to CNBC Tuesday.
⦁ President Donald Trump has repeatedly voiced his concerns about his country's trade deficits with several countries including China, and his administration is attempting to ⦁ open up China's economy to U.S. companies.
⦁ Since the president's inauguration there have been ⦁ fears a trade war may begin between the two countries, which would involve the introduction of tariffs and quotas on imports. Trump's Commerce Secretary Wilbur Ross has previously said the president will take "bold action" to address Chinese steel imports entering the market.
⦁ McCaughan says this kind of tough talk appeals to the president's base, but he added that Trump would "blame someone else" in the event of a trade war and any negative consequences.

⦁ Alexey Avdeev | E+ | Getty Images
⦁ "That's what politicians always do," he said. "U.S. assets abroad tend to be very high return … Whereas foreign investment into the U.S. is in Treasury bonds. So the income from the American assets is way bigger than from the liabilities - if you look at it that way the capital account is structurally in surplus – you can't have a trade surplus as well," he added.
⦁ The world has been teetering on the brink of a trade war for some time and this could be the biggest risk for investors, McCaughan also added. He says tariffs on steel imports would be bad for markets.
⦁ "As far as the market's concerned, tariffs on steel would be very bad news, because it would run the risk of setting off a trade war," he says.
⦁ "If the administration gets riled up by its base into tariffs, then you have anti-trade agenda winning."
⦁ Limited action from US?
⦁ China is the focus of trade deficit concerns because it is the U.S.'s largest trading partner and accounts for around half of the U.S. trade deficit. However, the administration may be limited in what it can do to China, according to a report by risk consultants Control Risks.
⦁ "Trump's options for inflicting severe and widespread economic pain on China are inhibited by legal, regulatory and legislative practicalities, including U.S. commitments under the World Trade Organization," the consultancy said in a report published in February.
⦁ "They are further constrained by the high likelihood of effective retaliation by China, particularly if he pursues more unilateral and unconventional options."

⦁ Carlos Barria | Reuters
⦁ President Donald Trump interacts with Chinese President Xi Jinping at Mar-a-Lago state in Palm Beach, Florida, U.S., April 6, 2017.
⦁ McCaughan's comments come after trade data from China disappointed markets. In July, exports from China grew 7.2 percent in dollar terms from a year ago and imports rose 11.0 percent in dollar terms. Both were much lower than expected.
⦁ Despite weaker-than-estimated growth, China maintained its trade surplus with the U.S. of around $25 billion. This trade gap is closely watched due to growing tensions between the two countries.
⦁ "Chinese trade data for July disappointed market consensus expectations. Both yearly export and import growth moderated in comparison with the previous month, against expectations for remaining just as strong," said Susan Joho, economist at Julius Baer, in an email to CNBC.
⦁ "Export growth to the U.S. almost halved amidst tensions over China's large trade surplus with the U.S."
Debt problems
The reason for the relatively lackluster trade growth indicated that China is failing to switch the focus of its economy from manufacturing to consumption, according to McCaughan.
"The reason growth is where it is in China has a lot to do with continued construction activity and that is not something that is long-term sustainable," he said.
"You run into debt problems very quickly if construction is what's driving the economy."

There would be no winners in a US-China trade war.
China said the US would bear the brunt of one, but that’s misguided.
Chinese Premier Li Keqiang just issued a strong message to Donald Trump: You really don’t want to start a trade war with us.
Speaking at a news conference on Wednesday, Li cited an article from “an authoritative international think tank” showing that “should a trade war break out between China and the United States, it would be foreign-invested companies, in particular US firms, that would bear the brunt of it.”
“We don't want to see any trade war breaking out between the two countries. That wouldn’t make our trade fairer,” he added.
Is Li right that US companies would end up hit harder than Chinese companies in the event of a trade war?
It’s true that a lot of US companies like Apple that rely on manufacturing their products in China would take a big hit from a dramatic escalation of tariffs, or border taxes, on goods flowing from China to the US.
But saying that those companies would really bear the brunt of a trade war eclipses a few important points. The first has to do with something called “import substitutability” — the ease with which the US can find substitutes for what it imports from China.
The reality is that companies like Apple or big US clothing companies would ultimately be able to move their operations to other countries with cheap labor such as Thailand or Mexico.
In fact, given that China’s swiftly rising manufacturing wages are approaching levels seen in Europe, a lot of foreign firms in China are already starting to make that pivot. So slapping tariffs on goods flowing from China to the US would accelerate a dynamic that’s already taking hold.
By contrast, Chinese companies importing key goods from the US won’t necessarily be able to find a substitute nearly as easily. Daniel Rosen, a founding partner and economic analyst at the research firm Rhodium Group, says that China would struggle to find replacements for huge quantities of agricultural goods and high-end technology that China sources from the US.
“The Chinese can’t buy replacement parts for a Boeing from other countries,” he explains.
In other words, many US companies can be more agile in their response to tariffs than Chinese ones. But more broadly speaking, it’s probably not better to think of trade wars between two countries whose economies are as tightly interwoven as the US and China as having winners and losers. It’s best to think of it as an “everyone loses situation.”
The conventional wisdom is that China relies more heavily on the US to keep its enormous export operation going, so it would suffer a bigger wound from a trade war. This analysis points to the fact that China exports a lot more to the US than the US exports to China.
The US goods trade deficit with China — that is, the amount by which its imports from China exceed its exports to China — is close to $370 billion. And the growth of the Chinese economy overall relies much more on trade than US economic growth does.
But the US also needs China, and aggressive tariffs on American goods going into China would be hugely damaging to its economy. Since the turn of the millennium, China has leapt from the 11th-largest export market for the US to the third-largest export market. The large volume of exports to China helps employ Americans — about 1.8 million of them, according to an Oxford Economics report published in January.
The US also benefits economically from the cheap Chinese goods that the US opens itself up to. Trade with China saves typical American households up to $850 a year, and that extra money gets spread across the economy and helps keep people employed in a variety of domestic industries.
Services that the US provides to China would also take a hit. Chinese restrictions on students and travelers coming to the US would hurt the revenues of higher education institutions and the tourism industry. “You can’t really find any American city that has a big tourism sector that’s not chomping at the bit to make China a bigger part of their game plan,” Rosen says.
Given the huge cost for both the US and China that would result from a trade war, it’s best to think of it as an event that would have no true victors — and thus something that should be avoided at all costs.