President Trump is pulling no punches in his complaints about trade with China in the run-up to the historic meeting this week at Mar-a-Lago with Chinese President Xi Jinping. Much of the rhetoric is straight out of Negotiating 101 -- establish extreme and unreasonable positions to anchor the issues to be discussed -- and we need not overreact. However, the initial discussions will cover essential issues that will eventually impact trade, our economy and the markets, so investors do need to care about more than whether the two leaders shake hands.
As an American living in Beijing, in unique circumstances no less, my view of the issues in play is somewhat different from conventional wisdom, since I see the competition up close and personal. So I took the liberty of writing a briefing book for the President. I am sure Fedex will deliver it to Mar-a-Lago any day now, but meanwhile I will share with you the executive summary on some key economic issues. Trump and Xi will go mano-a-mano on these, in private at least. I do not expect any resolution, but in private there should be some movement, and perhaps a few token initiatives to publicly demonstrate some progress. Each side has powerful incentives driving their positions, so any progress is going to be slow and painful.
The accusation of China as "a grand champion of currency manipulation" is easily dismissed, and I must conclude this is a phantom issue being created to use as a bargaining chip to address the real problems. Since the yuan started floating in 2005, it appreciated against the dollar -- slowly and with stability -- until three years ago, when it was allowed to retrace some of the upward move. The yuan is held reliably between 6 and 7 to the dollar. This may be labeled manipulation, but the manipulation is to help the RMB hold its value against the dollar.
This puts Chinese exports at a disadvantage, and imports U.S. inflation into China. The distortion is clear when you live in China and can see that many prices are just "wrong". As this is a developing country, Beijing and Shanghai should not be more expensive than New York or London! We need to be careful what we wish for. Were the central government to loosen capital controls and let the yuan float, it would drop like a rock, as capital rushed to escape the country. Our exports to China would be priced out of the market, and their labor would become even cheaper. This is an issue best quietly dropped, before any "resolution" has the chance to do us real harm.
To be found guilty in American courts, you need means, motive and opportunity. In certain industries, the Chinese clearly have the first and last, but labeling their inventory liquidations as "dumping" misses the mark on motive. The implication of this label is that there is a concerted effort to drive non-Chinese competitors out of business, at which point the Chinese would own a market and jack up prices to unconscionable levels. This is not what is happening in China.
The reality is far less sinister. The Chinese have a habit of piling into any business that looks reasonably attractive, quickly creating massive oversupply and driving down prices. This happens domestically, internationally, in raw materials, in services, in products ... in everything! Whatever the "dumping-du-jour" industry is -- one day solar panels, the next day steel -- you can figure there is no master plan for world domination, just another example of the Chinese way.
Having said that, we are under no obligation to be the Outlet Mall for their overproduction, because it is factual reality that incredibly cheap imports do destroy our jobs. They can liquidate their inventory elsewhere, thank you. But this problem will persist until capital controls are loosened. The growth of the Chinese economy is producing an astonishing amount of wealth, but that capital lacks enough good domestic opportunities to be reinvested. So it gets recycled into any marginally good business, and into tons of apartment buildings that sit empty, by choice of the owners. Our position should be to encourage a loosening of capital controls, slowly, to avoid the renminbi/dollar crash that would happen if controls were relaxed overnight. Encourage Chinese investment in higher return projects around the world.
Theft of Intellectual Property
This is the real issue at the moment, but as usual, it is nuanced. The simple and detectable method is outright copying -- pirated DVDs, copycat brand apparel, etc. The subtler challenge comes from the Chinese desire to learn our methods of design and production. For example, every foreign company doing business in China must have a Chinese partner company, which generally will control the joint venture. The shared operation gives the Chinese partner ample time to learn the design methods, trade secrets, production practices, and so on. After a few years, the Chinese partner can happily cancel the JV, since it now can produce a competing product with equal quality. The know-how has been transferred; meanwhile, the foreign company must cease operations, since it does not have a Chinese partner to comply with the law.
By the way, the central government does not condone IP theft, and has an active program in place to discourage it. And many Chinese business leaders, especially the ones leading modern global businesses, respect IP as well. But culturally, the idea of "copy-exact" is ingrained, and will take some time to be eradicated. Chinese businesses in general may not gain a respect for intellectual property until they have some of their own and they sell it outside of China. A leading candidate industry to drive a dawning respect for IP is biotech. Many drug companies are doing original research in China, and some will eventually create drugs that will be sold worldwide and require patent protection. Some are even traded in the U.S. already, such as BeiGene (BGNE) and Hutchison China MediTech (HCM) . When true IP innovators from China start to need the IP respect we take for granted, the tide will turn on this issue. Until then, progress will come slowly, as is always the case with cultural change.
Ultimately, I believe that the whole issue of trade with China is not a great use of our time and energy, because the country is not a particularly good market opportunity for our companies anyway. Foreigners fixate on its 1.4 billion people, but the vast majority are dirt-poor. Per capita income is $500 a month. This is not a vast market for imported consumer goods. Poor people need to be able to sell before they can buy. Every trade mission I have accompanied around China started with Americans excited about signing some export deal for their products, with every meeting then turning into their Chinese counterparts trying to sell products to them, get a cash investment, or create a cooperation agreement that consisted of a technology transfer to China.
Very few companies have a real market opportunity in China now. I would argue that only branded luxury goods like BMW (BMWYY) cars or Starbucks (SBUX) coffee have a compelling opportunity. And to the extent our brands and products are made locally, that activity helps earnings and market valuation, but does not create many American jobs. I think China needs at least one to two generations of building more export-related industries to satisfy the "sell" side of the trade equation. The Chinese people need to have something to sell to us, before they can buy from us. American companies that invest in China now and can live with little growth and little profit may end up having pretty good businesses in the second half of this century. Anyone not looking at the China "opportunity" this way is doomed to disappointment.