The Wrong Moves to Make in a Trade War

For some of us, things just come easy.

Maybe you were a natural athlete and still are. Maybe you’re great with numbers or words.

More often than not, we tend to be good at the things we’re interested in. If you love kicking the footy around, chances are you’re better than the average Joe when it comes to Aussie Rules.

Because you enjoy it, you do it more often. Call it accidental practice. And that practice makes you more knowledgeable, skilful, and savvy.

Other times people are just gifted. If you had tall parents, chances are you’d be taller than average and therefore you’d have a better chance of being a great basketball player.

Or maybe you come from an elite tribe of runners. Your body is genetically and physically adapted to running long distances. So, you’re probably better than most at it.

For countries, advantages come in the same two ways. Countries can create advantages through investment and hard work, or they are just gifts from God.

Australia is a good example of the latter. We’re blessed with resources. We have so much iron ore, coal and copper that we export it in the hundreds of billions.

Japan on the other hand is a case of the former. They’re resource poor, but savvy when it comes to manufacturing. With time and hundreds of billions in investment, Japan has become an advanced manufacturing hub.

But what happens when one country gets jealous of another country’s advantage? What happens when China wants to be India and Australia wants to be Japan?

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The negative impact of the trade war on China

You’ve likely seen the headlines.

Trade tensions aren’t doing China any favours. From South China Morning Post (SCMP):

China’s export and import figures were much worse than expected in December, underscoring the rapid weakening of the Chinese economy.

Monday’s figures suggest the negative impact of the trade war may be greater than Chinese authorities previously estimated, and point to the need for a more rapid and larger economic stimulus to stabilise growth.

However, overall Chinese exports last year were the largest in seven years and the trade surplus with the US reached a record high, boosted by strong gains in the first half of the year and the effects of order front-loading in the second half.

Trade results this year could be quite different, depending on whether China and the US are able to reach a trade deal that rolls back tariffs.

Alright, so let’s unpack that…

China is an export-led economy. That means they rely on international demand to justify their current level of output.

This output, the goods Chinese businesses produce, determines whether China can keep their economy growing above 6%.

Economic growth just happens to be the output of goods and services. So, if international demand spurs Chinese businesses to produce more goods, growth increases.

But with this trade war going on, the opposite is happening. US buyers are reducing their purchases from China.

And what China might soon have to rely on is domestic consumers to pick up the slack. But here is the problem: Chinese consumers cannot fill the shoes of American buyers…yet.

They’re just not rich enough.

So, when these American buyers drop off, China’s output and economy have only one place to go.

Down!

China still aims to lift domestic consumption. They have hundreds of millions of consumers already. They just need time to become rich enough to spend more on goods and services.

You could say China is aiming to be like India, a service economy led by internal growth. There’s no problem with that. But as I said it will just take time to get there.

There is bound to be a gap where international demand drops off and domestic demand needs to catch up. And in that gap, you’ll probably see China’s growth slip.

What policy makers are trying to do now is reduce that gap as much as possible and get domestic consumption up as quick as possible.

Maybe you saw their latest efforts to get people to buy more goods and services. One proposal was to lengthen the weekend by half a day.

As reported by SCMP:

Hebei province in northern China has proposed a 2½-day weekend to stimulate consumption…Municipalities in the province may add Friday afternoons to Saturdays and Sundays off, a directive published by the provincial government on its website said.

The document, which was aimed at increasing consumption during 2019 and 2020, said employers should adopt more flexible working hours and encourage leave on non-public holidays.

Similarly, Australia doesn’t want to be Australia anymore — or at least that’s how Kim Carr feels.

Australia is making the wrong moves

If we are the resource nation, Japan is the advanced manufacturing nation. And according to one Aussie pollie, advanced manufacturing sounds pretty good.

The Australian Financial Review writes:

Opposition spokesman for innovation and industry, Kim Carr, has flagged bigger government tax breaks for manufacturing research and development, extending taxpayer assistance for global firms designing cars and pledged to crack down on cheap steel diverted to Australia due to the US-China trade war.

…Senator Carr, from Labor’s Left faction in Victoria, is worried about Australia potentially losing out from General Motors and Ford doing global reviews of their product design locations.

Although car manufacturing in Australia has shut down, car makers like GM, Ford and Toyota still employ thousands of workers such as engineers, mainly in Victoria to help design vehicles and parts for global production.

Don’t get me wrong, I’m all for investing in technology and improving manufacturing.

But why link Australia to Japan’s fate?

The Land of the Rising Sun invested heavily into manufacturing just after the Second World War. They converted ammunition factories and started making cameras and binoculars. They also produced cars.

In almost no time at all, Japan rose to the second largest economy in the world. Everyone thought Japan would be the richest nation on Earth. We’d all be workers for the very rich Japanese tourists when they came to visit.

Yet those economic gains would be short lived.

Just like China, Japan finds themselves racing towards a similar problem: a finite level of demand for goods.

As countries like China and Japan increase production, and they do it more efficiently, they race ahead of global demand growth.

Markets for manufactured goods (including autos) become saturated, prices go down and the crappy businesses — the ones that took on too much debt or are uncompetitive — die.

And what happens to all those engineers and designers in Australia that Carr wants? They share in the struggle when things get tough for car manufacturers.

So why throw that lot in with a dying industry?

Forget about cars. Why not invest in our strengths? We should be investing in resources, education and food.

These are the things we already have advantages in. Why not improve these advantages with the money the government steals from you and me every year in the form of taxes?

What does this mean for investors?

Long-term I think this is all moving in one direction. A localised world where local businesses cater to local demand.

Why do I say that? Because everyone is getting better at producing things each year. Efficiency gains are out striping demand growth.

As soon as we have robot arms and automation running almost every factor, what good is cheap or (factory) skilled labour?

When we reach that turning point, producing something in Japan versus Australia will bear the same cost to producers.

So where will the advantages lie? They will be in the local markets. If a producer can build local infrastructure to cater to local needs and dominate that local market, then they’ll enjoy competitive advantages and high profit margins for years to come.

As an investor it wouldn’t hurt to start looking for these businesses now. Forget about the company looking to take a 5% share out of the global market. Focus on the company going after a small localised market already building up advantages.

I think you’ll do far better holding the latter than the former over time.

Your friend,

Harje Ronngard,
Editor, Money Morning

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Harje Ronngard is the lead Editor at Money Morning. He’s also the Editor of Wealth Eruption and co-Editor of the Third Wave Portfolio.

The aim of both Wealth Eruption and the Third Wave Portfolio is to find misunderstood opportunities. These are the type of investments that multiply small amounts of money five- to 10-times in size.

Harje has an academic background in investments and valuation. He’s had experience across a range of asset classes, from futures to equities.

For any investment, Harje believes you only need to ask two questions. What is it worth? And how much does it cost? These two questions alone open up a world of opportunities, which Harje shares with Money Morning readers five days a week.


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