In a plot straight out of a Hollywood cyber thriller, the US Justice Department indicted five Chinese military officers on Monday for hacking some big US companies and stealing trade secrets on steel production, energy and even nuclear power. Chinese officials responded sharply, accusing the US of hypocrisy and threatening to retaliate—driving trade war jitters. Should big trade barriers follow, it would indeed be a negative. But that’s a big if, especially for two countries with as long a history of trade spat bluster as the US and China. It’s early to say this is just another, but that perspective should be part of any investment decision or analysis involving the situation.
The alleged cyber attacks took place from 2006 - 2014, when the authorities claim members of China’s People’s Liberation Army used phishing schemes to hack email accounts at US companies and steal intellectual property. In response, China accused the US of double standards, citing the NSA program, apparently not realizing there is a clear difference between stealing patented technology and plain old fashioned snooping. For now, their only retaliation is suspending an upcoming cyber security collaboration meeting, though both sides note punitive measures like tariffs or sanctions are possible.
Considering this is the first time the US has indicted foreigners for cyber-crime, this event might seem serious enough to tip US-Chinese relations into trade-war territory—but before you jump to that conclusion, some perspective is in order. These countries have a long history of bickering over trade matters, threatening a whole lot—and then doing a whole lot of nothing. Since China joined the WTO in 2001, they’ve filed 24 formal grievances against each other. One turned hot in 2012, when the US slapped tariffs on Chinese solar panels, claiming Chinese manufacturers were flooding the US with solar panels sold below cost, killing domestic producers. China responded with a tariff on US raw materials used to make solar panels. Separately, there was the debate over China’s hoarding of rare earth metals, which caused a great deal of hot trade rhetoric in 2010. For years, China’s currency was a hot topic, with politicians arguing the (supposedly) artificially low yuan gave producers there an unfair advantage. Disagreements weren’t exclusively in trade either. In 2014, the US barred the Chinese units of the big four accounting firms from auditing Chinese firms listed in the US, prompting another round of threatened “consequences.”
In short, the last 13 years have been full of threats, finger wagging and the odd tariff or two. None have caused a full-blown trade war. Now, none involved charges of private property theft. This doesn’t necessarily make a trade war more likely, but dismissing potential risks is never wise—what’s most important is to weigh the likelihood the risk materializes. Key to this exercise is the simple fact neither side has an incentive to escalate the situation—both countries depend heavily on bilateral trade. Total trade (exports plus imports) in goods between the US and China was about $563 billion in 2013. That’s 3% of US GDP and 11% of US total trade—and 13% of China’s total trade and about 6% of GDP. If that falls significantly, both get hurt. Some might be tempted to see a cooler US/China trade relationship as a solution for the widening trade deficit (a fallacy, though that’s a topic for another day), but this isn’t the case. Since China joined the WTO, the growth rate of US exports to China vastly exceeds imports’. There is no giant sucking sound. China is becoming an increasingly important consumer of US goods.
If a trade war developed, it would hurt both sides, and there would be collateral damage globally—a negative. The US-China trade relationship is a key link in the global supply chain, as components of many goods pass between China and the US. Restrictions or tariffs could affect trade routes and make goods more expensive or even create supply shortages. This could hamper global commerce and set off a global chain reaction of protectionist policies. Which would come back and bite the US and China even harder, making it all the more unlikely either side triggers this chain reaction. Why would Chinese officials deliberately disrupt the economic stability they rely on to retain power? Why would US politicians alienate voters with self-inflicted economic pain?
Politicians on either side have nothing to gain from a trade war. That said, they have plenty to gain from threatening one. Tough trade talk plays well with voters (or, in China’s case, subjects), and it gets that much hotter in election years. During his 2008 Presidential campaign, for example, Barack Obama voiced the need to keep China from manipulating its currency for trade purposes, a view Mitt Romney repeated during his own 2012 campaign. This episode comes on the heels of Russian sanctions and criminal charges filed against Switzerland’s second-biggest bank for aiding tax evaders. Getting tough on China, Putin and Swiss banks in one fell swoop? A politician’s dream.
Given the economic consequences of a trade war, in our view, politicians have far more incentive to avoid one. However, that’s not to say it’s impossible—politicians can be irrational players, especially if they think big tariffs can get them more votes. Short-term considerations could trump longer-term reason. However, markets generally move most on probabilities, not possibilities. A big trade war, in theory, could be a big enough negative to truncate a bull market—but the key is whether it’s likely to do so. In our view, for now, a trade war doesn’t appear anywhere near likely enough to warrant material changes to a long-term investment strategy. At this point, rearranging your portfolio because a trade war might happen poses an even larger risk to your portfolio’s long-term prospects—guarding against something that doesn’t happen can mean missing opportunity. Risky IFs are always worth considering closely, but only strong probabilities, in our view, should drive big tactical changes. A US/China trade war simply isn’t a strong probability today.