The Investment Scientist

The Bizarre Turn in US-China Trade Conflict

Posted on: May 18, 2018

Early on the morning of May 13, President Trump tweeted:

“President Xi of China, and I, are working together to give massive Chinese phone company, ZTE, a way to get back into business, fast. Too many jobs in China lost. Commerce Department has been instructed to get it done!”

What?!?!?! Trump wants to save Chinese jobs? To say that I am caught by surprise is an understatement.

Let me give you a little background just in case you don’t pay attention to the news (God Bless You!)

When ZTE was caught selling telecom equipment to Iran and North Korea in 2016, they entered into a plea agreement with the US commerce department (Obama administration) that included the following stipulations:

  1. They will pay a $1.19 billion fine, the largest fine ever paid by a company.
  2. They will fire the four executives involved.
  3. They will discipline the 35 employees involved.

Fast forward to May 2018, just before the US trade delegation headed over to Beijing for negotiations, the US commerce department announced a 7-year ban on component exports to ZTE because they did not carry out the third stipulation of the plea agreement. It turns out the 35 employees were not disciplined, they were given their 2016 year-end bonus!

At the time, the administration’s position was that this had nothing to do with trade negotiations. Of course, the ban was not taken that way in China because ZTE is one of the few national champions in China.

Together with Huawei, they have dominated the world’s patent filings for the last decade. (See the chart below.)

5c74a0b3-9c7d-46f2-8e98-4c576e676082-original.png

But despite these great strides, ZTE is very dependent on US components. It’s a $17 billion company and 20% to 25% of its components are sourced through the US. Without the US components, it’s finished as a company regardless of how many patents they have.

The Chinese sprung into action.  Within a week, a $47 billion fund was set up to build a domestic component industry. So the commerce department’s action is not without long-term repercussions. But still, compared to the steel and aluminum tariffs that mostly hurt the US but barely scratch China, this is a quick win for the US. Who wouldn’t want to come to  the negotiation table with such a strong hand? That’s why Trump’s reversal is very puzzling.

When it comes to dealing with China, there are three camps in the administration: Trump is fixated on the trade deficit reduction; Treasury Secretary Mnuchin wants to open China’s financial and insurance markets and Director of Trade Council “Death by China” Navarro and Commerce Secretary Ross want to kill Huawei and ZTE to slow China’s momentum in the development of 5G. These are conflicting goals. I don’t think Trump’s tweet is the end of it.

The US-China trade relationship is the biggest cloud over the global economy right now. I will keep paying close attention to it so you don’t have to.

(Feel free to share if you find it insightful.)

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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