The US wants to put an end to the trade war with China as quickly as possible - The war will hurt the US most; if it goes on, it could undermine the chances of Trump getting re-elected

The article was originally posted on Webronza on August 23, 2018

In my last article, "US-China trade war, a hurdle set too high by Trump," I expressed my view that the trade row between the two countries would not cease easily. If so, why did Washington accept a delegation from the Ministry of Commerce of the People's Republic of China for trade talks?

There appears to be reasons and circumstances that have made the US want to put an end to the trade war as quickly as possible.

They are the moves surrounding soybean exports. When President Trump announced a 1.3 trillion-yen farmer relief package, he pleaded with a group of farmers to "be a little patient" and pledged that he would win concessions from trading partners by imposing high tariffs, thereby enabling farmers to enjoy more advantageous market conditions.

The question is whether things will go as he plans.

Will China suffer damage from higher tariffs on soybeans?

An article titled, "US-China trade friction on soybean supplies; reasons why China is at a more disadvantageous position than the US" on the Nihon Keizai Shimbun Commodity VIEW dated August 14, says that when focusing only on soybeans, the view that the odds are stacked against China seems to be a prevailing one.

The article points out that: Brazilian soybean prices have been on the rise in China, as the country has increased soybean imports from Brazil to offset the reduction in those from the US; this has in turn raised pork prices (because China relies on soybean meal to feed pigs), which may cause public dissatisfaction; and although any increase in pork imports could reduce demand for soybean forage, China has imposed retaliatory tariffs on US pork as well. Arguing that China cannot substitute the huge amount of US soybeans with Brazilian soybeans alone, and thus cannot help but purchase a certain amount from America, the article mentions that the US is somewhat benefiting as European importers snap up cheap US soybeans, while it is undeniable that China has serious concerns about the soaring prices of South American soybeans and supply shortages. On this basis, the article raises the question of whether China can endure the side effect of the new import duties which it decided to introduce on its own.

If the article is based only on the opinions of market players preoccupied with immediate business issues, such a conclusion may be inevitable. Now let me critically examine the article and evaluate the potential effects on both the US and China.

American soybean exports drop sharply

Here are the basic facts. Although China basically maintains its policy of self-sufficiency in grains such as rice and wheat, it has essentially abandoned its policy of being self-sufficient in soybeans used for oil production and animal feed, becoming dependent on imports. While the country produces 14 million tons of soybeans, it imports 97 million tons, which is more than 60% of the soybeans traded worldwide.

Of the total soybeans imported into China, 56% are from Brazil and 33% from the US, indicating that the two countries together account for nearly 90% (when viewed from the perspective of the US, 60% of US soybean exports, or more than 30% of the total US soybean crop, find its way to China).

Under these circumstances, what will happen if an additional 25% duty on US soybeans is passed onto the cost of importing?

First, China increases imports of relatively cheaper soybeans such as those produced in Brazil. Next, as Chinese imports are carried out by state-owned companies, they will deliberately increase imports of soybeans from countries other than the US (China even purchases Argentine soybeans, whose prices are on the rise due to poor crop). In addition, imports of alternatives to soybean such as sunflower, rapeseed and palm (grown for the purpose of extracting oil, soybean and these crops are collectively called "oilseed crops" on the international market and are not classified as grains) increases.

Of course, these measures alone cannot replace all of the 30 million tons of soybean supplies from the US. Accordingly, China also buys a certain volume of US soybeans whose import costs have risen because of additional tariffs. But how much volume? To what extent will it drop compared to the import volume before the imposition of the new tariffs?

First, in line with the increasing import prices of soybeans, China's total soybean imports will decrease. Moreover, as China will rely more on other countries as new soybean sources, US soybean shipments to China will plunge sharply.

The Financial Times dated August 17 forecasts that China's soybean imports from the US will decrease by 10-12 million tons over the next six months. To put it another way, US soybean exports to China will plummet by more than a third, representing 10% of the total US soybean crop. This could wreak havoc on the US soybean industry.

US soybean prices will also slump. We can say that the view that the US soybean industry will be seriously hit is widely shared among US soybean producers.

Brazil and Argentina increase soybean production

Next, let me examine the effect on China's pork prices that the Nikkei article points out. Pork prices are in fact on the decline due to overproduction, and consumers are unlikely to be affected in any way for the time being. If pork prices rise in the future, it is only necessary to import pork. Having imposed retaliatory tariffs only on US pork, China can purchase pork from other major exporters such as Canada and the EU under the same conditions as before. If China cannot import pork from the US, all it has to do is increase imports from other countries.

Of more importance is a fact that the article does not take into consideration; future soybean production in Brazil and Argentina.

In these countries in the Southern Hemisphere, the period of soybean planting, i.e. spring, runs from September to December, while that of soybean harvesting, runs from January to April.

The Brazil soybean harvest hit an all-time high (119.5 million tons) this year. However, the US Department of Agriculture (USDA) predicts that the country will have yet another record-high of harvest at 120.5 million tons next year (in 2008 when soybean prices increased due to decreased US crops, Brazil, seeing the results, boosted soybean production by planting soybeans on sugarcane fields; judging from the continuous rise of soybean prices at the moment, Brazil's harvest could surpass the USDA's estimate).

On the other hand, blighted by drought, Argentina's harvest dropped sharply from 55 million tons last year to 37 million tons this year. The USDA expects it to recover to 57 million tons next year, an increase of 20 million tons. This means the increase in Argentine production alone will exceed the expected decrease in US soybean exports to China.

In other words, even if prices for imported soybeans in China rise due to higher tariffs, China will become able to purchase cheaper soybeans from countries such as Brazil in four months.

The more time goes by, the more damage American farmers will suffer

The expansion of soybean production in Brazil was first driven by Japan.

In the wake of the US ban on the export of soybeans in 1973, Japan developed Brazil's Cerrado region, once called the "barren land" (a savanna accounting for a fourth of Brazil's territory), into agricultural fields from 1979 to 2001. As a result, the country's soybean production, which was only around 10 million tons in 1977, jumped more than tenfold in 30 years to threaten the US' position as the world's largest producer and exporter of soybeans. Brazil has about 100 million hectares of additionally usable farmland in the Cerrado (refer to: "The false claim that rising global populations will give rise to food crises").

If farmers remain patient as Trump pleaded with them to, they could take a heavy hit. Since tariffs on soybeans in major importing countries have traditionally been low, there can be no greater market access as President Trump seeks. Moreover, with the 1.3 trillion-yen farmer bailout being a one-time payment, no more relief packages are scheduled for the next fiscal year onwards.

From the American standpoint, the more time that goes by, the more soybeans other countries such as Brazil will produce, and the more ground the US will lose. As was the case with the Vietnam War, if a project which the US embarked on with the intention of finishing in a short time is protracted and evolves into a hopeless mess, it will cause massive damage. The US must end the trade conflict with China as quickly as possible and ask it to remove tariffs on imports of US soybeans.

Failure to settle the matter in an appropriate manner may affect the midterm elections. Key Senate battleground states in the coming midterm elections, including Missouri, North Dakota and Indiana, are closely related with the agricultural industry. If the US-China trade war drags on, it will have a measurable impact on President Trump's re-election. Iowa, the leading producer of soybeans in the US, is a swing state during presidential elections.

The biggest loser may be none other than the US

How about non-agricultural industries?

A considerable portion of an additional 25% tariff that the US has slapped on about US$34 billion worth of Chinese goods is offset by the falling Chinese yuan, which has lost 9% of its value against the dollar since the beginning of this year. Conversely, the stronger dollar which has risen 9% against the yuan, together with China's imposition of tariffs of up to 25% on US exports, has made US exports far less competitive.

Although consumer goods account for only 1% of the US$34 billion worth of Chinese goods, they account for as much as 23% of a further US$200 billion worth of Chinese goods on which Trump is planning to impose tariffs. If the prices of these consumer goods increase, consumers will begin to complain.

More noteworthy is the fact that third countries can benefit from US-China trade conflict. The dispute over soybeans has benefited Brazil, while that over beef, Australia, and that over automobiles, Japan.

I have thus far pointed out that a free trade agreement (FTA) designed to reduce or remove tariffs between two or more countries puts non-member countries of the FTA in a disadvantageous position. In contrast to an FTA, the recent trade war, in which the US and China hit each other with hefty tariffs, puts countries other than those two in an advantageous position, as they can export their goods to them with tariffs on their exports remaining unchanged.

In this respect, the damage caused by the US-China trade row is not as serious as that caused by the trade war after the Great Depression in which many countries slapped higher tariffs on all of the goods from the entire world. Figuratively speaking, in cases where there are several bridges to go into the US, even if one of the bridges that connects the US and China is closed, you can reach the US using other bridges. By contrast, all bridges were closed in the trade war after the Great Depression.

A look at exports to China finds that the number of American-made BMW and Mercedes-Benz vehicles exported to China has decreased due to higher tariffs, whereas that of Lexus models shipped from Japan to China has increased, spurred by lower tariffs. In addition, Japanese vehicles manufactured in China have become more cost competitive than American cars thanks to lower tariffs on automotive parts (refer to: "The Japanese and US automobile industries will have a showdown in the Chinese market").

Investing 100 billion yen each, Toyota and Nissan have built new factories in China, with a view to boosting their local production capacity by 20% and 30%, respectively. The US automobile industry is now losing ground.

The longer the problem lingers, the more setbacks the US will experience.

Is a truce likely to happen after the US midterm elections?

As pointed out in my previous article, Trump's negotiating objective is to eliminate the trade deficit and to prevail in the struggle for supremacy by preventing China from pressuring US companies to transfer high technology to Chinese partners. The latter measures are emphasized not by Trump, but rather by members of the US Congress. However, as is witnessed by increasing tariffs on Chinese imports, Trump has run roughshod over Republican lawmakers' opposition (refer to: "Trump's bailout of agriculture having the opposite effect"). Meanwhile, job creation through the elimination of the trade deficit, have a strong electoral appeal. Furthermore, a number of Trump-backed candidates won Republican primaries in the 2018 midterm elections.

Trump is expected to stay tough on China up through the midterm elections. There is a possibility that, after that, Trump, suffering from some weaknesses, may win concessions from China (it does not matter whether they are dubious ones, as long as they will enable Trump to tell the electorate that he beat China) to reduce the US trade deficit, thereby putting the trade war on hold. I think that this possibility is also suggested by the fact that, not the Office of the United States Trade Representative led by Mr. Lighthizer, who takes a hard-line stance toward China, but the US Department of the Treasury, for which Mr. Mnuchin, who has strived to smooth over the dispute, serves as Secretary, has acted as the US counterpart to the Chinese delegation in the recent trade talks.

If the trade war continues until the 2020 presidential elections, the US economy will suffer a major setback, undermining the chances of Trump getting re-elected. I think Trump is smart enough to know this instinctively.

(This article was translated from the Japanese transcript of Dr. Yamashita's column in "Webronza" on August 23, 2018.)

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