Fears of excessive tariffs peaked on Liberation Day in early April. Financial markets cratered based both on the excessiveness of the announced levies in addition to the irrational nature of the process to determine payments each country would make. That included a tariff on an unoccupied island, at least uninhabited by people. The economic pain to the penguins would have been unbearable!
For the last five weeks, the administration has stepped back in stages. First the so-called reciprocal tariffs were suspended, at least until July with the notable exception of China where tariffs were increased to an unbearable 145%. Trade between the two nations seemingly ground to a halt. But negotiations over the weekend essentially eradicated most of the tariff pain and restored, at least temporarily, normalized trade between the two nations. While there may be a modest economic hit to GDP for both nations until goods start flowing again in each direction, clearly any thought of separating the two nations economically would have been disastrous. One can’t unwind four decades of economic interdependence with a simple Executive Order setting huge barrier walls in place without catastrophic damage. While few expected 145% tariffs to remain in place very long, a retreat all the way to 30% was beyond expectations. Hence the 2%+ rally likely this morning.
The 30% tariff may not be the end point. China has abused the notion of trade equality since it entered the WTO three decades ago. Negotiations will focus beyond simply finding a correct tariff rate. China must stop dumping excess production on world markets below cost. It must respect intellectual property. It must allow foreign businesses greater access to its own markets. In short, if China wants to compete and become a greater economic power, it must do so by the same set of rules as the rest of the developed world. No one is naïve enough to suggest that all China’s wrongs will be corrected in a matter of days or weeks. Negotiations that began late last week are only a first step forward. Final agreements will take months, if not years.
China now has a choice. It can continue to operate by its own rules that have given it unfair advantages for years. That choice may help growth near term but it doesn’t create binding relationships. Only a few allies like Russia and North Korea would consider the renminbi to be used as a currency for trade. The alternative, a revised set of trade rules, first between China and the U.S., and then with the rest of the world, has the opportunity to further establish China as a leading economic power. No one doubts today that China is a great economic power. It produces more goods than the United States, Germany and Japan combined. It can’t consume all it produces and therefore supports its economy by selling the rest throughout the world. Now, led by the United States, selling those goods worldwide must be done fairly.
As noted, over the last several decades China has become a manufacturing powerhouse. But it wants more. Its goal is to be the most advanced economy in the world and profit by the superiority it might be able to achieve. It has built an education infrastructure that rivals the rest of the world, producing far more STEM graduates that any other nation. It subsidizes and incentivizes businesses in strategic areas like artificial intelligence, drug development, and military weapons systems. Its electric grid today is far more robust than ours and capacity is growing at a much faster rate. DeepSeek’s emergence as a major large language model, despite restrictions the U.S. has place on exports of high-tech semiconductors and related manufacturing equipment, shows convincingly that artificial barriers alone won’t stop Chinese progress. As we noted just last week, our future economic success will depend on a public/private partnership to support and accelerate the United States’ own development in the key arenas that China is focused upon. Any restrictions limiting the ability of Nvidia# to stay in front as the leading producer of key semiconductors and systems are counterproductive. Instead, the focus should be on providing proper incentives that the best technology, including as much of the supply chain as possible, be reshored to the U.S. What applies to semis also applies to drug development, electrical equipment, drones and other advanced weapons systems, and energy independence. Not only must incentives be created to achieve that goal, barriers have to be torn town. Specifically, our bureaucracy has to be torn apart and no longer stifle the building of required infrastructure. Rome wasn’t built in a day and Congress acts slowly. In fact, it only acts quickly at a time of crisis. With that said, the emergence of DeepSeek and other Chinese companies leading first to a competitive equality but perhaps on the way to economic superiority, and the dominance China has already established in the electric car business, are clear warning signs that must be heeded. They are heard within the Trump administration. Congress has to see the warning signs as well.
Wall Street is celebrating because all the ruckus of the past three months has set the stage for an economic transformation. But setting the stage isn’t the same as making any transformation happen. Both China and the U.S. see disruptive economic change coming. Each follows a different approach. China’s economy is state run and state led. President Xi is the de facto head of every major Chinese company. In China’s rush to become an economic power, state led decisions have advanced the nation at a breakneck pace. But all decisions haven’t been the right ones. It fostered vast overbuilding of real estate. The bursting of that bubble has resulted in huge economic losses and made cautious Chinese consumers even more cautious. Deviating from state-imposed rules stifles entrepreneurial spirits. Perhaps central planning’s main advantage is speed. A Chinese road gets built in months, not years or even decades. Environmental issues get dealt with after the fact.
With that said, the U.S. has its own set of advantages. Our free enterprise model has given birth to the computer age, commercial aviation, semiconductor development and a majority of the most effective drugs in the world. As a result, we are the richest nation by far. As our nation has demonstrated repeatedly, our private enterprise system is a far better allocator of capital than the federal government. It also invites much less corruption than a state-controlled economy.
Thus, what’s happening today in Geneva sets the stage for a new framework that will guide economic development worldwide for many years to come. A book written almost 30 years ago by Adam Brandenburger and Barry Nalebuff entitled “Co-opetition” described a world where competitors often cooperate for common good aside from the direct competition for supremacy. Look at auto malls as a perfect example. If you want to buy a car, it’s convenient that all the car dealers are centrally located. That’s the cooperative part. Who sells you the car is the competitive part. Donald Trump has always looked at the world in competitive economic terms. Why don’t I sell you more goods than I buy from you? I win; you lose. Sometimes that’s right. I want to sell you that car, not the dealer next store. But how do I do that? By offering the best car and the best economic value on the automall.
The goal must be to elevate the U.S. above everyone else via a framework that focuses on developing tomorrow’s best products in all the key areas. Who cares where the tee shirt is made. We all have finite resources. Being the best technologically in all ways should be our nation’s imperative. In the 1980s and 90s, Toyota proved that it made the best mainstream cars. That fact elevated our Big 3 to build better automobiles. They reclaimed partial leadership (e.g. trucks and SUVs) but never returned to dominance. On the other hand, in the 1980s, Japan dominated semiconductor manufacturing. But over time companies like Intel, Texas Instruments and later Nvidia found new markets which each could dominate. The biotech revolution gave us names like Genentech and Amgen.
Today presents the opportunity. Wall Street is optimistic. Hopefully, Wall Street is right. Let me end with one final point. Intel created the microprocessor and had a multi-decade run as a dominant manufacturer of semiconductors. But the real giant turned out to be Microsoft# which built upon the power of the microprocessor to develop software that became the foundation for so much of what we do today. And Apple# used semiconductor technology to create a whole new world centered on the iPhone. The Mag 7 are today’s Intel. They are building the infrastructure for all kinds of new intelligence-related uses we can’t even contemplate at the moment. The important point is that we, meaning the whole world, are at the cusp of a new revolution. The winners will be vast. Some are currently building the infrastructure. Some are using that infrastructure to build applications (or agents using today’s parlance) to better accomplish specific tasks. Some not yet public or even born will emerge as the next Apple or Microsoft. But disruptive change also fills graveyards. Companies focused on protecting the past will lose. Some simply won’t be able to afford to pivot as necessary. Tomorrow’s winners and losers have yet to be determined. It is our job to define both.
Local golfer Jim Furyk is 56 today. I don’t normally mention fictional birthdays but Homer Simpson is 70 today.
James M. Meyer, CFA 610-260-2220