How shippers and shipping can survive the Sino-American trade war by understanding its nature
 Like the great naval engagements in the days of wind and sail that led to decisive Battle of Trafalgar in 1805, trade wars are conducted in slow motion. There are few sudden moves.
Too few appreciate the unique dynamics at work, combining economic social wind and weather, and the conditions of rival forces that play roles for good or ill. Too many see the Sino-American Trade War as schoolboys wrestling in the mud, sorely in need of a teacher to make them play nice.
What is forgotten is that negotiation is the battle and the deal is the treaty that concludes the war. To understand the significance of the tactics it is important to understand how these titans, President Xi Jingping and President Donald Trump deploy forces at their disposal and camouflage their vulnerabilities.
More to the point is how shipping and shippers from and to China are to survive the titantic struggle while sustaining as few injuries as possible.
According to analysts Bill He and Ken Fung of FTI Consulting in Washington, DC, there are a number of things businesses need to consider when dealing with the uncertain business climate between the United States and China these days.
China, they said, responded to US with its own tariff increases on US goods and tariffs by placing select US businesses on a new "unreliable entities list." The escalation comes amid a period of ongoing uncertainty and increases pressure on US-China supply chains and business models designed for a world of low-friction goods and capital flows.
These developments raise questions: How significant are these developments and what industries or businesses are most vulnerable?
As it turns out, unexpected changes, whether economic, political or regulatory, are always a test and will expose companies that have inflexible business models or funding vulnerabilities, say Messrs He and Fung. The hike in US tariffs from 10 per cent to 25 per cent and the proposed expansion to new categories of goods puts significant pressure on Chinese manufacturers of tariffed goods that have concentrated US sales.
Similarly, for American companies sourcing a large share of goods from China that fall under tariffed categories, the recent increases are a direct blow. The difference between 10 and 25 per cent is critical in some cases, because it takes profit margins off the table. "For many affected business relationships, handling the initial 10 per cent hike was a challenge last year, and there may not be enough room to handle an additional 15 per cent," they said.
There are ways of means how vulnerable companies, and their stakeholders respond to conditions imposed by a trade war. In some situations on the Chinese supplier side, tariffs at 25 per cent can be an existential risk; depending on a given business’ liquidity and cash flow, and there may be little time to act.
This is particularly true, they said, for suppliers exporting to the United States under DDP trade terms, where the burden to pay duties in the destination country remains with the seller. For company management, just keeping up with changes in tariff categories and rates can be a challenge amid day-to-day operational responsibilities, not to mention the additional time required to assess their impact on the business and consider strategic changes.
For capital providers with stakes in affected businesses, the situation is often opaque - it can be difficult to get information to assess the situation, and yet timelines for making investment decisions in critical situations are often tight, with large sums at stake.
Questions to be addressed in these circumstances are how many of the Chinese manufacturer’s customer relationships are at risk? What are the contract terms and how soon might customers try to switch to an alternate supplier? Can the business find a manufacturing partner outside of China and maintain its existing US customer relationships as a sourcing agent? If so, will the manufacturing quality meet specifications? If losing clients is unavoidable, what alternative customers can the business target?
Knowing the right questions to ask and crafting a viable response requires a mix of deep financial and industry expertise, according to Messrs He and Fung. The goals are to manage short-term cash flow needs, stabilise longer-term business prospects, and protect stakeholders’ interests. In many cases, the best solution will draw on several strategies to balance these objectives.
Shippers must also ask themselves what does the trade war mean for supply chains and sourcing strategies going forward? What about the much discussed manufacturing exodus from China?
While this is a risk worth considering in the case of one's particular business, in general there is little to fear on a macro level. Despite tariffs and trade war uncertainty, companies around the world need Chinese suppliers as much as ever.
There is simply no one country or group of countries that has the manufacturing breadth and depth to match China, whose advantage is based on a mix of infrastructure and human capital and is the product of decades of compound growth, the two analysts said.
"While certain countries, like Vietnam in footwear and apparel, and Malaysia in small electronics, have developed niche expertise, there is no credible alternative in terms of capability and price to match China’s offering on a global scale," said Messrs He and Fung.
They are backed by data from the World Bank that aggregates manufacturing value added by country underscores the magnitude of China’s existing capabilities compared to other countries.
China was responsible for over US$3.5 trillion of manufacturing value added in 2017, far exceeding second-place United States and dwarfing the contributions of countries such as India, Indonesia, Thailand, Malaysia and Vietnam, which are often mentioned as alternative sourcing countries.
"Given the stark differences in current capabilities, for just 25 per cent of China’s manufacturing value added to shift to these other countries, the capacity in all of them combined would have to more than double. It would be difficult for such a shift to happen quickly," they said.
"Even tariffs of 25 per cent do not change this basic calculus - while it will meaningfully affect certain businesses (like the acute cases mentioned above), China’s cost and capability margin broadly remains strong despite the tariff increases."
Messrs He and Fung also cite a recent survey by AmCham Shanghai and AmCham China found that despite the recent trade war escalation, roughly 60 per cent of US firms sourcing manufactured goods from China were not even considering relocating outside of the country. For the remaining 40 per cent, their exploration of alternate countries will likely prove difficult.
Good sourcing requires navigating dynamic and diverse markets and cultures, many of which are unfamiliar to Western executives. Not all manufacturers are dependable, and are qualified at the right price. The process generally works best when a local market insider with a detailed understanding of the sourcing company’s needs and a rigorous screening process for suppliers bridges the two cultures. Robust due diligence of potential manufacturing partners, quality assessment backed by trial runs, and a running competitive bidding process among vetted, capable suppliers are critical elements of a good sourcing strategy.
The trade war is a hurdle that can be accounted for in a broader sourcing strategy. Increased uncertainty makes intelligent and efficient sourcing as important as ever.
The first step is for a business to objectively evaluate its current sourcing process. This can range from a holistic look at its global sourcing strategy to a more tactical analysis of the impacts of recent tariff changes. While company circumstances vary, a few general responses to the immediate challenges posed by tariffs are worth mentioning.
In some cases, for companies that have diversified global manufacturing and sales bases, it is possible to rebalance internal supply chains to reduce the flow of China-US goods at a cost that is lower than the US tariff rates.
For other companies, a careful analysis of their products alongside the US Harmonised Tariff Schedule can highlight opportunities to reclassify goods into non-tariffed categories. A similar product-by-product review can also be critical for intermediate distributors importing tariffed goods to justify (and in some cases, contractually validate) tariff-driven cost increases to their customers.
Looking at the macro perspective, we turn to Gene Frieda and Stephen Chang, analysts at PIMCO, a big fixed income investment manager in Newport Beach, outside of Los Angeles.
"The near-term risk of a crash or a crisis in China remains low," they say. "Despite limits imposed by higher debt levels, China retains plenty of tools, both fiscal and regulatory, to stabilise the economy.
"However, any shift in routine comes with the risk of an accident, and we are particularly watching exchange rate management, which could constrain monetary policy from supporting stimulus efforts," said Messrs Frieda and Stephen Chang.
China is currently unwilling to ease monetary policy out of a reluctance to accept currency depreciation, in part for geopolitical reasons but also recalling its negative experience with currency flexibility in August 2015.
"But with debt service costs now equating to 70 per cent of the total monthly flow of credit, we believe interest rate cuts have become imperative," they said.
The ratio of China’s M2 money supply (cash in circulation and short-term monetary liabilities) relative to foreign reserves has reached levels not seen since the early 2000s.
"Unless capital controls are perfectly binding, the rising ratio highlights a dearth of foreign dollars to help stem potential domestic capital outflows and maintain a stable currency. The lesson from the Asian crisis is that when this ratio rises, so does the risk of a sharper exchange rate adjustment. The catalyst is typically a significant slowdown in GDP growth.
"We believe if China fails to ease monetary policy as a complement to fiscal stimulus, it risks falling into a trap similar to what befell its Asian peers in the late ’90s. To avoid a sharper, more destabilising fall in the yuan, we believe it is necessary to stabilise growth quickly, before doubts about the economy’s longer-term trajectory deepen," said the PIMCO analysts.
On the micro shipper level, the He and Fung advice appears to be sound enough though offers no quick fixes we all hope for. At the macro level on can appreciate that President Xi is protected from public opinion by a closed-circuit media and President Trump is faced with a hostile media Congress and Civil Service establisment, all bent on exploiting his failiures and minimising his sucessses. Yet his vital statistics look good, markets up as never before, unemployment down as never before.
There is a curious reverse symmetry to their advantages and disadvantages; their respective blessings and curses. Trump is blessed with one set of advantages while Xi is cursed with the other set. |
