Trump Will Use the “Nuclear Option” on Trade

What we have seen so far are just the opening shots of the coming trade war. Think of it as the Battles of Lexington and Concord that opened the Revolutionary War. Much larger tariffs and penalties are waiting in the wings.

Trump will soon receive a report under Section 301 of the Trade Act of 1974. That report has been almost a year in preparation and will reveal that China has stolen over $1 trillion in U.S. intellectual property.

Section 301 of the Trade Act of 1974 is the “nuclear option” when it comes to trade wars.

I don’t want to get too deeply in the weeds here, but Section 301 gives the president broad authority to impose sanctions and penalties. The president will have a completely free hand to impose billions of dollars of damages if not more on China.

Trump could receive this report within days or weeks. Regardless, it is coming soon.

Once the president receives it, the law gives him 90 days to react. But he will likely act within days or weeks upon receiving it.

Importantly, Trump does not require Congressional approval to act. Again, the law gives the president enormous flexibility. So he doesn’t need Congressional backing as he did for, say, the tax cuts.

Initial reports indicated that these penalties will be about $60 billion. In fact, Trump used that figure in today’s press conference on tariffs. But that’s just for starters.

Trump will wait to see if China is willing to make concessions in other areas. If not, he can easily double or triple that $60 billion figure.

The penalties Trump seeks to impose are not limited to specific sectors but may apply across a wide range of goods and services from China that benefitted in any way from the theft of intellectual property (IP).

IP is a very tricky subject with a lot of gray area.

Trade restrictions on steel, for example, are much easier to implement. Steel is tangible. You can weigh it, track it, etc.

Intellectual property, on the other hand, is much more vague, much more amorphous. It exists inside human brains, or on the internet or a computer thumb drive. It can be everywhere at once in a sense.

So it’s much more difficult to identify, quantify, and throw tariffs on than traded products like steel, autos, solar panels or washing machines. Yet intellectual property is more important than ever.

We live in a world of technology, a world of the internet, of smart devices, and even cryptocurrencies for that matter. These are all forms of intellectual property.

Now, China has been stealing U.S. intellectual property for decades in various ways. Sometimes it happens when a Chinese scientist comes to the United States and takes what he learns back to China.

But a lot of the theft has been done through malicious hacking of U.S. technology companies. These could be big defense contractors like Lockheed Martin or Northrop Grumman. But they could also be small firms with one great innovation or idea. These smaller firms may actually be more vulnerable because they don’t have the defenses against hacking or cyber warfare that the big guys do.

With this stolen intellectual property, China has been able to build up companies like Huawei, a large technology and telecommunications firm. And its defense industry has made enormous strides because of stolen intellectual property.

Because intellectual property is so amorphous, the president could look at a wide variety of Chinese industries and say:

“You know those electronic products you’re assembling, like smart phones? They wouldn’t be so smart if you hadn’t stolen some of our intellectual properties. So we’re going to throw a tariff on them.”

These penalties will have a much broader and deeper impact than the steel and aluminum tariffs, or those on washing machines or solar panels.

China has issued a pro forma denunciation of the fines and tariffs, but have not announced any specific retaliatory measures in the immediate aftermath of Trump’s actions.

China will retaliate for U.S. sanctions not with their own tariffs, but with asymmetric financial warfare including diversifying reserves away from U.S. Treasuries into gold and European bonds, and with restrictions on U.S. direct foreign investment in China.

Both sides can continue the trade war in cyberspace with ongoing reciprocal theft of intellectual property and intrusions into critical infrastructure.

I want to mention one other trade weapon the president has at his disposal, something called CFIUS. CFIUS stands for the Committee of Foreign Investment in the United States.

It does not have to do with trade specifically, but with what’s called direct foreign investment. That’s when a foreign entity from China or Europe or anywhere else buys a U.S. company.

Generally, the U.S. has been very open to direct foreign investment in the same way we’ve been open to trade.

But there’s always one big exemption, which is national security. And the 1974 trade act, which I mentioned earlier, does provide a national security provision to limit direct foreign investment in the U.S.

CFIUS is designed to protect U.S. companies from foreign takeovers where national security could be compromised.

Nobody cares if a company from a friendly country like Canada wants to buy a nonstrategic asset like an ice cream company in the United States. No one thinks that involves national security.

But if the Russians or the Chinese wanted to buy AT&T, that’s a completely different story. That would not be allowed because that’s a critical part of the infrastructure of the United States.

That’s a simple example of how CFIUS can be used for national security reasons to protect against foreign acquisitions of U.S. companies.

The president has already announced that he’s going to be very aggressive in preventing Chinese acquisitions of U.S. companies. So that’s another arrow in Trump’s trade war quiver. He’s using them more aggressively than at any time going back to the 1980s — maybe even the 19th century.

What are the practical implications of tariffs, IP penalties, and all these trade war developments?

First, Chinese companies that export to the U.S. will be hit with tariffs. But U.S. companies like Boeing that import materials from China will be affected also. Further, U.S. companies that export to China will get hit with retaliation. And U.S. companies looking to expand in China will be denied permission.

Likewise, many Chinese companies looking to expand to the U.S. will be denied permission under CFIUS. And U.S. companies that are hoping for a Chinese buyout offer may not be able to sell to a Chinese company.

But it goes beyond China. You can take those examples and just substitute South Korea or the Eurozone. Will a South Korean company be able to buy a U.S. company if there’s a trade war going on? Maybe not.

So the trade war is going to ratchet up and get much more intense. Wall Street has its head in the sand. This trade war is not going away anytime soon. It will last for years, likely intensify and be a major headwind for stock prices.

Investors need to prepare immediately for the fallout from this massive escalation in the trade wars.

Regards,

Jim Rickards
for The Daily Reckoning