FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
February 12, 2019

IN THIS ISSUE:

1. Overview – China’s Rampant Cyber Theft

2. China Trade Deal Must Address Digital Theft

3. China’s Government is Behind Cyber Theft

4. America’s Future Depends in Large Part on China

Overview – China’s Rampant Cyber Theft

Chinese negotiators recently offered to buy enough American products to reduce the huge bilateral trade deficit to zero by 2024. Yet US negotiators rejected that offer to end the dispute. The problem is the proposed deal with China does little to address the more important issue which is China’s continued theft of US “intellectual property.”

Specifically, the US wants China to stop requiring American firms that seek to do business in China to have a Chinese partner and to share their technology with that partner. That policy is explicitly forbidden by World Trade Organization rules, which China has ignored since they joined the WTO in 2001.

The US also wants China to stop using cyber espionage to steal technology and other industrial secrets from American companies. Chinese President Xi Jinping agreed to end such digital theft of US industrial technology after he met with President Obama in 2015. Unfortunately, that agreement was very narrow and referred only to theft by “both governments.”

Although the agreement did lead to a temporary reduction in cyber theft of industrial technology, cyber attacks on US companies by Chinese state-owned industries have increased again in recent years, which President Xi denies.

The US Trade Representative, Richard Lighthizer, recently estimated that China’s technology theft is costing the US economy $225-$600 billion a year. And the FBI has warned that China’s cyber theft of American technology is the “most severe threat” to US national security.

So, US negotiators are demanding that any new trade deal with China must include strong penalties and significantly stronger sanctions if the Chinese don’t stop the theft. The deadline for the current negotiation is March 1, at which time stronger sanctions are set to go into place. That’s what we’ll look into today.

China Trade Deal Must Address Cyber Theft & Espionage

As I have written in recent months, our large trade surplus with China is not a serious problem. Sure, we’d like them to buy more from us, and it appears they will. As noted above, the far greater problem is the theft of intellectual property from US companies.

Although the US has a large trade deficit with China, that is not the reason why it is imposing high tariffs on imports from China and threatening to increase them significantly more after the end of the current 90-day truce on March 1. The Chinese use the stolen technology to compete with US firms in China and in other parts of the world and to enhance their military. President Trump wants this stopped.

The US tariffs are clearly hurting the Chinese economy, and its stock market is down substantially. The Chinese authorities say they are eager to conclude an agreement with the US in order to stop the economic slowdown and reverse the decline in their stock market.

The US government has no desire to stop China’s economic growth or the growth of its high-tech industries. But stealing technology is wrong. It has gone on for too long and should not be allowed to continue. President Trump is determined to stop it.

If nothing is resolved by March 1, the US will raise the tariffs on $200 billion of Chinese exports they sell us from 10% to 25%. That will hurt the Chinese economy further and cause the Chinese authorities to take the US demands more seriously – and to negotiate accordingly.

No Question China’s Government is Behind Cyber Theft

The US Justice Department says that Chinese hackers have targeted intellectual property, confidential business and technological information and other data at more than 45 US companies in at least a dozen states and within federal government agencies. The Department claimed last year that over a dozen other countries were harmed as well.

Deputy Attorney General Rod Rosenstein said this last year:

"America and its many allies know what China is doing. We know why they're doing it. And in some cases, we even know exactly who is sitting at the keyboard perpetrating these crimes in association with the Chinese government."

Rosenstein added that more than 90% of the Justice Department's economic espionage cases in the past seven years involved China. And he said that many of the companies that have been targeted by Chinese defendants operate in sectors that are listed as targets for strategic development in the official Chinese government policy called "Made In China 2025."

FBI Director Christopher Wray also emphasized the scope and scale of China's state-sponsored theft, saying individuals acting at Beijing's behest are "the most active perpetrators of economic espionage" in the world.

So, there’s no question that the Chinese government is at the heart of cyber theft. It remains to be seen if they will stop this criminal activity by the March 1 deadline, or face a huge increase in US tariffs to 25% on most of its goods coming into the US. If that happens, prices for Made In China goods will go up, hurting American consumers.

America’s Future Depends in Large Part on China

Most conservatives believe that President Trump caved in to liberals when he allowed the government to reopen recently, without getting funding for his border wall. As a result, he and his administration are desperate for some kind of significant accomplishment to ensure his re-election in 2020.

For better or worse, the Trump administration has decided that a new trade deal with China is that significant accomplishment. Like it or not, Trump appears to be betting his re-election on the General Secretary of the Communist Party of China, Xi Jinping.  

If Xi doesn't make a deal with Trump on trade, some feel that the US economy will sour and we could be in, or headed toward, a recession as we approach Election Day in 2020 – in which case Trump could lose. On the other hand, a good trade deal with China just ahead greatly increases the odds that Trump is re-elected next year.

It is unnerving that the fate of our country could lie in the hands of a communist dictator. But that's the nature of our interconnected world when dealing with the most populous country on the planet. Many believe that gives China  the upper hand in negotiating a new trade deal, or just about anything else. Some believe China is in a position to simply wait us out.

Xi, after all, is China's "supreme leader" for life (or until another bloodthirsty communist unseats him). Any American president has at most eight years, and in Trump’s case a lot less, to negotiate important agreements successfully. Remember, as pointed out above, the new much higher trade tariffs are set to go into place March 1, less than three weeks away.

Until last week, there had been hope that Trump and Xi could meet later this month when the president travels to Vietnam to meet Kim Jong Un. However, the Secretary of State confirmed last week that no such meeting is planned and said such a meeting was very unlikely.

With the deadline looming, some have questioned whether President Trump was right to play the “tariff card.” Some argue that the Trump administration could have gone another route to punish China for its cyber theft. Specifically, they say we should have convinced the World Trade Organization (WTO) to revoke China’s membership. That would be a crushing blow.

The US could also have unilaterally removed China’s Most Favored Nation (MFN) status which we made permanent in 2001. That would be another blow. But for reasons we’ll probably never know, the Trump administration elected to take the tariff route rather than the WTO/MFN options.

As you read this, our trade negotiators will be in Beijing bargaining for a new trade agreement and the end of cyber espionage and theft of intellectual property ahead of the March 1 deadline. No one knows what will happen if a deal is not reached and the tariffs go to 25%.

If no meaningful deal is struck, and the tariff goes to 25%, I believe the global equity markets could get very ugly very quickly! I expect they will get ugly even before the March 1 deadline if the talks aren’t going well.

The bigger question is whether the American people are willing to ride out a nasty trade war with China and a potential market meltdown? I’m not so sure. If the equity markets tank, there is no way to know how investors will react if their IRAs and 401(k)s plunge over the next few weeks.

Donald Trump's chief China negotiator, Robert Lighthizer, and his team certainly have their work cut out for them. We have to hope China’s leaders realize that their economy will go even further in the tank IF the president pulls the trigger on the increase to 25% tariffs. That’s a big IF, but I believe President Trump will do it.

If the China trade war escalates, we could be in for a rough patch in the markets just ahead.

Finally, if you haven’t considered our Alpha Advantage Strategy, which has the ability to go long or short, now is the time to give it a serious look. There should be time to get you in before the fireworks start. Call us at 800-348-3601. It could be the best move you make this year.

In any event, fasten your seatbelts!

Best regards,

Gary D. Halbert

SPECIAL ARTICLES

US-China Trade Talks Resume as Deadline Approaches

US-China Trade Talks Focus on Intellectual Property

Gary's Between the Lines Blog: Solid Majority of Americans Oppose Border Wall

Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.