The U.S.-China Trade War, Explained

You've heard about the trade wars. What you may not know are all the dirty details. In this segment of Industry Focus: Energy, Motley Fool analysts Jim Mueller and Nick Sciple give investors an overview of what a tariff is and what effects it can have on businesses and consumers.

A full transcript follows the video.

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This video was recorded on Sept. 27, 2018.

Nick Sciple: I know tariffs have been in the news for the past six months or so, Jim, but for listeners who may not fully understand what exactly a tariff is and how it works, can you give them a rundown of what a tariff is and how it works?

Jim Mueller: Sure. A tariff is a tax on something that's coming into a country that is being imported by a company inside the United States. That means that the exporting company or the country it's coming from is not the one paying the tax. These are not taxes paid by China or Chinese companies that are going to the U.S. Treasury. These are taxes paid by mostly U.S. companies on the import of the good, whatever it is. Those are going into the U.S. Treasury.

The companies have a couple of ways of dealing with that extra cost on their goods. They can decide to eat the cost. That is, their profit margins are going to go down. Or they can pass along the extra cost to the consumer. Whether it's a retailer like Walmart bringing in goods, so prices at Walmart are going to be raised, like they hinted at earlier this week, or whether manufacturers are going to have to pass along the costs to the consumers. The price of everything goes up.

Sciple: Exactly. You want to nudge these domestic consumers to maybe switch their sourcing to United States products. Let's go ahead and jump into exactly what these tariffs are that came down this week, and the significance of them from a dollar point of view.

Effective Sept. 24, President Trump announced a 10% tariff on $200 billion in Chinese imports. That tariff is currently 10%, but at the end of 2018, that's expected to rise to 25%. What's significant about this tariff, I know this has been in the news for a long time, this is the third round of tariffs, and it's the largest round of tariffs. Back in July, we had $34 billion worth of Chinese goods tariffed. Then, in August, we had a follow-on of $16 billion in tariffs. So, this is really a huge jump up of $200 billion.

This is affecting all kinds of goods. The list, if you look it up, is pages and pages long. Some significant things, pretty much any agricultural product is likely going to be tariffed, handbags, textiles. Some significant things that were not tariffed: smart watches, Apple made a specific plea to have those exempted, as well as some car seats, playpens, more child care type-products, those were exempted. Another thing that's significant about the size of these tariffs is this $250 billion aggregate tariff amount that we reach after these new tariffs were put in place is about half of U.S.-China trade.

Mueller: Yeah. U.S. brings in a little over $500 billion worth of goods from China. The $250 billion so far this year is roughly half, as you said. President Trump has also indicated that if things don't go as to what he wants to happen, he's going to do it on the rest of it.

Sciple: Exactly. President Trump has said that if China were to take retaliatory action on these tariffs, which they have, in fact, and I'll explain that here in a second, that he's going to put in place another $267 billion worth of imports. For all intents and purposes, that would put a tariff in place on 100% of U.S.-China trade.

Pivoting to China here, China also announced some tariffs on $60 billion worth of goods that also went into effect on Sept. 24. This is in addition to, China had also had previously announced tariffs of $50 billion. The total U.S.-China trade is about $130 billion of imports of United States goods into China. This second round of Chinese tariffs is going to now cover $110 billion of the $130 billion of U.S.-China trade -- again, almost 100% of the entire trading relationship.

So this is pretty significant in that almost all the cards have been played here. If all the threats and allegations with regard to tariffs are followed through upon, all of U.S.-China trade is set to be under some kind of tariff barrier in 2018. So this is a really important time to talk about the significance of these tariffs.

Mueller: Right. The first round of the Chinese tariffs was mostly on agricultural goods. The second round is more industrial goods -- small aircraft, computers, and textile see a 5% duty imposed on them. Bigger things like industrial chemicals meet some more agricultural -- frozen vegetables, for instance, see a 10%. But what's interesting is what's not been added to this list. That's primarily crude oil. China is a big importer of oil, and they haven't yet put on a tariff on to what they import from the U.S. as far as that goes.

They've also done something interesting in that, while they've increased the tariffs on American goods, they've lowered the tariffs on some of the other goods from other places. For instance, electrical equipment or machinery. That's an effort to try to drive their own consumers away from choosing U.S. products and choosing others. That's another way to try to hurt American companies and America.

Sciple: Exactly. This has really come to a head. We're speaking on Sept. 27. There had been plans for U.S.-China trade talks to take place today and tomorrow. But now, as a result of these new rounds of tariffs from the United States, China has stated that Washington is "putting a knife to China's neck and that China will not participate in the trade bully ism of the United States." What we're really seeing is, there's not a lot of signs that the two parties are going to come to the table and work something out here anytime soon. This is looking like it's going to be a protracted trade conflict between the countries that will cover the entirety of trade.

Jim Mueller, CFA has the following options: short January 2019 $80 calls on Walmart Inc. and long January 2019 $55 calls on Walmart Inc. Nick Sciple owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.