Global Market Commentary

A Trade War With China? That’s Already Been Happening For Decades


A Trade War With China? That’s Already Been Happening For Decades


During last year’s U.S. presidential campaign, we began reading discus-sions about the possible effects of a trade war with China. Since the new administration took office, such dis-cussions have become ubiquitous. But even last year, we were left scratch-ing our heads: the risks of a trade war with China? Do these pundits really not know that the U.S. and China have been in a trade war for the better part of a generation?


(The answer is, no, they probably don’t, which is no small part of the reason they were blindsided by the grass-roots popularity of insurgent candi-dates such as Donald Trump and Ber-nie Sanders.)


It is often said that China abandoned its self-destructive Maoist command economy back in the 1980s. This may be so, but if the implication is that China thereby embraced free-market capitalism, such a conclusion is incor-rect.



China’s Mercantilism


In fact, the modern Chinese politi-cal-economic system is a new phenom-enon which has never existed before: a hybrid of political authoritarianism, domestic capitalism, and international mercantilism. It is that mercantilism that has created a trade war between the China and the U.S. (and the rest of the developed world) in the past 30 years.


Under mercantilism, a government regulates its own economy in an effort to undermine for-eign states economically or politically to its own advantage. We do not mean through simple comparative advantage, but through less trans-parent means, which are often illegal under international trade agreements such as those that are binding on members of the World Trade Organization (to which China acceded in 2001). In European history, mercantilism was the basic for-eign trade and policy position for most states un-til free trade began to win devotees in the 1800s. It included strategies such as forbidding colonies to trade with other nations; monopolizing mar-kets; banning the export of gold and silver (a form of monetary manipulation); forbidding trade to be carried in foreign ships; subsidizing exports; promoting manufacturing and industry through research subsidies; controlling wages; and restrict-ing domestic consumption of imported goods through various barriers to trade.


There are some obvious parallels between elements from the above list and contemporary Chinese economic and trade policies. What Chi-nese policies could justly be designated as forms of mercantilism?


First, exchange rates. Countries with freely convertible currencies have tools at their disposal to influence exchange rates and support domes-tic exporters — but when currencies can be freely exchanged and priced on a global market, such tools are more difficult to use and far less effective. China does not have a freely convertible currency, and while the government has allowed the yuan to move more against other nations’ currencies since 2015, it is still tightly managed. Of course, a managed currency is like a universal tar-iff. Somehow, a political fiction was maintained in the United States under both the Bush and Obama administrations that China was not a currency manipulator, despite occasional threats to label it


as such. President Trump famously promised to name China as a currency manipulator on “day one” of his presidency — a promise he has not kept.


Second, export subsidies. These subsidies include, for example, tax rebates to exporters, sub-sidies for the construction of factories, reimburse-ments for startup losses, and the use of provincial governments and banks to aid in the financing of new and ongoing businesses. All of these unfair practices have allowed Chinese manufacturers to undercut their competition by dumping products into foreign markets priced below their real cost. President Trump’s Secretary of Commerce, Wilbur Ross, who has long experience in the steel busi-ness, has been outspoken in pointing out the unfair practices which support China’s steel industry; but so far, contention within the Trump administration has hindered consensus on a policy response.


Third, piracy, intellectual property theft, and forced technology transfers. It is well-known that state-sponsored (or at least state-tol-erated) Chinese hackers are constantly engaged in industrial espionage against U.S. corporates in an effort to steal trade and technology secrets. For decades, the notion of “intellectual property” was completely alien to Chinese authorities, and mov-ies, television shows, music, software, brand names and images, etc., were permitted to be stolen and counterfeited with sporadic and minimal if any efforts at enforcement. Further, U.S. firms who want to do business in China are required to work with Chinese partners and transfer technology to those partners. Intellectual property has now received some attention from the Trump adminis-tration, which is an encouraging development.


China’s advantages against U.S. manufacturers are thus not simply a matter of lower manufacturing costs due to cheaper labor or lower environmen-tal standards, though those have both played a role. Rather, many of these advantages derive from

unfair practices in which the Chinese government deploys domestic and monetary policies to subsi-dize its own firms. Whatever else that might be, it’s not free trade; and the use of such policies over an extended period, with the profoundly negative effects that they have had on American industry and workers, is nothing if not “trade warfare.”


It’s amazing that so many U.S. administrations have said and done so little about this ongoing war. Officials such as Wilbur Ross are noteworthy because they are stating truths that are obvious to American workers and businesspeople, no matter how much they may be derided and belittled by academic economists and the denizens of doctri-naire think-tanks.


Having said all this, we want to take pains to emphasize that we are simply noting policies that are unfair to U.S. citizens and corporations that have not been properly addressed by U.S. policymakers, and which should have been stopped long ago. We are not making any kind of across-the-board criticism of Chinese entrepreneurs, Chinese businesses, or the Chinese government. As we have noted many times in this letter, there are many Chinese businesses which are dynamic and powerful innovators — for

example, as we have written recently, e-com-merce, gaming, and social media companies. Further, identifying unfair trade practices engaged in by the Chinese government does not directly affect investment prospects for these firms, some of which still currently represent some of the best investment opportunities we see on a global level.


Investment implications: Disaster does not await if the U.S. government acts to address some of the egregiously unfair trade practices in which the Chinese government has long engaged. Not only do we not need to fear a “trade war,” we should frankly acknowledge that the U.S. and China have been in a trade war for decades, and in many respects the U.S. has gotten the worst of it, largely because elected officials from both par-ties were persuaded that helping the Chinese nation on its path to develop-ment was more important than defend-ing U.S. workers and industries. Now the pendulum is swinging in the other direction — that’s all. So don’t fear a trade war; and also, don’t fear invest-ment in some of the truly innovative, fiercely growing Chinese technology firms, which are still some of our favor-ite stocks in the current global environ-ment.



Why Quantum Computing Matters


Quantum computing is a classic case of the dilemma that confronts investors who like to mon-itor long-term trends and themes in technology and society. Even now, quantum computing is not an investable theme. The companies now doing the most work on it are too big for any signifi-cant effect to make it to their bottom line within a reasonable time horizon for most retail investors.


The companies that will be the must-own winning investments in the future probably don’t exist yet.

But still, investors have to pay attention. The world is on the cusp of disruption by a set of technologies that will mark a new inflection point in modern industrial history. At the nexus of all those technologies sits quantum computing.

Quantum Computing, Industrial Revolu-tions, and the Death of Moore’s Law


You’re  probably   familiar   with  “Moore’s     Law”


  • the principle first stated by Intel [NASDAQ:


INTC] co-founder Gordon Moore in 1965 which described the exponential pace of increasing com-puting power and its declining cost. Over the past half century, power (the density of transistors on an integrated circuit) has doubled, and price halved, about every two years.


The transformation of the modern world has been driven, so far, by three phases of industrialization. First, starting in the late 18th and early 19th centu-ries, came steam power and railroads. Next, start-ing in the 1870s, came oil, chemicals, automobiles, electrification, and mass production. And most recently, starting in the 1940s, came computers, digitization, microprocessors, and ultimately the internet. Each of these phases dramatically accel-erated the pace of technological and social change: perhaps we could call them the Age of Steam, the Age of the Automobile, and the Digital Age.


If there is a single engine powering the Digital Age, it has been Moore’s Law. Observations like the following are commonplace, but bear repeating: the cell-phone in your pocket has more computing power than a Cray-2 — the 1985 supercomputer whose liquid cooling system captured the public imagination, and which cost $37 million in 2017 dollars.


The exponential rise of cheap computing power has given us a world now on the cusp of functional artificial intelligence and computers that can pro-gram themselves and acquire, interpret, and use data at a superhuman and exponentially acceler-ating pace. Almost any technological innovation you read about in daily media was enabled by the advances of the Digital Age. In the past few weeks, for example, new gene-editing technology has been on the front page (although of course we wrote


about it in 2015). This technology would have been impossible without the sequencing of the human genome that the Digital Age, and Moore’s Law, delivered. Only a decade ago, two Ivy League economists, Frank Levy and Richard Murnane, could casually refer to driving a car on a busy street as the kind of task that computers could never master; not only is that impossible task already being done, but investors are discussing how it will transform the bottom line of compa-nies such as Alphabet [NASDAQ: GOOG].


But as analysts and industry spokespeo-ple increasingly recognize, Moore’s Law is coming to an end. The Semiconduc-tor Industry Associations of the U.S., Europe, Japan, South Korea, and Taiwan have put out an annual chip-technology forecast for the last 25 years, based on Moore’s Law — and they announced last year that the report for 2015 would be the last. Chip architectures are coming up against hard physical limits as they approach the atomic level.



(There are still some prominent cheerleaders for Moore’s Law; INTC’s CEO, Brian Krzanich, writes that he has “witnessed the advertised death of Moore’s Law no less than four times” during his career. Other executives and analysts observe that if INTC really had the secret to keep Moore’s Law going, they would be doing better at getting their presumably faster and cheaper chips into mobile devices.)


Moore’s Law, then, brought us to the threshold of a new stage in the saga of the world’s transfor-mation by technology: the stage whose first signs include universal connectivity, the internet of things, big data, artificial neural networks, and machine learning. Futurists are glimpsing the world that we’ve discussed in these pages before — a world where self-creating and self-programming comput-ers take humans out of the loop as they unshackle innovation from the cognitive limitations of their

flesh-bound creators. And just at this threshold, Moore’s Law is faltering.



What’s Coming Next — Fear and Hope


We predict that you will begin to hear more about “the end of Moore’s Law.” It is a theme that could easily be taken up alongside other cur-rent pessimistic themes — for example, that technol-ogy and demographics are setting up a deflationary future that will result in permanently lowered pros-pects for economic growth in much of the devel-oped and developing worlds, or that automation will result in a permanently unemployed underclass that will have to be pacified with a universal basic income (basic income and the internet — the mod-ern “bread and circuses”).


The same sorts of pessimism and anxiety have greeted each phase of the modern world’s path of industrial development. This kind of reaction seems to be an inevitable compo-nent of society’s adjustment to the new world that a technological revolution is ushering in. The next phase, which will likely be known as the Age of Artificial Intelligence, will be no different. Inves-tors who allow themselves to be persuaded by pessimistic arguments are simply going to miss out on the most powerful techno-logical, social, and economic trends.


So here’s our take on why the death of Moore’s Law may simply mark the next acceleration of technological transformation, and how Moore’s Law may in fact be reborn with the Age of Artificial Intelligence.


The answer is quantum computing. (If this sounds too much like science fiction, remember: self-driving cars were still science fiction in 2005.)


Quantum Computing and the Rebirth of Moore’s Law


We’ve discussed quantum computing here before. There’s a reason we’re mentioning it again now, which we’ll discuss below, but first here’s a brief refresher.


A classical computer stores data as “bits,” with each bit being represented by a zero or a one. A quantum computer exploits a property of quan-tum mechanics called “superposition,” in which a given particle may be not just in one state or another, but in both simultaneously. Thus a quantum bit, or “qubit,” may be a zero, a one, or a superpo-sition of both states. The upshot of this is that a classical computer with n bits can be in any one of 2n different states. But a quantum computer can be in all of those states simultaneously. So as the number of qubits increases, a quantum computer’s superiority would increase exponentially.


The hurdles to the arrival of “quantum supremacy” are technical. In order to remain in a superposed state, a qubit must be completely isolated from interaction with the surrounding world. In prac-tical terms, that means that most quantum com-puting models have to be kept at the temperature of intergalactic space. Critics of quantum com-putation, including those who once maintained, incorrectly, that it would simply be impossible, focus on the problems caused by “noise” — the random results that can occur because a system is imperfectly insulated from its surroundings.



The New Research That Made Us Go “Hm-mmmm”


Recently we read a paper in which a team of researchers from Raytheon [NYSE: RTN] 

and IBM [NYSE: IBM] demonstrated the superiority of a quantum algorithm even in a currently existing, “noisy” quantum system. The type of algorithm tested would be particularly useful in machine learning where a computer is trying to extract useful information from a mass of extraneous information — think of a sensor try-ing to “see” street signs in a storm. (Interested readers can find the paper here: “Demonstration of quantum advantage in machine learning,” Nature, April 17 2017. Good luck with the math.)


Results such as this lead us to believe that the nay-sayers are wrong. Moore’s Law as it existed based on 20th-century classical computing technology may be nearing the end of its lifespan. However, the complex of technologies that are about to usher in the next stage of technological transformation are finding support in the arrival of a fundamen-tally new and exponentially more powerful com-puting technology — quantum computing. Even the current early quantum computers are already showing themselves to be perfectly adapted for the coming world of big data, machine learning, and artificial intelligence.


Investment implications: Quantum com-puting is not yet an investable theme for retail investors. The major public com-panies developing the technology may never see direct benefits from it that sig-nificantly impact their bottom line. The successful small companies that will rise



Market Summary


The U.S. Economy


U.S. economic data for the second calendar quar-ter came out yesterday, and they were very strong. According to the latest revision, U.S. GDP grew by 3% in the quarter, and was far above the estimates of almost all economists. For the third quarter, the


to future prominence probably do not yet exist. Quantum computing will not enter the mainstream for another five to ten years. For now, there are two rea-sons for investors to pay attention. First, the end of Moore’s Law in classical com-puting will result in negative news cover-age — coverage that should not dissuade investors from attention to the real underlying fundamental trends. Second, when quantum computers arrive, they will not be small and they will not be por-table. As this technology arrives, it will be deployed to users through the cloud, and because of its transformative power, it will reinforce the cloud’s dominance.


Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s principals and clients own GOOG and INTC. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies men-tioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.



most accurate predictor of U.S. economic growth, the Atlanta Fed’s Nowcast, is calling for 3.4% GDP growth in the third quarter. In spite of Hurricane Harvey, we anticipate strong growth in Q3 2017.


Business spending and consumer spending are strong, and this bodes well for corporate profits

and for stock prices. We are not shocked to see that even in the seasonally tough period of August and September, the U.S. stock market is holding up well.



U.S. Markets


U.S. stocks are uneven. Some market sectors are doing very well and others, especially small-cap and value stocks, are doing very poorly. As we have been pointing out for months, large growth stocks, especially in disruptive technological areas, are in demand, and we continue to favor them. We have repeatedly recommended Alphabet [NASDAQ: GOOG], Facebook [NASDAQ: FB], Apple [NAS-DAQ: AAPL], and others. We also see that bio-technology stocks are regaining their momentum in the wake of some high-profile M&A and drug approval news.


Videogame stocks are moving higher with solid growth and exceptional demand.


We also note that financial technology stocks like Mastercard [NYSE: MA] and Visa [NYSE: V] are acting well, while financial and bank stocks in gen-eral are not acting well.


Industrial electronics and semiconductors are other areas of strength. Areas of weakness con-tinue to include retailers, finance, and oil.



Europe, the U.S. Dollar, and Emerging Mar-kets


In our opinion, Europe remains neutral, and as long as it is not attractive, it will not be a destination for investment money at this stage. Emerging mar-


kets have done well, and should continue to attract capital.


Emerging markets including China, Singapore, Hong Kong, Taiwan, India, and others which are manufac-turing bases will continue to do well. On the other hand, in our view, countries that are predominantly raw-material producers are not attractive. The U.S. dollar, which may fall longer term, is close to beginning an oversold rally in the next few weeks that will create pressure on commodity prices.





Gold has moved to $1,300 plus as we expected, and we are still bullish on gold, with one caveat: if the dollar strengthens, it will make it hard for gold to move rapidly higher, and gold could experience a correction. We are watching gold and the dollar closely, and will keep readers informed.


Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Cur-rently, Guild’s principals and clients own GOOG, AAPL, and FB. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that par-ticular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.


Thanks for listening, we welcome your calls and questions.