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Why the $375 billion US-China trade deficit can be totally misleading

Krystal Hu

U.S. Commerce Secretary Wilbur Ross is heading to China for another round of trade talks on Saturday. As the White House pledges to impose a 25% tariff on $50 billion worth of goods from China, corporate America’s stakes are particularly high. New research from JPMorgan and The Conference Board suggest it’s not just how much U.S. companies import from China, but how much they make in China.

President Donald Trump has repeatedly said the $375 billion trade deficit between the U.S. and China is a result of failed trade policy. He also claims as the country that is exporting more, the U.S. has more leverage in tough negotiations. But U.S. companies pocketing profits in China are often ignored, and they could become China’s tool to retaliate if the trade war ever comes true.  

Another round of trade talks between the U.S. and China will resume this weekend. (AP Photo/Andy Wong)

Over the past decade, U.S. companies have doubled down on their Chinese subsidiaries through huge investments, from building factories to setting up stores across sectors. Intel (INTC), for example, built a $5.5 billion chip plant in northeast China. China has also become Starbucks’s (SBUX) fastest-growing market, as the coffee chain plans to open a new store there every 15 hours through 2022.

It makes economic sense for U.S. companies to make bold moves in China — demand is booming and the production cost is relatively low. Like the U.S., local governments in China also offer incentives to invite foreign capital to buoy the economy and create jobs.

(Screenshot/JPMorgan note)

Chinese companies have brought huge overseas cash to the U.S., which is not necessarily recorded in the staggering trade deficit number. “The bilateral U.S. trade deficit with China almost disappears once you include sales of in-country subsidiaries,” wrote Michael Cembalest, chairman of market and investment strategy at JPMorgan, in a note on Tuesday. “U.S. companies are doing almost the same amount of business in China as Chinese companies are doing in the U.S., but through their subsidiaries rather than via exports.”

Cembalest thinks the U.S. has a lot to lose if China retaliates against U.S. companies doing business in China. Those multinationals are often among the largest employers and capital spenders in the U.S. Most of them are public companies whose shares are widely held in U.S. defined benefit contribution plans like retirement accounts and 401(K)s. Walmart (WMT), the largest private employer in America, nows operates 424 stores in China after entering the market in 1996.

(Screenshot/JPMorgan note)

Latest Conference Board research also shows foreign firms’ significant roles in China’s “export machine,” especially in high-tech sectors, and how they stand to take the biggest hit from a U.S.-China trade war. Foreign Invested Enterprises (FIEs) in China are responsible for 979 billion, or 43%, of exports from China in 2017. In the Information and Communications sector, which the proposed 25% tariff targets, 79% of China’s exports are from FIEs, many of which are American-owned.

JPMorgan’s Cembalest is optimistic about trade negotiations. After all, U.S. companies in China also contribute to the domestic economy. The linkage between the world’s largest and second-largest economies is bigger than ever, and he believes there is enormous economic pressure on China and the U.S. to find common ground.

Krystal Hu covers technology and economy for Yahoo Finance. Follow her on Twitter.

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