There are no winners in a trade war. The global economy is witnessing the truth of this expression as the escalating conflict between China and the United States weighs on the indicators of economic performance worldwide. But even as we recognize that the long-term cost of the trade war will be spread across the globe, in the short term, the tension will also create opportunities for those nations which are poised to capitalize on the emerging commercial gaps.
A Good Thing Gone Bad
Tempers have been flaring between the United States and China for years. The trade war began in earnest in July 2018, when the United States started to levy a 25% tax on $34 billion USD worth of imports from China. China immediately responded in a tit-for-tat manner, implementing retaliatory tariffs on an equal amount of US goods. Since then, the amount and intensity of the tariffs has increased, with the most recent round of tariffs going into effect on September 1, 2019.
Of course, the conflict has not been limited to tariffs. In the months since the trade war began, China has filed multiple suits against the United States under the WTO. Meanwhile, China’s currency has been allowed to devalue to the lowest value seen in a decade. Chinese officials fervently defend the move, denying that it was done in reaction to the evolving trade war. Yet it is undeniable that the weaker Chinese yuan will make Chinese exports relatively less expensive for consumers both in America and around the world.
One of the most potent tools that China has in its arsenal is the leverage of tariffs against agricultural products from the United States. In 2017, the last year before tariff interference, the United States exported $19.5 billion USD worth of agricultural goods to China. By 2018, that figure was down to just $9.1 billion USD. Through July of this year, cumulative agricultural exports are running another 8.3% behind prior year.
In early August, China’s Ministry of Commerce stated that certain Chinese companies will no longer purchase US agricultural products. The Chinese strategy is undeniably a serious hit to American farmers, many of whom have already been dealing with a challenging crop season and dwindling financial solvency. Zippy Duvall, the President of the American Farm Bureau, characterized the effects of the trade war as, “a body blow to thousands of farmers and ranchers who are already struggling to get by.” Targeting US agricultural exports provides a secondary, strategic benefit for Chinese authorities by weakening the support of rural voters for President Trump, a key bloc which has, thus far, been firmly behind him.
Bridging the Gap
Albeit a smart and calculated move by China to exert pressure on the US using the lever of agricultural trade, the country’s population of 1.4 billion people still depends on food, feed, and fiber above and beyond what is produced domestically. If these products are not going to be sourced from the US, where will they come from? Many agricultural superpowers, particularly those located in South America, are willing and able to rise to the challenge.
China imports an enormous range of agricultural products from the United States including grains, animal proteins, fruits, vegetables, and processed products, among many others. While any amount of Chinese imports is relevant to a given industry, the need for a few key products is especially critical. To maintain an uninterrupted supply, China will be highly motivated to identify alternative sources of these products in particular.
As it happens, many of China’s key agricultural imports from the US can be supplanted with product sourced from South America.
· Soybeans: Without doubt, soybeans have been receiving the most attention throughout the conflict, and with good reason. Soybeans represent nearly two thirds of China’s agricultural imports from the United States, valued at $12.2 billion USD in 2017, before shrinking to just $3.1 billion USD in 2018. South America is particularly well positioned to capitalize on the opportunity to supply additional soybeans to China. After the United States, Brazil is the second largest global producer of soybeans. Argentina, Paraguay, Bolivia, and Uruguay also rank among the top 12 soybean producing countries.
It is true that most of these countries already ship significant volumes of soybeans into China. Nevertheless, it is logical that these volumes will grow further. In fact, this shift is already occurring. Between 2017 and 2018, Brazil’s shipments of soybeans to China grew by 34.5% or $7.0 billion USD – accounting for a significant portion of the value sacrificed by the United States over the same period.
What is perhaps even more compelling is the expansion opportunities of these countries. Boasting a strong agricultural heritage, relative land and water availability, and lower cost of production, many South American countries could easily invest to expand soybean production if the temporary dynamics brought about by the trade war translate into structural characteristics of global trade.
· Cotton: Accounting for 5.0% of US agricultural exports into China in 2017, cotton is the second most valuable agricultural export from the US to China. For this crop, South American producers face serious competition from other global powerhouses, especially India.
Weaker demand from China over the last couple years initially diminished the impact of the tariffs. In fact, between 2017 and 2018, US cotton exports to China dropped by just 5.5%. Over the same period, however, Brazil’s exports of cotton to China increased by over three and a half fold. So far in 2019, US cotton exports to China have plunged by 35.0%. When the data is tallied, it is all but certain that Brazil will have picked up more of this volume.
· Dairy Products: Between 2017 and 2018, US exports of dairy products into China fell by 13.3%. Most of this drop represented declines in shipments of whey products, skim milk powder, and cheese. South America is particularly well suited to replace a share of this supply, with the shift already beginning to occur. As US exports were falling, dairy product exports from Uruguay into China were rising by over 300%.
In the last few months, China has made several public demonstrations of their intentions to solidify commercial relationships between Chinese companies and South American dairy suppliers. A commercial memorandum between dominant Uruguay milk cooperative Conaprole and Chinese firm Mengniu has led to speculation that the two organizations will pursue further trade. On the regulatory side of things, after 12 years, China recently authorized 24 Brazilian dairy factories to begin exporting into China. Curious timing, indeed.
Of course, the ability of the South American dairy industry to meet Chinese demand will depend very much on its own health and viability. Just a few years ago, both Argentina and Uruguay were selling significantly larger volumes of dairy products into China. Since that time, weather effects and depressed farm level economics have diminished the milk pool. A strong appetite in China for dairy products, however, could be just the spark these industries require to grow once again in earnest.
To some extent, reduced exports of US agricultural goods into China has been compensated by increasing exports into other markets. Many American producers expect that as their global competitors, such as those in South America, rush to meet the Chinese demand, neglected consumer needs will be created for US exports to fill. While this shift may occur to some extent, it is critical to recognize that trade is not necessarily a zero-sum game. Furthermore, the longer the trade war persists, the more likely it is to influence production decisions, which could fundamentally impact global supply and competitiveness dynamics.
The Trade Winds are Shifting
China is no stranger to South American agriculture. Reading between the lines, strategic investments in the continent’s infrastructure and agricultural value chain indicate that China expects South America to play a crucial role in feeding and clothing its population for years to come.
As China has long anticipated looking toward South America to fulfill its agricultural needs, the trade war with the United States may have just accelerated this process. South American farmers are now being presented with a tremendous opportunity. Their ability to rise to the occasion will determine if they are able to steal a piece of the pie, or if we will all be left crying over spilt trade war milk.