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“We're all better off because Italy makes the pasta and Switzerland makes the watches.”

— Howard Marks

Thursday value-added mailbag

Q: What’s the best way to reduce the trade deficit with China?

With logic, I think.

The US trade deficit with China is officially calculated based on the final-assembly value of imports — but most of the value in what we import from China comes from elsewhere.

When Foxconn assembles iPhones, for example, it imports, say, $493 of parts from places like Japan, South Korea and even the US, puts those parts together, and exports the assembled iPhone to Apple for roughly $500.

That would leave China-based Foxconn with a profit of just $7, but the entire $500 value of the phone is then attributed to China in trade statistics.

I’d argue that overstates the bilateral trade deficit between China and the US by about 70x.

iPhones are an extreme example because they’re a high-margin product that includes hundreds of parts sourced from dozens of countries.

But one study from the Federal Reserve suggests that using a value-added approach reduces the US trade deficit in goods with China by at least 33%.

Using a value-added approach then, would reduce the $295 billion trade deficit reported for 2024 to $177 billion.

(But either number is far better than the $1 trillion deficit that the president appears to have plucked out of thin air.)

The $295 billion that most people cite also ignores the surplus that the US has with China in services, which is estimated at about $30 billion for 2024.

So, net-net, the real trade deficit with China may only be about $157 billion — which doesn’t seem like too much of an emergency to me!

Also, Foxconn made a gross profit margin of 6% in 2024 while Apple made a gross profit of 46%.

Adjusting the US-China trade deficit for profitability would make it feel like even less of an emergency.

Q: Who’s getting the better deal then?

Stratechery’s Ben Thompson believes the current arrangement is a good deal for everyone, but especially so for the US: “We have a perfect system. Asia makes all the stuff, we make all the software, everyone gets rich, we get richest of all. Everything is amazing.”

But he follows that with an important caveat: “Except for the national security problem of us having total dependency on [China].”

Selling software is a much better business than selling hardware, so the US benefits disproportionately from the current state of trade with China.

But it does create a national security issue when we only make software and China makes all the hardware.

In a 21st-century military conflict, controlling an army of drones and robots running on slightly outdated software will be more valuable than having the latest software but no ability to make drones and robots. 

Q: Is Trump doing the right thing then?

If so, it’s by accident.

According to reporting by Bob Woodward, when President Trump was asked in his first term why he continued to believe in tariffs against all economic logic, he responded, “I just do. I’ve had these views for 30 years.”

For 30 years, his unwavering view has been that the US should reshore manufacturing for economic reasons alone. 

But that ship has long since sailed.

“Full onshoring is not viable,” Ben Thompson notes. “The US has moved too far up the value chain, [it’s] not going to move back down.”

(And who could blame us? Factory jobs are hard.)

If the goal was to reduce dependence on China, President Trump would be friend-shoring, with zero tariffs on allies like Mexico.

Instead, he’s tariffing friends and foes alike.

Q: Should Apple be exempted from China tariffs?

They were last time and President Trump appears to be considering it again: “There are some that have been hit hard,” he said yesterday. “We’ll take a look at that.” 

I suspect this has less to do with altruism and more to do with the fact that imposing tariffs and then granting case-by-case exemptions gives him incredible power.

If so, that alone would be a sufficient argument against his extreme form of protectionism.

"If we want an economy where lobbying is important — verging on corruption and favoritism and corporate welfare — we'll go for tariffs,” the economic historian Chris Meissner explains.

“But if we want efficiency and innovation, I think low tariffs is the winning combination."

Q: Who got yippy yesterday?

Secretary Bessent said that yesterday’s pivot wasn’t really a pivot: “This was his strategy all along.” 

But the president himself said otherwise.

Asked by a reporter what made him delay the tariffs, the president responded, "I was watching the bond market.”

This appeared to make him “yippy,” as bond markets have been known to do.

It’s another case of the “bond vigilantes” that Ed Yardeni first described way back in 1983: “If the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

More famously, James Carville said a decade later that he’d like to be reincarnated as the bond market because “you can intimidate everybody.”

If the bond vigilantes are back — this time intimidating the president into re-embracing the Art of the Deal — that will be good news for everyone.

Q: Who was frontrunning the news yesterday?

Not the president’s trade representative who appears to have first heard the news while attempting to defend the president’s tariffs in a hearing on the Hill.

But someone clearly did.

Trading volume in both Nasdaq and S&P call options spiked wildly just minutes before the president announced the 90-day pause in a Truth Social post.

Who was responsible for that can be easily determined — there’s a highly detailed audit trail for every options trade, should investigators at the SEC choose to follow it.

(Prediction: They won’t.)

Q: Is art subject to tariffs?

Not traditionally, no. 

But that may have changed this week.

“All artwork made outside the US will be subject to a 10% tariff,” one law firm advised its clients (before the 90-day pause). 

“On 9 April, that tariff will increase to 20% for artwork made in the European Union countries” and more for art made in certain other countries.

Finally, a use case for NFTs!

Q: How is crypto holding up in the selloff?

It has been difficult to pay attention to crypto this week with stocks and bonds moving like, well, crypto. 

But I did see that the best performing ETF of the year — up 247% —  is a 2x short Ethereum ETF.

So, crypto’s not holding up great, I guess.

I’ll start paying attention again and report back next week.

— Byron Gilliam

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