When we think about the flow of goods and services between nations, broadly speaking we would first turn to the Current Account. Ultimately this account captures flow of receipts and payments; if a country is bringing in (imports) more than it is shipping out (exports), then we would consider this country to be in a Current Account deficit. There are other factors, such as foreign aid, business investment, etc. that are included in this equation, but for this week’s newsletter, I’m going to focus on the trade portion.

 

There are a multitude of factors which impact the trade flows to and from a nation. We start with an understanding of what a country have a comparative advantage in, i.e. producing a good or service at a low opportunity cost vs other trading partners. In the past, China has had a comparative advantage in manufacturing textiles and other goods at relatively low supply cost, including labour. What almost seemed inevitable some years ago, became reality at the end of 2023, when China became the world’s leading vehicle exporter following an increase of 58% from the year before. Not surprisingly, hybrids and electric vehicles (EVs) were a main driving force behind this.

 

 

We are moving to a carbon neutral world, so an increase in EVs should be a good thing, no? Also, an increase in production and supply would mean a lower cost to the consumer, wouldn’t it? Surface level, yes, but when we drill down and analyze the longer-term impacts of this trend continuing, we find some pretty significant issues. Largest being the detriment to domestic automotive manufactures and industry as a whole as it becomes increasingly difficult to compete with cheap goods amidst inflationary input and wage pressures. Given that the US and Canada are open economies with free trade, we can’t just put a halt to these imports. Here enters tariffs. A tariff is essentially a tax imposed by the importing nation on the goods/services brought in by another nation. The increase in cost resulting from the tariff increases the cost to the domestic consumer, making them less attractive. There are several reasons a government may impose tariffs, but in this case specifically, the end goal is to protect domestic industries.

 

The US was in a 4 year review before announcing a 102.5% tariff on Chinese made EVs last month, an increase of over 75% from the existing 25%. Less than a month later, the European Commission also released it’s intent to impose additional duties of up to 48% commencing on July 4th. This will be under review until November 2nd at which point companies who are deemed to be cooperating (think of Tesla and BMW who have operations in China) could potentially see an increase of only 20% vs a non-cooperating company who would be hit with the higher amount. Finally, last night, the Canadian government announced that it is preparing potential new tariffs on Chinese-made EVs in efforts to align themselves with the actions of the US and the EU. This didn’t come as a complete shock, given the public announcements of some Canadian auto industry groups and Premier Doug Ford encouraging the Federal government to act in lock step with the US to avoid putting Canadian jobs at risk.

 

Digging a little deeper into the Canadian landscape, Chinese EV brands presently are not dominating however, over the past 12 months, imports have grown. Recall that Tesla switched from U.S. factories for it’s Canadian sales to a manufacturing plant in Shanghai – so if you’ve purchased a Tesla in the past year, it’s captured as a Chinese import. Keep in mind we currently impose a 6% tariff with a federal rebate of up to $5,000. There has been no formal commitment as of yet and conversations and analysis will continue in the coming weeks. While there is always risk of Chinese trade retaliation to potential additional tariffs, we also have to be mindful of creating an opposing position to the US given an upcoming review of the US-Mexico-Canada free trade agreement (USMCA). As a nation, we have already implemented targets when it comes to producing zero-emission vehicles and EV adoption. Specifically, by 2035 we have aimed to phase out the sale of new combustion vehicles, being replaced by zero-emissions vehicles for new sales. For solely EVs, they will make up one-fifth of all sales by 2026, three-fifths by 2030 and one hundred percent by 2035. This is not a long runway, which is also why we have seen significant initiatives in spending for new plants for companies such as Chrysler owned, Stellantis, Volkswagen and Honda. 

 

Shares of U.S. listed Chinese EV companies such as Nio and Li Auto dropped 1.4% and 1.5% respectively in premarket trading following the news release. In the following weeks we will have more guidance as to what the future holds for EV imports, but at the end of the day there is a fine line between fostering a competitive environment for consumers and protecting domestic economies.    

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Ally Pyle

 

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Ally Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Ally Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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