A rare Monday update, with several important storylines that played out last week and over the weekend. As always, you can sign up for the mailing list here: http://eepurl.com/dp7wZL.
New weapons to fight a trade war: As we discussed last week, the trade war is on, and the Trump administration has targeted China’s “Made in China 2025” program as the focus of our efforts. It’s hard to tell how this will play out, in part because there are still competing factions within the White House that want different things. The moderate group, led by Secretary of the Treasury Steven Mnuchin and National Economic Council Director Larry Kudlow, simply seek to reduce our trade deficit with China (as this site has repeatedly argued, a significantly flawed endeavor). The hawks, led by U.S. Trade Representative Robert Lighthizer and presidential adviser Peter Navarro, seek fundamental changes to Chinese trade policy. China has struck back by targeting (primarily) U.S. agricultural products, and now analysts are writing about what other weapons each side has if the trade war continues to escalate.
On the U.S. side, our biggest weapon is our economy’s strong growth, in part owing to those same tax cuts, which may indicate that the economy can absorb the shock of higher prices. Additionally, because we buy more from other countries than they buy from us, our tariffs on their goods should be more effective than their tariffs on us. Over the weekend, the administration clarified its intention to move forward with China-specific regulations that require a CFIUS-like review of investments from China above a certain threshold in companies with “industrially significant technology.” At the time of this writing, the anticipated threshold was a 25% equity investment, although officials were clear that the threshold could change. And U.S. companies should expect “industrially significant technology” to be very broad in scope. Separately, Congress is rebuking President Trump’s effort to save embattled Chinese telecom company ZTE.
On the Chinese side, predictions range from embargoing the export of rare earth minerals to the U.S., which would halt our ability to make many high-tech products that rely on the specialized metals; to simply ignoring U.S. intellectual property rights (in other words, adopt a no-holds-barred piracy policy); to the “nuclear option” of stopping the purchase of U.S. Treasury bonds, which finance the operation of the entire U.S. government. Back in 2013, rates for U.S. Treasury bonds were historically low and below the rate of inflation—meaning anyone who purchased a U.S. Treasury bond was effectively paying the U.S. to run its government. Rather than reap that opportunity, Congress engaged in debt ceiling brinksmanship which led to the sequestration program to cut the federal budget and reduce the federal debt. Now, as we face the prospect of a significant buyer of our bonds walking away, coupled with reduced governmental revenues due to recent tax cuts, the magnitude of the missed opportunity five years ago may be coming into relief.
Either way, just the prospect of a trade war is hurting the global economy, and some of Trump’s former advisers worry that the damage will wipe out the economic gains attributed to the tax cuts passed earlier this year. Republicans, who dominate in rural and agricultural districts, are worried about their election prospects when the tariffs against U.S. agriculture begin to bite. Far from deterred, Trump appears ready to double down on his trade strategy as a political strategy to win the 2018 midterms.
Reformwatch 2018: On the CFIUS reform effort, the Foreign Investment Risk Review Modernization Act was easily passed last week in the Senate as a rider to the National Defense Authorization Act. The House is yet to move on its companion NDAA, but is working towards action before the August recess. CFIUS reform prior to the midterms is a high probability.
When things progress logically: Relatedly, with the expansion of CFIUS jurisdiction on the near horizon and several high-profile blocks of Chinese acquisitions in the U.S., early numbers indicate that Chinese investment in the U.S. has plummeted 92% in 2018 compared to 2017 levels. The lack of Chinese investment in the U.S. has not equated to a slowdown in work among CFIUS attorneys in DC. Anecdotally, when you talk to the bar, everyone is as busy as they’ve ever been—even those who don’t write blog posts for a solo practice.
Eye for an eye: In an indication that the U.S. is warily beginning to fight fire with fire, earlier this week, U.S. cyber command expanded authorizations for “offensive” cyber operations against adversaries. And separately, DOD announced that it would fund billions in investments into microelectronics research. DOD was rather candid that the move was meant to counter Chinese efforts in the space.
And finally, the shareholders strike back: Certain of Qualcomm’s shareholders have filed a derivative suit against the company for losses sustained when the share price dropped after President Trump blocked Broadcom’s hostile attempt to acquire Qualcomm. The suit alleges that Qualcomm’s public filings made materially misleading statements or omitted material information. This analysis, published on Lexology, plays up the potential for risk when a company, under threat of a hostile takeover, unilaterally files with CFIUS. This firm disagrees. The suit is primarily about the accuracy of public statements that Qualcomm made during the pendency of the hostile bid by Broadcom, not about the appropriateness of unilaterally filing with CFIUS. To be sure, one element of the suit seeks damages for losses sustained after Qualcomm disclosed information about its interactions with CFIUS—and that element is almost certainly a loser. The President of the United States of America intervened in the transaction and blocked it on national security grounds. That move absolutely vindicates Qualcomm’s instinct that the hostile bid should be reviewed by CFIUS, and thus its decision to file. Indeed, the CFIUS regulations have a section that explicitly facilitates unilateral filings in the case of a hostile takeover attempt. Unilateral filings are an effective—and efficient—way for one side of a transaction to engage CFIUS to resolve any issues for both sides. Far from risky, it is the smart move to quickly determine whether national security issues may frustrate a takeover attempt or harm future value. Probably more to the point, shareholder derivative suits are exceedingly common in public company deals. The mere existence of a suit in this case does not yet warrant doomsday predictions, and probably never will.