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How the Trade War Impacts Cotton

Both the United States and China are exchanging tariffs on cotton, and the wider impact of the moves could mean macroeconomic consequences.

The U.S. has already enforced $34 billion worth of tariffs on Chinese goods coming into the country, and another $16 billion—which will make up the first $50 billion it promised to hit China with—is forthcoming. While cotton wasn’t targeted in that round, the new list of $200 billion in additional tariffs released Tuesday had cotton all over it.

President Trump instructed the United States Trade Representative to begin the process of imposing an additional $200 billion in tariffs on imports from China, and the list of tariff lines set to face new 10 percent duties includes cotton, cotton linters and pulp, cotton yarn, cotton sewing thread, cotton waste and cotton woven fabric, to name just some.

China, in its like-for-like retaliation on $34 billion worth of tariffs on U.S. goods, has added 25 percent tariffs to uncombed cotton and cotton linters to its list thus far—and another list is expected as the trade battle between the two powerhouse nations continues.

Some insight into U.S.-China cotton relations

China’s cotton imports have been on the rise and are expected to continue climbing over the next several years now that its government-controlled cotton stockpile has dwindled. And because it can’t meet demand with its domestic cotton supply.

“China traditionally has a production deficit between 10-15 million bales,” Cotton Incorporated senior economist Jon Devine explained. “That deficit had been filled by reserves in recent years, but with reserves now lower, that gap should be increasingly filled by imports.”

That begs the question, considering the U.S. is the world’s largest exporter of cotton: where will China get its cotton from?

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“In the 2017/18 crop year, the U.S. should export 16.2 million bales. By comparison, the next largest exporter is India at 5.0 million bales,” Devine said. “It would take the sum of India, plus the next six largest shippers to equal the volume that the U.S. ships.”

That’s why things could prove positive for the U.S. cotton industry.

“If China increases its imports by 5-10 million bales over the next several years, it is hard to see how that would not benefit the U.S. because the pool of exportable supply is limited once you move beyond the U.S.,” Devine explained. “If the U.S. does prove to be unaffordable for Chinese mills with the tariffs, the cotton that is redirected to China from other sources (e.g., India, Brazil) should open up demand for U.S. cotton in other import markets (e.g., Vietnam, Bangladesh) where cotton from non-U.S. exports could have otherwise gone.”

What this all means for the cotton industry

In light of China’s cotton import demand falling sharply in recent years—from more than 20 million bales in the 2012/13 season to just 5.4 million bales in the 2017/18 season—the U.S. had already been reducing its reliance on China as an export destination. Over the 2012/13 to 2017/18 period, China’s share of U.S. exports dropped from roughly 40 percent to between 10 percent and 15 percent, according to Devine.

The U.S. cotton industry, however, carried on.

“Even with China taking only about half of the volume it had commonly had throughout the 2000s (4-5 million bales), the U.S. managed to sell the second and third highest volumes for export on record over the past two years,” Devine said.

And though China is already collecting duties on U.S. shipments of uncombed cotton, the impact has so far been minimal for domestic suppliers.

Cotton traders’ weekly reports showing how much they sell and ship each week have turned up little in the way of canceled sales.

“When we look at cancellations, there have been a few to China, but they have not been large relative to the volume of cotton that remains contracted for shipment to China (about 500,000 bales for 2017/18 delivery, about 1.5 million bales for 2018/19 delivery),” Devine said. “In recent weeks, cancelations to other countries have been greater than those for China, and those cancelations were likely related to recent price volatility.”

Regardless, cancelations from China will be something to keep an eye on as the industry looks to estimate the impact of tariffs on U.S. cotton exports to China.

How tariffs will play on price

With several categories for importing cotton into China, and some facing varying tariff levels, the exact impact the increased duties will have on price may be complex to determine. While some imports could face the 25 percent increase in tariffs, it isn’t yet clear whether imports passing through free trade zones will be subject to the new duty.

Either way, prices may be headed upward.

“The implied tightness in exportable supply suggests upward pressure on prices, and we likely have been seeing a reaction to that in cotton prices in recent months. Nonetheless, collective stocks for the world outside the U.S. are forecast to reach a record this summer, and collective volume will serve as a buffer against a rising tide of Chinese import demand,” Devine said. “Over the short term, the extent to which those are burned up (or not) should shape price direction regardless of tariffs. Longer term, the cotton market will need to pull in more acres to keep up with rising Chinese import demand.”

The short- and long-term of it

What much of this tariff battle and its impact on cotton boils down to, is more uncertainty ahead. And as Devine explained, the sector was already facing a fair level of uncertainty not knowing exactly how much more cotton China might import and when.

One thing that is certain, however, is that there will be reverberations throughout the supply chain in the short term.

“In terms of supply chain reactions, if the tariffs do remain in place, the flow of cotton through Vietnam could be expected to continue to be profitable,” Devine said.

Vietnam has been a “significant” source of growth in cotton mill use of late, according to Devine, who explained that Chinese government controls on cotton fiber imports has fueled much of that growth.

“Because there are no quantitative limits on cotton yarn imports (there are limits on the tonnage of cotton fiber) and because duties are either low (5 percent for India and Pakistan, countries without FTAs with China) or non-existent (countries with FTAs with China, like Vietnam), it was cheaper for Chinese fabric mills to import yarn,” Devine explained. “A lot of that yarn came from Vietnam, and over half of all the fiber spun into yarn has gone to China for the past several years.”

Longer term, the tariff threat could escalate well beyond its impacts on the cotton industry.

“The possibility that the tariffs could result in an economic downturn somewhere is a concern,” Devine said. Tariffs can lead to higher consumer prices, which means inflation—which means the Federal Reserve may look to more increases in interest rates. “Higher interest rates can slow economic growth, and there is a concern that overly aggressive increases in interest rates could be a factor contributing to the next U.S. recession.”