The escalating trade war between the U.S. and China is putting General Motors (GM, Financial) in between a rock and a hard place. The good news is that the iconic American car company manufactures the cars it sells to the Chinese market in China, skirting the problem of imports. GM’s Chinese capacity is about 5 million units a year and in 2017, 4 million units were sold.
The bad news is that trade tensions between the world’s two largest economies probably won’t help either. It might make GM an American eyesore in a Chinese sea in the midst of an escalating trade spat, and the Chinese government is known to be impetuous and unpredictable when it has been slighted.
The real issue though isn’t the direct effects of a trade war, but something else that is two degrees removed. The reason a trade dispute has erupted with China, while the Trump administration claims it stems from an intellectual property dispute on a legal basis at least, really has to do with low interest rates. Low interest rates breed over-borrowing, which leads to trade imbalances on both the individual and national scales.
Just as low interest rates induce individuals to keep borrowing more and more due to the low cost of money, they also induce nations to borrow and spend more and more for the same reason. High debt on an individual level means that one’s personal balance of payments is more heavily weighted to imports (consumption, generally speaking) than exports (production). On a national level, it’s the same story. There are just a few more steps in between.
GM itself is heavily dependent on very low interest rates, not the least of reasons is that 41% of retail finance receivables in 2017 were from consumers with sub-prime credit scores. These liabilities are racked up by GM Financial, GM’s credit subsidiary, and if interest rates rise on sub-prime borrowers, they can no longer pay.
We’ve seen it before in the housing market, and we’ve been seeing it in spades in the passenger car market as well.
The answer then is not that a trade war with China will impact GM directly. It probably won’t. Much more important are interest rates, which both allow the U.S. to rack up trade deficits and allow companies to go deeper and deeper into debt and rack up sales.
Defenders of highly indebted companies like GM, leveraged about 200%, would say that most of that debt is held by buyers of its vehicles and as long as these buyers can keep making their car payments, everything should be fine. That’s true. But given that nearly half of all GM Financial borrowers are sub-prime, any substantial rise in interest rates could stop the gravy train.
Rates have been below historical norms for decades, since around the late 1990s, which is when the US balance of payments started getting so lopsided. The global rise in rates is already happening, in LIBOR, in U.S. Treasuries and in corporate bond rates. That’s what GM shareholders should be watching. The developing trade spat between the U.S. and China is just a symptom of that, and while it shouldn’t affect GM directly, a sustained rise in rates will.
Disclosure: No positions.
