Market Overview

How to Profit From Talk of Trade War Between America and China

The United States Congress moved closer to passing a bill that would punish countries that the United States accuses of keeping their currencies artificially low. The law is clearly aimed at China, which has long been accused of manipulating its currency in order to make its exports more competitive pricewise. China's critics claim that China's artificially low yuan has cost America millions of jobs.

China's reaction to the proposed US law has been furious, with some leading Chinese saying that such a move by the United States could spark a trade war between the world's two most important economies. The Chinese say that instead of blaming China for its economic problems, the United States needs to address its own structural problems. The Chinese have criticized the United States over its low savings rate, dependence on debt and hi-tech export controls.

The export controls are of particular interest to the Chinese who say that they are to blame for much of the trade imbalance between the United States and China. However, it's more likely that the Chinese want more access to American technology than they are concerned over the size of the two countries' trade gap.

If the United States Congress passes a bill to penalize China for currency manipulation, it could have negative effects for the United States, China and the world economy. The two countries' economies are so intertwined now that neither might benefit from a trade war. If a trade war erupted between China and the United states, owners of the ProShares UltraShort S&P500 (NYSE: SDS) and Direxion Daily China Bear 3x Shares (NYSE: CZI) ETFs could profit. A trade war between the United States and China is unlikely to have a winner, so investors who shorted American or Chinese stocks could benefit from the falling stock prices caused by a major dispute between China and the United States.

China could retaliate to any penalties imposed upon it by selling off some of its holdings of US government debt. If China began liquidating even a fraction of its US bonds, it could devastate bond prices. Investors who anticipated such a move and bought the ProShares UltraShort 20+ Year Treasury (NYSE: TBT) or the ProShares UltraShort 7-10 Year Treasury (NYSE: PST) ETFs could see their investments climb higher.

The US dollar wouldn't fare well in such a scenario, so ETFs like the PowerShares DB US Dollar Index Bearish (NYSE: UDN), the CurrencyShares Swiss Franc Trust (NYSE: FXF) and the CurrencyShares Japanese Yen Trust (NYSE: FXY) would see their share prices move higher.

Some investors might actually feel that a trade dispute between the United States and China would be in America's favor. With more dollars being invested and spent in the United States, the American economy could receive a much needed boost. If this were to occur, the SPDR S&P 500 (NYSE: SPY) and the iShares Russell 2000 Index (NYSE: IWM) ETFs could see significant long term growth.

Companies like Google (Nasdaq: GOOG) that have suffered because of their rocky relationships with the Chinese government could also benefit because competitors like Microsoft (Nasdaq: MSFT) and Yahoo! (Nasdaq: YHOO) would have less of an advantage in China if American companies were less welcome there.

Other investors might believe that because each side has too much to lose, a trade war between China and the United States is highly unlikely. American consumers and businesses have come to depend on China for low priced goods, while much of China's stellar economic growth has been fueled by American dollars. These investors might feel that neither side has much to gain and too much to lose for an actual trade war to happen.

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