What Next in the Trade War?
A sense of optimism has returned to global financial markets, as they take in the expectation of continued accommodation by central banks and the resumption of trade talks between China and the US. While President Trump’s capacity to surprise and his tendency to interject directly make the eventual outcome of the trade negotiations difficult to predict, there are four developments investors should be prepared to encounter.
A sense of optimism has returned to global financial markets, as they take in the expectation of continued accommodation by central banks and the resumption of trade talks between China and the US. While President Trump’s capacity to surprise and his tendency to interject directly make the eventual outcome of the trade negotiations difficult to predict, there are four developments investors should be prepared to encounter.
First, China will be looking to slow the negotiations at every opportunity. It is well documented that China’s negotiating approach differs considerably from that of Western countries, with the Chinese preferring to ‘play the long game’, gradually building relationships during discussions that may prove advantageous to their end. In the case of these trade negotiations, this elongated approach is overlaid with a much more urgent US political calendar.
By virtue of President Trump taking ownership of the trade dispute, he has inadvertently tied the timing of its resolution to his bid for re-election in 2020. Moreover, as a leader who boasts primarily about his deal-making credentials, the president needs a success in the biggest negotiation of his first term to pitch credibly for a second. This will not be lost on the Chinese, who are largely unconstrained by timing. They will look to slow the talks — but not to stall-speed, as that would risk escalation — hoping for greater US concessions as the election draws near.
The second development will be the barrage of US criticism that is certain to follow any agreement, in part due to the wide range of issues subject to negotiation. What started as a relatively straightforward, if conceptually misguided, desire to reduce the US trade deficit with China grew quickly to include several more difficult and contentious issues.
The upshot is the US will now find it impossible to claim an across-the-board victory with China and compromises that will be required if a deal is to be struck before next year’s elections will draw quick congressional condemnation. This has already been evident with bipartisan criticism of President Trump’s announcement at the G20 summit in Japan that prior restrictions on Chinese technology company Huawei would be eased. One senator has pledged to bring forward legislation to prevent such an easing and more confrontations along these lines should be expected. A lesson from the UK’s Brexit negotiations is that these kinds of domestic conflicts over tactics and strategy can be just as damaging to business sentiment as the negotiations themselves.
“Trade policy will be a bigger factor in 2020 elections than in any US elections in recent memory, meaning there will be plenty of noise around the issue along with the possibility of unexpected changes.”
The third likely development is more explicit US discussion around exchange rates. It is too early — and alarmist — to suggest the trade war will morph into a currency war, but President Trump has spoken out against a strong dollar, mostly while criticising the Federal Reserve. Such verbal interventions can be effective in the very short term. A longer-term and more explicit dollar policy has been absent for some time, with the Federal Reserve allowing markets to determine exchange rates, as do most central banks in advanced economies. US currency market intervention has happened only three times in the past 25 years.
Based on the US administration’s periodic embrace of policies and approaches considered unconventional in contemporary circles, the likelihood of a change to its ‘hands-off’ exchange-rate policy is growing.
And since exchange-rate policy is within the purview of the Treasury Department, the administration would not be subject to further criticism related to the independence of the Federal Reserve. Circumstances that could make a change in US exchange-rate policy more probable may include continued monetary easing in Europe and Japan, a depreciation of the Chinese renminbi and a lack of improvement in the US merchandise trade deficit.
The final point investors should consider is that international trade relations globally are in for a turbulent period. It would be ideal if China and the US reached a comprehensive agreement to end their dispute, but a more realistic outcome is that even if a settlement is announced, the two countries will remain engaged in discussions around trade, investment, procurement and technology issues for years to come.
And just as the US has opened the door to a more active trade policy, tying trade to a broader foreign policy agenda, so too will other countries. This is already evident in the recent flare up of old animosities between Korea and Japan around World War II reparations, one consequence of which is new Japanese export restrictions on inputs in Korean semiconductor manufacturing. In an era of growing global populism tinged with nationalist sentiment, trade policy is not immune.
In summary, investors need to be alert to the fact that trade policy will be a bigger factor in 2020 elections than in any US elections in recent memory, meaning there will be plenty of noise around the issue along with the possibility of unexpected changes. In addition, the US-led inclination of using trade policy to further other foreign policy objectives is likely only in its early stages, again raising the prospects of unexpected change. It will be some time before global trade returns to previous trends of greater liberalisation and openness.
This edition of Global Perspectives was published exclusively first by The Straits Times.
