SANDY MCGREGOR: Decoding Trump’s trade war
From Trump’s viewpoint, America’s trade deficit is a vulnerability that gives other nations the power to tell America what to do
There’ve been many confusing articles about the impact of the US-China trade war. One way to gain perspective is to consider what happened after the depression of the 1930s, when world trade imploded for more than a decade.
A major contributor to this calamity was America’s Smoot-Hawley Tariff Act, which imposed draconian duties on imports into the US. Economists implored President Herbert Hoover not to sign it — he ignored them.
Much of the support for those tariffs came from constituencies similar to those who now support President Donald Trump. But the Tariff Act was a disaster: the world sank into a mire of tit-for-tat tariff retaliation. Trade imploded.
Only after 1945, and a new generation of political leaders, would this be addressed. Critically, there was now widespread support within the US for participation in a new world order, in which reducing tariffs was a priority.
The first round of tariff negotiations in 1947 was followed by seven more rounds, ending in 1994. Over 47 years, average tariffs fell from 22% to 5%. Countries such as Singapore and South Korea used export-led growth to develop into modern, wealthy societies. Since 1990, globalisation has lifted more than 2-billion people out of poverty.
It was a thriving system — until Trump, whose world view harks back to the isolationism that was a central US political feature before World War 2.
Trump does not accept that the US should be subject to an international consensus with which he does not agree. And he has a mercantilist view of the economy, which is at odds with the paradigm of globalisation.
In a global economy, it is of little importance whether a country runs a current account surplus or deficit. Trade balances are a manifestation of different nations’ saving habits. Germans, for instance, who save a lot, have a large current account surplus. Americans, who save little, have a trade deficit.
However, this comfortable proposition is not accepted by mercantilists, who view each nation in isolation.
From Trump’s viewpoint, America’s trade deficit is a vulnerability that gives other nations the power to tell America what to do. He sees its trade imbalance as the outcome of a system stacked against US business. He believes that the US must, at the least, have a balanced current account. Above all, he wants to put US interests first, and is unwilling to conform to an international consensus or promote global prosperity.
Slow investment could worsen the global slowdown, potentially tipping the world into recession
By last year, the US had a current account deficit of $488bn, of which the trade deficit with China accounted for 86%. It was this imbalance that attracted Trump’s ire.
In true Trump style, negotiations were sparked by a unilateral imposition of tariffs early in 2018. China responded in kind, and after a series of tit-for-tat escalations, the US imposed tariffs on $250bn of imports from China by September last year. China retaliated with tariffs on $110bn of US goods.
Finally, last December, presidents Xi Jinping and Trump agreed to a truce, suspending tariffs while talks took place.
But in May this year, Trump suddenly tweeted that China was not negotiating in good faith and he imposed tariffs of between 10% and 25% on $200bn of Chinese imports. Beijing predictably retaliated, and negotiations collapsed.
Now, both parties have strong reasons to find a consensus. Trump needs a trade war victory to bolster his 2020 re-election campaign; and China can no longer sustain its economic growth as it has in the past. A sharp drop in exports would make things worse.
But Trump has pushed China into a corner. The Chinese government has mobilised public indignation against the US, so it will be difficult to go back to the table if Trump continues to act in a way that offends Chinese pride.
But even if talks continue, there is no guarantee of a favourable outcome.
Despite Trump’s denials, tariffs are a tax on the US consumer. Given the size of the US economy, the direct impact of the China tariffs will be small, say 0.3% of GDP. But if the trade war expands to other countries, the cost could grow.
For business, investment decisions could be delayed pending greater clarity, and slow investment could worsen the current global slowdown — potentially tipping the world into recession.
It is widely expected that if there is no settlement, both the US Federal Reserve Board and the Chinese monetary authorities will respond to any slowdown with aggressive monetary easing. Now, while that typically does wonders for asset prices, if the world tips into a recession, the game changes.
It is now more than 10 years since the recession of 2008. In the US, it has been the longest period of continuous growth in its history. Usually, it is an unexpected event that sparks the downturn. In 1973, it was the oil shock. In 2008, it was the US housing market.
The trade war poses a similar threat. It is possible that central banks may keep the show on the road with an orgy of money creation. But with interest rates so low, central banks may no longer have the firepower to prevent a recession. Something will bring the expansion of recent years to an end: if it isn’t the trade war, it will be something else. Either way, it is an environment which urges caution.
• McGregor is a portfolio manager at Allan Gray