Several years ago we wrote about the end of globalisation and a movement into a more multi-polar world order, with disheartenment with widening income distribution, driving a changed environment. The US trade war with China is an obvious recent example. This week we consider the medium outlook for these discussions and how this might affect markets.
The US’s initial justification for embarking on the trade dispute with China was the protection of US manufacturing jobs from unfair competition from subsidised Chinese state-owned enterprises. However, it has quickly become evident that the disagreements go much wider and deeper than early signs suggested. Issues around intellectual property rights, data security and national security have now entered the scene, and the talks are now so broad and complex that a short-term compromise seems implausible.
Clearly, there is more at stake here than the terms of trade. It is the rise of China and the possibility it may overtake the US as the world’s greatest power that is at stake. At the beginning of Donald Trump’s regime, some commentators suggested that before he left office, China would overtake the US in terms of the size of its economy. Obviously since then US growth has substantially accelerated while China has remained at a similar level, pushing the date further into the future. However, it is that threat that, in many ways, is driving the US’s stance. Similarly, China has the stated aim to regain the position it once held as the world’s greatest power and it is pursuing a clear plan to achieve it.
The conflicting goals from both sides are not the only barriers to resolution, there are also cultural differences between the parties, as evidenced by the Chinese citing the tone of the agreement as a barrier to settlement. Additionally, there are very different political systems confounding the process. The Chinese are able to take a multi decade, if not multi-generational approach to the achievement of their goals, so long as domestic living standards are improving at a rate that keeps the current regime in power. The US faces a four year election cycle which leaves only narrow windows where short term pain can be suffered, without risking a change of leadership. The Chinese clearly have the advantage here unless tariffs are raised to such a level that material amounts of substitution of Chinese goods with other suppliers can occur, a process that inevitably takes time.
In summary, it comes down to the pain threshold of the negotiating parties as much as the perceived benefits of a resolution. Our view is that while near term compromises are possible, in the long run further disputes are inevitable now that China is no longer perceived as an opportunity for US companies, but a threat to the US on many levels. The market implications for this major change are much more nuanced than the near-term reactions we have seen thus far. Some of the implications include slower growth and marginally higher inflation in the US and an even greater need to reposition the economy towards domestic growth and the ‘Belt and Road’ strategy for China.
As with most intractable problems, our strategy is to try and avoid speculating on the unknown, in this case by avoiding the obvious losers such as companies with a high dependence on Chinese supply chains. However, as markets increasingly come to the view that this is an issue that isn’t going away, it is likely to have priced the risk in and learned to live with it. No doubt markets will soon move on to worrying about some new issue, while climbing the wall of worry.
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