Clash of models bodes uncertain trade winds

The recent trade truce between China and the US is likely to extend beyond the existing end of February deadline, but negotiating a longer-term solution may prove problematic

A leading economist fears the Sino-US trade tensions are set to run on and on as a fundamental "clash of models" is being played out and that the recent cessation of trade hostilities is mainly down to political expediency.

Short-term political realities will gain the upper hand in the Trump administration to cool tensions, according to Michael Spencer, managing director, chief economist, head of research, Asia Pacific, Deutsche Bank.

"I don't believe we will get a further escalation in tariffs in the near term, nor do I believe Donald Trump wishes to see the US economy slip into recession. He will have noted the equity market sell off, no doubt. The US administration has every incentive to reach a deal and it is for that reason that I believe the truce will hold out," he says.

"It is worth bearing in mind that the Chinese government is not immune to political pressure," he adds, addressing a recent high-level chamber of commerce event in Hong Kong.

Spencer highlighted little adverse impact on trade flows when taken overall, though he concedes the growth in exports from China to the US is undoubtedly set to take a knock, especially in a scenario where a vast chunk of Chinese exports to the US are subject to tariffs. Those tariffs that are already in place are unlikely to be removed soon, he stresses.

But Spencer sees the longer-term direction of US trade policy and geopolitical maneuvering as less than clear cut.

"Those in the administration who take the extreme view like John Bolton, the US national security advisor, may wish to see supply chains exiting China. Tariff policy may squeeze margins to such an extent that companies such as Apple elect to leave China," says Spencer. "With China exporting around US$550 billion to the US, this supply chain realignment is potentially excellent news for countries in the region."

However, shifting exports worth half a trillion dollars from China to other Southeast Asian nations would entail a sizeable uplift in productive capacity and is likely to be disruptive.

Spencer has some sympathy with the view that China may have taken advantage of the open market system of nations in Europe and the US for corporate control, whereas in China, investment remains partly closed, and instances of "egregious" interfering in investment is quite a common experience.

"Ripping off technology to make tables is not a pressing issue. But doing it to further Industry 4.0 or artificial intelligence is another matter," he says. "Ultimately, the reality is that preventing the Chinese acquiring technology may prove difficult."

Despite Spencer's optimism for a trade truce over the short term, underlying the friction between China and the US is a fundamental disparity in ideology, which he describes as a "clash of models", an irreconcilable divide between China's state driven industrial policy on the one hand and the West's private sector led growth on the other.

Under these circumstances, reaching agreement on all pertinent issues could prove difficult, as could monitoring whether or not Chinese behaviour has changed significantly, he adds.

"Around 2013, President Xi delivered on his promises and China's private sector was the engine of growth. But since then Xi has been unable to deliver real reforms, and trade tensions will continue to simmer," says Spencer.

The unprecedented level of uncertainty surrounding trade policy is the number one factor behind recent turmoil in equity markets. The UK vote for Brexit and President Trump's sharp break with past US government policies on international economic and security relationships have unsettled businesses and investors.

Financiers are spooked, and this reasoning becomes clearer with the knowledge that around a third of S&P 500 companies receive earnings based on overseas operations.

Financial markets traditionally factor in the future and, according to Deutsche Bank's analysis, commodities, bond and equities are pricing in a recessionary outlook for the G3 economies. Yet, while the real data – and surveys – suggest a period of slower growth lies ahead, economic fundamentals do not suggest such an abrupt decline in growth is likely.

In a nutshell, Spencer insists politics not economics is the root cause of recent financial meltdown, and Deutsche Bank readily admits to low confidence levels in political forecasting. Their analysts expect the UK to leave the EU with a "soft Brexit" and that the US and Chinese governments will come to agreement to prevent a further escalation of the trade war – an extended "truce".

"As the possibility of the more negative political outcomes declines in the coming months, we expect markets to respond to what will likely be better than expected growth in the global economy," says Spencer.

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Date

15 Jan 2019

Channel

Capital Markets

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