Thoughts on the global trade war

By: Regina Chi • June 12, 2019

After months of trade optimism, trade tensions have re-escalated with U.S. President Trump launching further trade actions against China, Mexico and India. U.S.-China talks broke down in early May as discussions between the two countries collapsed. President Trump’s recent tariff threat to Mexico targeted illegal immigration, which underscored the point that no country is immune from U.S. tariffs or bans in its effort to achieve its political goals. The further threat to cease India and Turkey’s preferential trade privileges was carried out in the same vein. These actions mark a pivotal point in U.S. policy, highlighting the weaponization of trade, which can have material implications for the global economy and financial markets.

The trade dispute with China continues

The tone in China turned increasingly negative following President Trump’s executive order, which banned U.S. companies from using information and communications technology from anyone considered to be a national security threat. This was immediately followed by the U.S. Department of Commerce’s inclusion of Huawei Technologies Co. Ltd. on its ‘Entity List’, which effectively bars it from buying the critical parts and components it requires from U.S. companies without U.S. government approval. From the U.S. perspective, the core issue with Huawei lies within its close ties with the Chinese government and fears that its equipment could potentially be used to spy on other countries and companies. From China’s perspective, the move by the U.S. was construed as a direct form of aggression towards their ‘national champion’ tech company that has a dominant share in 5G technology1 and is the second largest manufacturer of smartphones in the world behind Samsung Electronics Co., Ltd.2

In our view, this sharp pivot by the U.S. from a trade war to a technology war is based on a vast overestimation of China’s technological capabilities. Indeed, China is quickly moving up the value chain; however, it still falls short in several areas. While China is the second largest economy in the world after the U.S., it is still an emerging market country with GDP per capita of less than US$9,000 compared to US$60,000 in the U.S.3 Consequently, in order to avoid the middle-income trap, China’s leadership remains focused on transforming its economy from one predominantly driven by quantitative development to one that is qualitatively driven.

Nevertheless, the trade escalation between the two countries continued as China retaliated by creating the ‘Unreliable Entity List’, a list which will include foreign companies, individuals and organizations that break their commercial contracts and stop supplying Chinese firms, but their overall response has been measured so far. Most recently, China published a white paper to formally outline its position on the trade consultations between the two countries. Importantly, it stressed that cooperation between the two nations is the only win-win path towards a better future.4

President Trump targets Mexico and India

On May 30th, President Trump announced (tweeted) that he would impose a 5% tariff on all imported goods from Mexico and would continue to increase tariffs each month until they reach 25% if the border crisis persists, effective June 10th. The announcement was made despite the White House making headway with its push to ratify the United States-Mexico-Canada Agreement (USMCA). However, leading up to the deadline, President Trump announced on June 7th that the two countries had reached an agreement and the tariffs scheduled to be implemented by the U.S. on June 10th would thereby be “indefinitely suspended”. As part of the deal, Mexico pledged to deploy its National Guard throughout Mexico while prioritizing its southern border with Guatemala. Mexico also agreed to expand its program to allow asylum-seekers to remain in Mexico while their legal cases proceed. While the deal offers few new solutions to stem the flow of migrants, with some suggesting that Mexico had already agreed to such border actions months before Trump’s tariff threat, it was still enough for Trump to claim a political win.

President Trump yet again weaponized trade as he terminated India‘s designation as a developing nation. This ended years of preferential treatment under the Generalized System of Preferences (GSP), which allowed the country to export approximately 2,000 products into the U.S. duty-free, including auto components and textile materials. The impact on India‘s economy as a result of rolling back export incentives is fairly immaterial due to the fact that exporters were deriving duty-free benefits of only US$190 million of the total US$5.6 billion worth of GSP items traded.5

No proof of currency manipulation…yet

The U.S. Treasury recently issued its semi-annual report on the macroeconomic and foreign exchange policies of its trading partners. On an annual basis, the Treasury considers whether countries manipulate their currency in order to prevent effective balance of payment adjustments or to gain an unfair advantage in global trade by depreciating their currency. The Treasury declined to name any specific country a currency manipulator, though it noted that it would carefully monitor and review its ’manipulator’ designation for China before the next report. While the Treasury reduced its threshold for some of the criteria it considers, it expanded its list of countries from 13 to 21 and added five additional countries, including Italy, Ireland, Singapore, Malaysia and Vietnam.

What’s next in the U.S.-China trade war?

While we continue to believe that a trade agreement can be reached between the U.S. and China, the ongoing ideological tensions between the two countries will likely continue to persist for a long time with history tending to repeat itself.

If there is one thing we have grown accustomed to under President Trump’s presidency, it is the unpredictability and velocity with which things can change. And as we witnessed last year with a similar ban by the U.S. on Chinese telecom equipment maker ZTE Corp., the Huawei matter and potentially the trade tensions along with it could be resolved sooner rather than later. However, China will not capitulate for any deal. The deal will have to be done with mutual respect and cooperation and China has made it clear that it will not compromise on major principles. In the meantime, China still has the ability to continue to stimulate its economy, including additional counter-cyclical measures. This was evident when the People's Bank of China announced a RRR (reserve requirement ratio) cut for small and medium-sized banks immediately following the U.S. tariff increase.

Still, rising trade uncertainty points to risks that are skewed to the downside as they could pose a significant headwind to sentiment, global trade, economic growth and financial markets. Should President Trump continue to push his trade agenda forward, imposing further tariffs, particularly on the remaining US$300 billion of imports from China and the corresponding countermeasures, it could result in the global economy entering into recession. Of course, a trade settlement can prevent such a dire scenario from unfolding.

[1] Dell'Oro Group, April 3, 2019.
[2] IDC Research, Q1 2019 data.
[3] The World Bank, 2017 figures.
[4] China's State Council Information Office: China's Position on the Economic and Trade Consultations, June 2, 2019.
[5] Deutsche Bank, June 6, 2019.

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Publication Date: June 12, 2019

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