There’s big debate going on. A very big debate. It is whether or not China and the US are engaged in a trade war or an economic war. The difference between the two is captured in a piece by noted economist and author Richard Duncan at the SCMP:
The deepening trade dispute between the United States and China could mark a “turning point in history”, ending the system of global trade that brought low-cost goods to consumers and fuelled the rise of the Chinese mainland and other emerging markets in just a few decades, according to noted economist and author Richard Duncan.
Bangkok-based Duncan believes the US$50 billion of Chinese products designated for 25 per cent tariffs by the Trump administration – in addition to a proposed 10 per cent tariff on an additional US$200 billion in Chinese goods – may represent the first steps in a policy shift by Washington that goes far beyond what many observers expect.
“I am becoming concerned that they really do intend to put up trade tariffs on a very large scale against China and that perhaps there’s more to this strategy than just balancing trade. They may be intent on stopping China’s economic growth altogether, now that China has become so large they are becoming not only an economic competitor, but potentially a military threat to US global dominance. If that’s the case, this could be a turning point in history,” Duncan said in a new South China Morning Post business podcast.
While it is too early to say how the trade talks between the two sides will play out, one concern is that escalating tariffs, beginning with the US$34 billion of Chinese products which went into effect on July 6, are about to become the norm, rather than the exception.
Another is whether the trade policies are really designed to reverse the deindustrialisation of the US economy – a theme made prominent during Donald Trump’s presidential campaign.
“Over the last 30 years the rapid economic rise of China has really transformed the world, but if the US starts putting tariffs on US$200 billion and US$500 billion of Chinese exports, then China’s economy could go into a very serious crisis,” Duncan said.
Duncan, who now publishes independent research at his subscription video newsletter Macro Watch (richardduncaneconomics.com), said China’s growth could come to a “screeching halt”, resulting in millions of job losses, while a domino slowdown would also be felt among its major trading partners.
Another outcome would be rising inflation, higher interest rates, and a global drag on asset prices ranging from stocks to real estate.
“The impact would be global and we would see a drop in metal prices and that would be a blow to metal and mining companies. Also as commodity prices fell, the economies of the commodity-producing economies would go into recession,” he said.
There are two schools of thought on this. The first is that Donald Trump has in mind a simple trade war. This notion is supported by the progressive lifting of tariffs on Chinese goods and White House rhetoric to date. It is also supported by Trump’s wider tariff agenda and his jawboning for a lower US dollar.
The second school of thought is that the US is pursuing an economic war. This was captured recently by Steven Bannon:
If this is the objective then the US will drive tariffs and the USD upwards to break both the Chinese trade and capital accounts. China will see both falling trade to the US and major capital flight driving a domestic credit crunch. The US will need to keep stimulating to achieve this end, just as Ronald Reagan did versus the USSR.
There is a third possible outcome which is probably the highest risk. That is that the US begins with a trade war and stumbles into a economic war. This could easily happen because China cannot meet the US demands or it mishandles its response. From here it is frighteningly easy to see how the US applies its tariffs right up to $500bn, China responds with an aggressive internal anti-US goods boycott. The US responds in kind and global recession is upon us, with Australia at its epicentre.
The fourth scenario is more benign. Both leaders are under pressure over the issue at home. Via WSJ on Trump:
Mr. Barr is one of 24 GOP representatives whose re-election this November is rated a toss-up by the Cook Political Report, and he complained that bourbon makers in his district were being hurt by European retaliation for U.S. steel tariffs. “We want to know when we’re going to get a solution.”
With Republicans growing increasingly worried about losing control of the House this fall, fears aggravated by polls showing the unpopularity of Trump trade policies, Rep. Bill Huizenga (R., Mich.) read aloud to the White House advisers a text from a tool-and-die maker in his district who was facing higher raw-material costs because of the aluminum and steel tariffs. “I was making sure that they heard the message that this is not just uncomfortable—it’s painful and it’s damaging,” Mr. Huizenga later told reporters. He said that because his district also includes farmers, who are getting squeezed by the retaliatory tariffs, “we’re getting it coming and going in western Michigan.”
Many of the lawmakers said the GOP-led Congress should keep alive the prospect of legislation to curb Mr. Trump’s ability to impose tariffs on the table, even after the apparent thaw in relations between the U.S. and EU.
With mid-terms looming at year end this could break either way.
Richard MacGregor notes that Xi Jinping’s critics are growing bolder, via AFR:
In recent weeks, the signs of a nascent pushback against Xi’s absolute power have started to emerge. Some are cryptic, given the nature of Chinese politics, contained in coyly worded postings on social media. Some are the stuff of rumour, or back alley news, as the Chinese call such information, which flourishes in the absence of a free press.
The whisperings emanate from a variety of sources – retired leaders, rival factions within the CCP, the intelligentsia and the economic policy making apparatus. None presage Xi being toppled from power, nor are they an indicator of meaningful political reform of the single-party state. The ruling communist party, in whatever form, is here to stay.
But after nearly six years during which he has relentlessly accumulated power and sidelined rivals, either by ousting them from office or having them jailed for corruption, Xi’s multitude of critics and enemies may be finding their voice.
Either or both leaders could be forced to sue for peace, triggering a big risk-on rally for global markets.
So, how do we position investment for these outcomes? We use scenario analysis.
A successful US trade war on China results in moderately bearish outcomes. China stimulates as its trade account is attacked but the balance of forces still means weaker growth. This results in ongoing falls in Australia’s terms of trade.
A successful US economic war on China results in an historic house price crash and deep recession as the terms of trade fall heavily and Australia joins the Chinese capital flight, lifting mortgage rates just as the RBA runs out rate cuts.
At the same time, there is the benign outcome which will lead global markets very much higher before the cycle ends so we can’t afford to simply duck for cover in a bunker somewhere.
There is no saying which way this will go. Even putting odds on it is impossible given the political nature of the risks. What we can say is that the bad outcomes represent, at this stage, more than just a tail risk. They are a hedge risk that you should have a plan for.
That means lifting them from a consideration that would normally be covered by some small allocation of portfolio insurance to an active allocation rebalancing that lowers your exposure to this specific risk. The easiest way to cover yourself on this front is to have a generous amount of your wealth positioned offshore because the worse the outcome of the trade war then the lower the AUD will go.
We also maintain a solid exposure to international shares so that we do not miss the updraft if it comes.
David Llewellyn-Smith is chief strategist at the MB Fund which is long US equities that will benefit from a falling Australian dollar so he is definitely talking his book. Below is the performance of the MB Fund since inception:
If the ideas above interest you then contact us below.
The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
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