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How much damage will the trade war do?

It is difficult to know if and when President Trump will want to do a deal with China. It would seem to be in his interest to do so.

It is difficult to know if and when President Trump will want to do a deal with China. It would seem to be in his interest to do so.

John Redwood

in Features


Earlier this week share markets retreated sharply on news of an escalation in the US-China trade war. As expected, Presidents Trump and Xi failed to reach an agreement at their last meeting, but they did re set the senior negotiating teams on both sides for more talks. President Trump then announced his intention to go ahead with imposing 10% tariffs on the remaining $300bn of Chinese imports into the US that so far are free of tax, whilst China retaliated with a ban on buying US agricultural products.

On top of these two unhelpful developments was the US decision to accuse China of being a currency manipulator that brought the markets into freefall. Candidate Trump had always threatened to brand China in this way on coming into office, but was restrained from doing so for the first couple of years by advisers who thought they could secure an overall agreement with China by talking to them. When China allowed the yuan to fall below 7 to the dollar, Presdient Trump had his way. Treasury Secretary Mnuchin duly announced that China is a currency manipulator, on the new grounds that when the yuan fell away on trade fears China should have used some of her reserves to prop her currency. There is not thought to be evidence that China gave her currency a push down by selling it herself.

Official channels

Under the US Trade and Competitiveness Act 1988, once the US has so named a country the government is meant to pursue remedies directly with the country or in conjunction with the IMF. It is unlikely the IMF will intervene strongly on the US side on this occasion. The US is already in talks with China over this and other trade matters. It is nonetheless annoying to China to be designated in this way, when they argue their recent interventions in the currency markets have all been to push the yuan higher, not lower.

It is difficult to know if and when President Trump will want to do a deal with China. It would seem to be in his interest to do so. The current situation is damaging US food exports to China, helping weaken world trade and manufacturing and hitting the stock market. As he turns more attention to the campaign trail for the 2020 election, President Trump would ideally like to see stronger food exports, stronger manufacturing worldwide and more new highs for equities. China is well aware of the US election timetable and is probably digging in thinking President Trump will have to give some ground soon. President Trump is upping the stakes to try to show he can live without a deal if necessary. In the meantime he seems to like the large revenues coming from tariffs. He sometimes suggests these are paid by China, whereas they are in the main paid by US voters in the form of more expensive import prices.

Growth under threat

All the time, the trade dispute remains a struggle between the US and China its impact on world growth and stock markets should be less than the offsetting impact of central banks and their easier money policies. Were Mr Trump to widen the trade war to include the EU in general and German cars in particular it would do more damage to the world economy and take stock markets down further. Equity markets rose for much of this year to date on thoughts of even looser money policy. The Fed's 25-basis-point cut in its rates is seen as the harbinger of more to come. The European Central Bank must be limbering up for more loosening. Russia., India, Turkey, Australia are all into cutting interest rates.

Other disputes emerge

Markets are going to have to live with more government friction affecting trade. The decision of Indian prime minister Narendra Modi to end the special privileges of Kashmir under Indian control reflects his determination to put a Hindu nationalist agenda before his pro-business stance. The result is damage to India/Pakistan trade and a further substantial deterioration in relations between the two countries. Many emerging market countries continue to impose tariffs and quota restrictions on their trade accounts.

More volatility was always likely after such a good first half to the year. We warned not to expect similar gains in the second half to those in the first. We do not yet think the cycle is over or we are about to enter a big bear market, as it looks as if once again the central banks will ride to the rescue with ever lower rates and more credit. Markets will want yet more of the same as offsets to the trade tensions and threats. Meanwhile, just as he ratchets up the disagreements with China, President Trump is making progress in talks with the Taliban over the future of Afghanistan. This President is a trade warrior, but a very reluctant military warrior in the Middle East, unlike his predecessors. That at least reduces one big source of worry, a clash of the major powers in the Middle East.

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