The trade war between the US and China

The development around the recent G20 summit was somewhat reassuring, but the uncertainty around the trade policy is still unresolved and the impact on the global growth outlook is becoming more and more visible. In the following article we are looking at the build-up of the trade war and are highlighting possible outcome scenarios. This article will be followed by a series of further articles where we disucss and highlight the impact of the trade war on the various asset classes.

US President Donald Trump has complained about China’s trading practices during his campaign in 2016 already. One of his central promises was to bring manufacturing back to the US. The US launched an investigation into Chinese trade policies shortly after he took office in 2017. After initially promising talks, the US imposed tariffs on billions of dollars worth of Chinese products last year, and Beijing retaliated immediately.

Fears about a further escalation have rattled investors and hit stock markets

Both countries agreed to postpone new trade tariffs in December 2018 to allow for new talks. However, hope for a deal faded this spring when further tariffs were imposed by both sides. Last year, the US imposed three rounds of tariffs on more than USD 250bn worth of Chinese goods. The duties of up to 25% cover a wide range of products. China hit back by imposing tariffs ranging from 5% to 25% on USD 110bn worth of products including chemicals, coal and medical equipment. Tariffs imposed on Chinese goods, at least in theory, make US-made products cheaper than imported ones, and should encourage consumers to buy local.

Just when a trade agreement between the United States and China appeared to be in sight, negotiators found themselves back at square one. The immediate reason for the disruption was China’s insistence on a substantially rewritten draft agreement, which, according to US President Donald Trump’s administration, reneges on previously agreed terms. However, the main reason for China’s changes to the draft – the reason behind its reluctance to meet US demands – lies in a fundamental miscalculation by the Trump administration.

The IMF warned a full-blown trade war would weaken the global economy

Simply put, the US seems to have been overplaying its hand. The agreement that China rewrote was negotiated amid an aggressive US campaign against the Chinese telecommunications giant Huawei. That campaign has included adding the company to America’s trade blacklist, thereby cutting off its supply of critical technologies, and pushing allies to isolate the company as well. While such actions will without a doubt hurt Huawei, the company can eventually offset its losses by forging ties with other fast-growing Chinese tech companies.

Both US and international firms have said they are being harmed

For the rest of the world, however, the Trump’s administration’s attacks on Huawei – and on China more generally – will have far-reaching consequences. China is too deeply embedded in global supply chains simply to go away. Alienating the world’s leading manufacturer and industrial producer – with its consumer market of 1.4 billion people – will severely disrupt global value chains and cast a shadow over the entire world economy.

The relief or just another twist in a never-ending saga?

A truce agreed last December collapsed and in May the US raised tariffs on $200bn of Chinese products to 25% from 10%. Again China retaliated with tariffs on $60bn of US goods. The US began planning to hit an additional $300bn of Chinese goods but, at the G20 in Japan in June, Mr Trump called that off and said he would continue to negotiate with Beijing “for the time being”. However, it remains to be seen whether real progress was made.

The table below shows the most likely scenarios we identified, ranked according to their likelihood.

The most likely outcome in our opinion is a continuation of talks without any further imposed tariffs for the time being. However, the predictability of such talks is, as the past shows, very difficult. Given that there is an election year in the US coming up next year, there is a chance that President Trump will do everything possible to support the economy. Hence a de-escalation of the trade war should be in his best interest as well. In a series of articles, we will share a detailed analysis of the impact of the trade war on the various asset classes.