Markets worry about a trade war, and relax when they think it is about to be settled. Mr Trump’s attempts to negotiate new trading terms are often called a war but it’s actually a hard negotiation. The President threatens or imposes higher tariffs with a view to getting the other side to propose lower ones with better market access for US exporters. The aim is not to demolish the trading partner. It is not undertaken with gunboats, and is a different preoccupation from previous incumbents in the White House who wanted to use US military power to intervene in difficult conflicts. Meanwhile there are traditional disputes between Russia, China and the west that go well beyond arguments over tariffs. There are continuing trade sanctions against Russia for past misconduct, and western concerns about some of the ways China is flexing her new-found power. These also have an impact on world trade and markets.
The Kerch Straits Bridge links Crimea to southern Russia. Russia uses this partial impediment to shipping and its control of the coast of the Sea of Azov to intercept and inspect western shipping seeking to use the ports of East Ukraine including Mariupol and Berdyansk. This has become one of the points of tension between Russia and the western allies and a reminder that trade can be a pawn in a wider dispute between the power blocs of the world. In the South China Seas the advances of China into the Paracel and Spratly islands and other reefs and artificial islands worries neighbouring countries and leads the US to try to keep open shipping routes by sending the odd warship close to the Chinese installations. These are more serious issues which if mishandled could end up with military exchanges. We assume the US does not want these to escalate. The Western allies condemn Russia taking Crimea, but there is no sign that any of the governments or military planners think there is any way of getting Crimea back by force to be part of Ukraine again. Nor are there are any signs that the West would take military action to try to evict China from the islands well beyond her shores that she is turning into military bases.
We assume the West will not want to escalate military action in response to Russian and Chinese provocations.
This leaves us to worry more about the lively verbal exchanges over tariffs. The President started from the proposition that the US trade deficit was too large, and was based on unfair trading terms with the main surplus countries of the world. This led him to target China and Germany who run the two largest surpluses of all and who both export large quantities of goods to the USA. He also worried about the way in which jobs in manufacturing were leaving the US, as companies set up factories in cheaper labour areas like Mexico to take advantage of the trade provisions of the Nafta Treaty. Mr Trump dislikes multilateral agreements in general. They are slow to negotiate, difficult to change, and do not allow the US the same scope to shape them to her needs as one of the signatories. Given the size and power of the US he presumes that bilateral deals will serve the US better.
This analysis led Mr Trump into fierce exchanges with his Nafta partners, with the EU who run Germany’s trade policy, and with China. He has been in negotiation longest with his Canadian and Mexican partners in Nafta and has announced recently a revision to the deal with Mexico that he says will be fairer for the US. Much of the proposal is modernising the existing treaty for the digital age. The plan includes higher percentages for local content in goods that can be traded tariff free, and a minimum pay requirement to assist US based auto workers and to make transferring factories to Mexico more problematic. The markets breathed a sigh of relief that Nafta survives. Canada is likely to sign up as well, so the Nafta legislative framework remains despite a President who called it the worst US trade deal in history and looked as if he might want to cancel the whole thing.
The rows with China remain deeper and unresolved. So far each side has imposed higher tariffs on $50bn of traded goods. Mr Trump is threatening many more tariffs on a much wider range of Chinese exports to the US. Given the big imbalance of trade the US could hit many more Chinese goods than they can hit back. Now Mr Trump has claimed a win with Mexico it may be that he sees no urgency to do the same with China. He may also be concerned about the military advances of China, and the growing influence achieved by the Belt and Road strategy. All of this points to more negotiating threats before any settlement.
The argument with Germany and the EU is scarcely engaged. The EU has offered talks, understanding the threat to their motor industry. Mr Trump objects strongly to the 10% tariff on US cars into the EU when the US only charges 2.5% on EU cars into America. The President may turn to this and heat up the discussions once Nafta is dealt with.
Our base case for the year ahead assumes these trade disputes will be resolved with deals or will continue through talks. We assume the West will not want to escalate military action in response to Russian and Chinese provocations. If we are right there will be continuing noise about these matters, with down days in markets when people worry too much. In the end it looks as if Mr Trump wants to claim a win and keep the good times rolling. So far there is nothing in these conflicts to interrupt growth of around 3% for the world as a whole, nor to derail the favourable outlook for company profits and dividends.
The above article was previously published by Charles Stanley on 31st August 2018