- The US-China trade war again seems to be escalating.
- The feared market collapse has not yet happened.
- However, upside potential looks limited while the uncertainty continues.
In 1980, China's share of economic output was just two percent; nowadays it is well over 18 percent.
The simmering US-China trade dispute continues to weigh on markets. For well over a year now, delegations from the two superpowers have been shuttling between Washington and Beijing, trying – so far in vain – to reach agreement. Instead, the conflict continues to escalate.
Interpretations of what it all means for markets change almost daily. Sometimes, the view is that it’s really not that bad, because the two adversaries will surely have to agree sooner or later. For a self-proclaimed deal maker like US president Donald Trump, sabre-rattling is a regular part of the toolset.
Then fear rushes back in: the US president seems to mean what he says, China reacts accordingly with counter-tariffs and the battle lines visibly harden. Just how do the antagonists think they are going to get out of this mess? Anything seems possible.
Uncertainty means volatile exchange rates
One thing does seem clear, however: whatever the actual economic impact, investors hate nothing so much as uncertainty. Times like this, when no-one can tell where the needle on the barometer will finally come to rest, are often linked to volatile exchange rates.
How serious is the situation?
It is all the more important, therefore, to keep a cool head: how serious is the situation really? The USA is already imposing punitive tariffs of up to 25 percent on various products from China with a trade value of over USD 250 billion. China’s retaliatory measures so far affect US goods with a value of over USD 110 billion.
This seems to be far from the end of the spiralling escalation. The USA is already threatening China with duties on further imports with a total value of USD 325 billion. Furthermore, more Chinese companies could find themselves excluded from the US market as telecommunications equipment supplier Huawei has.
China can hurt the USA too. It could react to US tariff barriers by devaluing the renminbi, thereby expanding the conflict into a currency war. US president Trump has already published a Tweet saying that "China will be pumping money into their system and probably reducing interest rates", and has invited the US central bank, the Fed, to give them a taste of their own medicine by reducing interest rates sharply[1].
Trade barriers have a global impact
Most observers agree on one thing: tariffs are toxic for trade, and hurt many companies’ business – and not just in the affected countries. The global economy is so tightly intertwined that the effects are likely to be felt everywhere: suppliers in Asian could be affected, as could European markets where some of the products with artificially inflated prices in the USA would be diverted.
One result of the trade war is that the S&P 500 index in the USA fell back quite a bit in May from its high at the end of April. Losses on the Chinese stock market have been even more visible.
However, there are some signs of hope: Trump has postponed a decision about tariffs on imported European cars until mid-November 2019, for example, giving the German car industry in particular some breathing space. Meanwhile, the US president is pushing on with the ratification of the USMCA trade agreement with Mexico and Canada.
Hands off China?
Having risen to the position of the world's second economic power, China is also not nearly as vulnerable as it was before. In 1980, China's share of economic output was just two percent; nowadays, it is well over 18 percent [1]. Many Chinese companies now earn a large share of their turnover from the domestic market. Internal demand in this huge nation of 1.4 billion inhabitants has been growing strongly in recent years, not least, because many Chinese people are becoming more prosperous. China's dependence on exports, which was the country's Achilles' heel at earlier points in its growth, has therefore reduced considerably. This does not mean that a trade war will have no impact. But, unlike in the past it would no longer be a disaster for the economy of this giant nation.
Furthermore, the Chinese government will not stand idly by and see its most important goal of economic growth ruined. Instead, it is likely to try to apply countermeasures to stimulate new growth, such as interest rate reductions, further investment in infrastructure projects and further market liberalisation.
So far, the US has imposed punitive tariffs of 25 percent on goods with a total value of USD 250 billion. Goods worth a further USD 325 billion could be added soon.
Presidents Trump and Xi will next meet in person at the G20 summit in Osaka on 28 and 29 June.
If one thing comes out of these data, it is this: the USA and China need each other. The mutual interest in returning to business as usual sooner or later is considerable.
Pressure from financial markets could lead to reconciliation
DWS believes the parties will probably come together sooner or later. Pressure from financial markets might be just as big a contributor as growing dissatisfaction in broad swathes of the US economy, where people are increasingly feeling the impact of the new tariff barriers in their own pockets.
President Trump has already announced that he will meet China's President Xi at the G20 summit at the end of June. Many financial markets participants believe these discussions could be the first step towards an agreement. This is all the more likely, as it becomes increasingly clear that any further escalation is ultimately likely to hurt rather than help both sides.
From a logical point of view, there are therefore many arguments in favour of the trade war ending smoothly. But Trump would not be Trump if he did not have a few negative surprises up his sleeve that could cause upheaval on the capital markets. A defensive strategy thus remains the order of the day.
