Markets vulnerable as Trump set to actively prepare for China trade war
- Markets are too sanguine about China-US relations.
- To reverse China’s allegedly unfair gains in trade, geopolitics and cyberwars, Trump is more likely to threaten trade war than investors perceive, since he sees China as vulnerable due to debt/social pressures.
- Markets can fall significantly during the negotiations and only recover once a deal is reached.
With Donald Trump’s inauguration on 20th January, talk will give way to action as investors see what actually happens in the first 100 days. We think global stock markets are likely to fall significantly, as Trump euphoria gives way to a focus on tensions between China and the US and on other negatives, notably rising inflation and interest rates. We would see those weaker markets as ultimately offering a buying opportunity, since we believe the eventual outcome will be a deal between Washington and Beijing covering both trade and geopolitics.
An asymmetric relationship
Donald Trump clearly sees the US-China relationship as grossly asymmetric, across a range of areas:
- In trade (China accounts for far more of the US deficit than any other country, even adjusting the data for goods from third countries reaching the US via China)
- In geopolitics (the US has largely acquiesced in China’s territorial claims in the South China Sea, but in return China has done nothing effective to stem the threat to the US posed by North Korea)
- In military capacity (China’s military spend has grown faster than the US, its missile and naval capabilities versus Taiwan and beyond have been transformed)
- In cyberspace (Trump repeatedly stresses Chinese cyber espionage against US firms, especially in high-tech know-how)
- In direction (under President Obama, these issues have been allowed to get much worse)
Only in one key area is the asymmetry the other way round:
- Strategic economic and social vulnerability (China’s debt and social strains suggest it could face domestic pressures far greater than the US in the event of a global economic downturn).
So any US dialogue with China, whether friendly or hostile, will take place against the background of a threat, spoken quietly or loudly, to start a trade war in which both sides will suffer, but where China would face far greater risks.
The opening moves in this process have been played. Donald Trump has nominated three hawks to key trade positions (Robert Lighthizer, Peter Navarro and Wilbur Ross), earning the description of a protectionist “Iron Curtain” from China’s Global Times, while his website donaldjtrump.com cites a range of tough measures (labelling China a currency manipulator, bringing trade cases, etc). Yet meanwhile, some members of his transition team have denied plans for a trade war. These inconsistencies look like classic negotiating ploys, making clear the ultimate threats while leaving the door open for a deal.
From a Chinese perspective, it is surely rational to retreat from some of the enormous gains made during the Obama years, rather than risk Donald Trump actually carrying out his threats. A partial roll-back or re-direction (on trade, on reining in North Korea, on military and territorial expansion, and cyberwars) could still leave China in a far stronger relative and absolute position than it was a decade ago, with everything still to play for in the longer term. And Trump is surely a smart enough negotiator to minimise any loss of face for China in this process. So the end-game of these negotiations is likely to be an agreement that is seen as good news for the global economy and markets.
Danger zone for markets
But before we reach that end-game, it is likely to be a bumpy ride. China is unlikely to make worthwhile concessions immediately. More likely, there will be a period of testing of strength and resolve on both sides. Trump’s team, without actually starting a serious trade war, may start removing the current legislative barriers to doing so. This is likely to be the danger zone for world markets.