Equity markets had their best moment last week when the United States announced that the imposition of additional tariffs on Chinese imports would be delayed from Sept. 1st to Dec. 15th – after the main Christmas shopping season.
The enthusiasm did not last long as equity markets might have realized 1) the US announcement is a tacit acknowledgment that tariffs hurt US consumers, and 2) how frequent new protectionist measures or back-pedaling from them have become lately.
Overall, the US and China act as long-term competitors for global predominance rather than as partners. The trade conflict and the emerging currency war are but reflections of this. The long-term nature of this conflict also implies that there will continue to be ceasefires if its economic impact reaches a certain pain threshold but no long-term peace.
Even if not all tariffs become effective, they have two clear implications. First, they undermine the multilateral trading system based on WTO rules and second, they erode trust between trading partners.
As a result, policy uncertainty has increased significantly since the beginning of last year. In the past, higher policy uncertainty, at least in Euroland, went hand in hand with lower capex spending. However, protectionist trade measures have outnumbered liberalizing measures for many years now.
Another trend that pre-dates the Trump presidency is that the growth rate of global trade no longer exceeds GDP growth. In previous cycles, trade growth remained behind GDP growth in recessions only but grew more strongly during economic expansions. The growth rate of trade has been particularly disappointing since the beginning of this year when it fell behind the growth rate of industrial production every single month.
Looking more closely at the individual data, it seems that Chinese imports, in particular, have declined relative to their industrial production lately.
One explanation for the lower trend of trade growth is the shift towards services as a share of GDP. While it is true that service trade has increased steadily, it still cannot explain the full decline of the goods trade-to-GDP ratio. Instead, total trade as a share of GDP peaked in 2008 – hence, before the Great Recession.
In the short term, we have little hope that trade will pick up again. The softer global PMI points towards lower demand for manufactured goods in the coming months and the political climate is unlikely to change at all. So far, the cyclical manufacturing downturn has affected the services sector to a moderate degree only.
The lower share of manufacturing in most economies means that, unlike in the past, a manufacturing recession does not automatically lead to a recession in the overall economy – though that is likely in Germany, which relies heavily both on trade and manufacturing.
For the US and China, it will be important that their trade war does not escalate so fast and to the point where it would put an abrupt end to their supply chains. In the medium term, those can and will be shifted or rerouted to other countries.
As an example, we already observe that exports from Vietnam to the US have surged. Given enough time for economies to adjust to the new tariffs, and the significant expected central bank policy easing (and some fiscal stimulus) across the world, we remain optimistic that this trade war will not trigger a global recession.
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