Implications of a US-Japan deal

October 21, 2019 12:41
Japan has successfully removed a currency clause from a trade deal, which US President Donald Trump initially wanted to implement. Photo: Reuters

Even as investors continue to worry about the trade war between the US and China, there are other trade disputes that have been simmering. In Asia, Japan and South Korea are engaged in a dispute over supply chains and security, exacerbated by old wounds that go back millennia. The US is also attempting to renegotiate terms of trade and security agreements with these two key regional allies. Against this backdrop, the US and Japan recently announced plans to sign a trade deal, albeit excluding autos.

Effects on President Trump’s re-election

Arguably President Trump’s need to pass a trade deal with Japan became more important once the tariff war with China heated up. Yet domestically, the Japan deal is not on the public radar in the US, meaning Trump is under very little political pressure to punish the Japanese. A bilateral trade deal between the US and Japan is subject to Japanese parliamentary approval so this lack of public scrutiny bodes well for the Trump administration, which may be running out of time before the 2020 presidential election. Further, the current levels of negotiation will enable Trump to remain magnanimous when discussing Japanese/European trade, while focusing public attention on his own trade achievements, like the renegotiation of North American Free Trade Agreement (NAFTA).

Japan has successfully removed a currency clause from the trade deal, which President Trump initially wanted to implement. Years of ultra-loose monetary policy has resulted in Japan facing negative interest rates, and it needs to intervene in the currency markets by keeping the yen at low levels in order to feed the export-led economy. Trump is keen to weaken the dollar in a bid to strengthen US exports, lower the consumption of foreign goods and lessen the trade deficit.

Domestically, were Trump to successfully depreciate the USD it could potentially bolster his chances for re-election in 2020. However, engineering a weaker currency has proven more difficult than anticipated. In June the European Central Bank decided to restart quantitative easing which pushed down the value of the euro. Meanwhile, China has permitted the renminbi to depreciate against the USD, undermining the impact of US tariffs.

Around Asia, it seems highly likely that regional currencies will not wish to appreciate against either the USD or renminbi, in order not to lose export competitiveness. Accordingly, with Japan, Europe and China all suppressing currency appreciation, the USD has nothing to depreciate against, except possibly sterling after Brexit uncertainty ends – and obviously the ultimate currency, gold.

Together, the US and Japanese economies represent approximately 30 percent of global GDP so, were this deal to collapse, there would be potential ramifications for economies globally. The market reads trade uncertainties negatively and Japan itself has suffered from the US-China tariff fights as the yen appreciated, resulting in lower Japanese exports and negatively affecting their economic outlook.

Investment implications of a US-Japan deal

Although a US-Japan agreement would likely benefit Japanese industrials (excluding autos) and US agriculture, there is also a focus on e-commerce and digital trade. Both countries have agreed to address “unfair trading practices including intellectual property theft, forced technology transfer, trade-distorting industrial subsidies, distortions created by state-owned enterprises, and overcapacity”. The Trump administration looks to be leveraging its relationships in the region in an attempt to restrict China from working with other nations in the fields of space, defense, nanotechnology, biotech and other areas.

Such coordination should boost companies domiciled in both domestic markets. However, some of that positivity might be offset if Japan and South Korea continue to withhold key technology components from one another, with the key losers being multinational tech supply chains.

Although US-China trade tensions negatively affect global demand, many companies are already moving supply chains away from China and into ASEAN countries, creating opportunities in other parts of the region. However, ultimately an ongoing trade war between the US and China will create further industry fragmentation globally.

It’s fair to say that most countries throughout Asia would prefer to have access to the markets in both the US and China. Being forced to choose sides is not a decision anyone wants to take – though the looming threat of recession in the US and EU may be one of many reasons why Asia may choose to promote trade within the region:
• In the short-term, Japan may side with the US, as illustrated by the current deal, but in the longer-term, it’s not that simple:
-- Japan owns US$1 trillion worth of Treasuries, but also has US$1 trillion invested in China.
-- 50 percent of Japanese corporate revenue is derived overseas, with China as one of Japan’s largest markets accounting for 20 percent of sales and profits. Although revenue derived in the US is currently larger, its margin is lower.
• A similar dynamic is at work in South Korea – which relies on US defense technology but exports nearly three times more to China than the US.
• It’s unclear what Hong Kong’s future holds given the uncertain future of the current status quo.
• For Taiwan, it may be prudent to take advantage of its position between two superpowers.
• The vibrant, youthful economies of India and Indonesia will likely require greater partnerships with China, particularly given the ageing demographics in the West, which will become a systemic decelerator of growth.

It seems that Trump’s main priority is to “win” the battle with China, and secondarily to find a resolution to a nuclear North Korea. It is difficult to forecast when, how or if the economic hostilities between the US and China will end, but investors should to keep an eye on growing trade tensions and their likely impacts as old alliances are frayed and new ones form. In the short term, investors may see the US as the better and more attractive economic opportunity, but China could be the longer-term victor.

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As Global Strategist at Allianz Global Investors, Neil Dwane is responsible for presenting strategic house views and overseeing the Economics and Strategy Research teams.