Last week, the US imposed tariffs on imports of solar panels and washing machines. A mercantilist, protectionist US is what President Trump promised and he is now attempting to deliver on it. What is less obvious is the level of trade under the last 2 administrations under Obama. Total trade, exports plus imports fell from 2012 to 2015 but has since resumed its growth, both in absolute terms and as a share of GDP. The trade balance rose sharply in 2008 before consolidating. Since 2016, it has begun to deteriorate again. The re-shoring of manufacturing under the previous President had significant impact on trade and the recovery in American manufacturing.
China’s strategic response has been to become more dependent on domestic consumption and less so on exports. China remains heavily driven by investment. Total trade as a percentage of GDP in China rose steadily to peak in 2006 and has since trended down steadily. In absolute nominal terms, China’s total trade peaked in 2014, fell for the next 2 years but has rebounded in 2017 to a new high. The absolute nominal trade deficit of the US with China has become more volatile since 2009 but otherwise has trended wider and stands at close to a record.
The reality facing countries in the wake of the financial crisis was that they had just raided the national coffers to bail out their banks and investors. Households who drew on home equity for consumption saw the value of their collateral dwindle and access to credit was also cut off by more stringent bank regulation. The general climate did not encourage corporate investment. There was but one avenue of growth and that was trade. In this scenario, the purchasing power of a country’s populace is a valuable resource to be guarded. Hence a more mercantilist, protectionist world.
It has been 10 years since the crisis, the economy has healed, the housing market is growing once again and banks have been recapitalized, although tighter lending standards remain. Also, there has been a recovery in international trade and manufacturing as economies recovered. Will the world become less insular and resume globalization, or will it continue to cling to protectionist tendencies?
Somewhat incredibly, the US has embarked on fiscal expansion, this when the national debt as a proportion of GDP stands at the highest level since WWII. Last week we had another US government shutdown, which has since been resolved, at least until Feb 8, less than 2 weeks from now. There will be more arguments over how much the country can borrow. Debt levels across the globe from China to the US have surged in the last 10 years, as governments bailed out investors and tried to revive flagging economies. Low interest rates were designed to spur investment and consumption. Investment has been slow as corporates hoarded cash and the banking system was still being repaired. The bond market grew strongly but capital raised has so far flowed to buy back shares or pay dividends. Consumption has recovered somewhat although wage growth remains slow despite tight labour markets.
With the current level and breadth of growth it is unlikely other countries will follow the example of the US from a fiscal standpoint. If anyone the US was the least needing a fiscal boost, not least through a more regressive tax code. Much depends on whether investment will grow. There are some signs that it has begun to but these are green shoots and interest rates are rising. As for consumption, it is hardly to prudent to encourage further expansion of household balance sheets. By elimination, it falls again to trade to take up the slack and so the risk of a resumption if not an escalation in protectionist tendencies.
What can we expect from a resumption in trade war? Emerging markets are more dependent on trade than developed ones. The US is especially self-sufficient and China has taken the last 6 – 7 years to make itself more self-sufficient. Manufacturing will begin to underperform Services again as manufactured goods are more traded than localized services. Commodities might come under pressure as manufacturing slows.
The US economy is growing steadily and its central bank is raising rates. Not many countries can boast these two factors, yet the USD has weakened sharply this year. Some attribute it to EUR strength as the European economy continues to power ahead. Another factor might be the robust growth in emerging markets as global trade has rebounded. Yet the ECB is unlikely to tighten financial conditions, merely slowing or stopping its expansionary programs in September. The BoJ has also similarly maintained status quo with policy. Relative central bank policy still supports the USD. Yet the USD has confounded economic growth data and monetary policy. One explanation is that the USD is a safe haven currency and the recent bullishness for the global economy and for equity markets is part of a broader decline in risk aversion which is affecting the value of the world’s risk free currency.
BoJ and ECB
The BoJ held its monetary policy meeting and kept monetary policy unchanged in all areas. It also kept its growth and inflation outlook unchanged. The ECB similarly signalled no changes to policy. USD weakness is complicating the job of policy makers as it acts as an indirect brake on their economies and could encourage them to delay tightening. For now, momentum is driving all markets from equity to FX and commodities. Fundamentals, strong as they may be, have been put on hold.