Geopolitical risk has returned to take center stage.
US President Trump, well-known for his unpredictable and mercurial nature, is also a shrewd negotiator. Just last week, Trump disclosed that he was targeting 10 May 2019 to announce a trade deal with China. However, over the weekend, Trump put pressure on China to strike a trade deal before 10 May by threatening to increase tariffs on US$200 billion worth of Chinese imports to 25 percent from 10 percent.
The punitive tariff threat was initially fired during September last year and was supposed to be officially imposed at the start of 2019. However, after meeting with China President Xi Jinping during the G20 Summit in December, Trump agreed to a trade truce and delayed the tariff hike for 90 days. Following “great progress” made in trade negotiations, Trump further delayed tariff hike indefinitely.
However, tensions seem to be simmering recently and Trump has shown his displeasure. On twitter, Trump bemoaned that a trade deal with China is moving “too slowly” and that China is reneging on earlier commitments. In the previous editorials, I have mentioned that China has been relying on delay tactics when dealing with Trump. As US consumers also bear the brunt of Trump’s tariffs, public grievances are brewing and Trump needed to take a more aggressive stance to get a breakthrough.
On 6 May 2019, the markets nosedived in reaction to the renewed tariff threat. However, transaction volume was large as many investors picked up stocks at lower prices, betting that a trade deal could still be brokered by 10 May 2019. Trump is eager to get the trade deal finalised with China so that he could turn his attention to other matters, including dealing with the European Union.
Amid the stock rout, Oracle of Omaha Warren Buffet warned that a full-scale trade war between the US and China would be “bad for the whole world”. As such, he thinks that an event like this is highly unlikely and would be “nonsense” for investors to sell based on the negative headline.
The US’s huge trade deficit with China gives it significant leverage against the Chinese economy, but US manufacturers and importers are also suffering the unintended effects of trade tariffs on China. If the scope of tariffs on Chinese goods is extended to consumer goods such as toy, electronics and clothing, the effects on consumers would be no different from a consumption tax. If trade tensions escalate, Trump may have to face the backlash of a drop in public popularity.
US taxpayers are also suffering from retaliatory tariffs. In particular, China targeted US agricultural imports. In 2017, the US exported US$30 billion worth of agricultural products to China. A year later, that figure dropped to US$13 billion. Soybean exports to China led the decline, registering a 75 percent drop to US$3 billion in trade value. Midwestern agricultural states in the US, especially Iowa, have borne the costs of the trade war.
To manage Trump’s latest threat, the People’s Bank of China announced that it will lower the reserve requirement ratio, releasing Rmb280 billion of long-term funds for small and medium-sized banks as well as rural commercial banks. These banks must have assets of less than Rmb10 billion.
The latest round of policy easing is slated to begin from 15 May, and is targeted to help small and private companies. The move helped to reassure investors unnerved by Trump. That night, the US Dow Jones Industrial Average opened 1.8 percent lower, but managed to rebound sharply to close just 0.25 percent in the red.
Through previous experiences, the Chinese government has learned to ignore Trump’s threats and intimidation, or he would ratchet up his demands incessantly. The Chinese leadership understood that it would be more important to prepare for the worst. As such, Xi introduced the “six stabilising” principles and hastened the opening up of its 1.3-billion consumer market to cushion impacts of US confrontation.
During the opening ceremony of the recent second Belt and Road Forum for International Cooperation, Xi delivered a keynote speech in which he reiterated the Chinese belief that “a promise is worth a thousand gold” and further mentioned a number of opening-up policies.
In the past few months, information disclosed about ongoing trade negotiations was largely in-line with what Xi has said at the forum. Did the US really succeed in pushing China to open up its economy or was it more like that China is strategically ready for it?
Regardless of the motivation, China opening up its economy is definitely a good thing for the investors. With a population of 1.3 billion people, China would not just be the world’s factory but would also be the largest market in the world. Amongst the largest beneficiaries are the banks, financial institutions and branded luxury retail companies. Even recently, the Chairman of the China Banking and Insurance Regulatory Commission said that it would introduce 12 new measures to further open up China’s banking and insurance sectors.
However, there will be negative side effects to China’s open-up policies. For one, if China was to reduce tariffs across the board, retail industries abroad would be significantly disrupted. If the retail prices of imported dairy products or luxury jewelries are similar in Mainland China compared to Hong Kong, Chinese citizens would be less incentivized to spend money overseas.
The Belt and Road initiative (BRI) was proposed by Xi in 2013 to match up against the US-led Trans-Pacific Partnership (TPP). The TPP, which excluded China, was the centerpiece of former US President Obama’s strategic pivot in Asia and was widely viewed as a containment strategy to curb China’s rise.
When Trump was elected two years ago, he immediately took issue with the TPP, criticising it to be against Americans’ interest. Following which, Trump withdrew the US from the TPP agreement, choosing instead to launch a full-frontal trade war with China. As a result, China also adapted the BRI and lauded it as something more in-line with its open-up policies.
Currently, the Trump administration is in the process of unravelling globalisation. The US has already begun reworking trade pacts with Mexico, Canada, China, Japan and soon-to-be EU. Trump has also withdrawn the US from the Paris Climate Accord.
As the US slowly recedes into protectionism, China’s BRI is increasingly becoming the main driving force in advancing globalisation. The US clearly sees it as China’s global power play with hegemonic intentions and hence dissed the summit by not sending any officials to attend.
During its 1 May 2019 meeting, the US Federal Reserve decided to leave interest rates unchanged. While within expectations, Trump had previously called on the Fed to cut interest rates. Nonetheless, speculators were disappointed when the Fed eventually snubbed Trump by refusing to cut interest rates. Consequently, the US stock market tumbled for two consecutive days following the Fed’s announcement.
After-meeting remarks from Fed Chairman Jerome Powell further revealed that the likelihood of any rate cut in the short-term is not high. With US stocks hitting new records and recent strong economic data, the case for interest rate cuts – other than for pleasing Trump – is simply not there.
Next year would be the US Presidential election. For Trump, it would be essential for him to deliver a prosperous US economy in order to have a higher chance of being re-elected in 2020. The most direct and effective way is to stimulate the economy by easing monetary policy.
Many former US Presidents had in the past pressured the Fed to cut interest rates in their third year of their presidencies. Likewise, most of the former Fed Chiefs also knew how to “cooperate”.