Is President Trump right? Jul 11, 2018

When it comes to trade, he might be.

While starting a trade war may be a questionable strategy, the US may have a legitimate beef regarding the fairness of trade with China and, to a much lesser extent, the European Union.

How did we get here?

After World War II, the US was the central force in re-building post-war Europe, supporting the global economic recovery and helping establish important institutions such as NATO, the IMF and the World Bank. The US opened up its market to foreign imports now worth about $3 trillion annually to create trade allegiances and promote global growth. In fact, as can be seen below, we have been in a generally declining trend in tariff rates.

China and Europe

When it comes to trade between the US and China, imbalances have grown, as can be seen in the chart below. China imports roughly $125 billion of goods and services from the US, while the US imports $500 billion from China. As in post-war Europe, the US-China trade relationship is tilted against the US, but is part of a larger geopolitical strategy. One of the benefits of the exchange was helping create a more capitalist China. Giving preferential access to the US market was one way to create a China that was more prosperous and less authoritarian. The first goal has been successful but the second is proving more difficult, particularly as rising populism may be viewed by China as the failure of democracies.

More than trade

Trade surpluses and deficits are but one aspect of the current struggle. China has been accused of stealing intellectual property, not doing enough to combat counterfeiting and making access to its market extremely onerous and unfair to foreign entrants.

Europe is not without blame either. Yes, with the creation of the common market within the EU, inter-Europe trade barriers have shrunk, but barriers for non-Europeans still exist. Autos have been a particular area of concern to the US, where arguably the country should have a bigger share of the EU auto market. Tariffs and other non-tariff barriers can be quite high for foreign firms looking to access the EU market.

Using the threat of tariffs to lessen trade barriers?

Though branded anti-trade, Trump’s high risk/reward strategy of aggressively imposing tariffs and duties could theoretically lead to less protectionism in the long run. If China, Europe, and others are persuaded to reduce various trade barriers, the global economy could eventually see lower tariffs and expanding trade. In a best-case scenario, we could see better access to China for US businesses, less tariffs on US automobiles into Europe, and even more US milk exports into Canada. This outcome could actually result in lower overall prices and more trade!

A high risk strategy

This outcome is far from certain, and we may see more volatility before anything more positive materializes. A trade war used as a means to an end would initially hurt global growth, asset prices and global relationships. Corporate investment would suffer, given the increased uncertainty, and global supply chains would be disrupted. Inflationary fears may pick up as customers start to price in higher prices for products and services. So this is a high risk but potentially high reward strategy!

How does it all end?

We think Trump’s trade tactics are not about blowing up the global economy, but rather pushing global trading dynamics towards more balance. Trump has been pretty consistent for years on his view that the US is getting “a raw deal” when it comes trade and he has surrounded himself with trade hawks, so it appears he is in it for the long haul. We think the final outcome could be more benign for certain regional deals such as NAFTA, but more economically significant for changes to the US-China trade relationship.

One would think that China, given that the country may have plenty to lose, will blink first and make more legitimate efforts to open markets and combat other issues the US has identified. But China has long-term plans and may feel they can wait out the US, which is stuck in a biennial election cycles. Clearly, the path between here and there is very uncertain indeed.