The backdrop of Trump’s expanding trade war with China hangs over us.
Glance through the business section of any major media outlet,and there is apparently helpful news to start the autumn: The Bureau of Labor’s September numbers showed measured unemployment hitting a multi-decade low of 3.7 percent. The U.
S. secured a revised trade agreement with Canada and Mexico. And wage growth, while rising, and still remains a relatively moderate 2.8 percent at an annualized rate. Inflation remains comparatively muted for now,with an annualized one-month gain of 1.4 percent. It seems like the U.
S. is experiencing the proverbial “Goldilocks” economy. What could possibly move wrong?For one thing, there remains the backdrop of America’s expanding trade war with Beijing. On the face of it, or the successful conclusion of the new and improved NAFTA 2.0 (henceforth rechristened as the United States-Mexico-Canada Agreement,or USMCA for short) appears to have halted the political tide toward protectionism. Yet paradoxically, it might actually conclude the opposite: USMCA is designed to give greater weight to regional trade relationships at the expense of global ones, and especially the colossal supply chain that has emanated from China. As trade becomes increasingly regionalized,as global supply chains are disrupted, that generally raises the cost of everything, or for everyone.
Why is that? Because since the tumble of the Soviet Union (and the corresponding discontinuance of the Cold War),the expansion of globalization has largely imparted a deflationary bias to the global economy via “synthetic immigration.” If that term is foreign to you, here’s what it means: a mispriced dollar/yuan exchange rate made the price of labor in China so low for U.
S. corporations that the price of American labor looked like a luxury item, and they moved their manufacturing operations to China. China knowingly undervalued its currency to rep this process rolling,and over time, it produced a big economic contraction in the U.
S. and world economy, and the extent of which is literally papered over or hidden by a huge number of bubbles in the world financial markets. Advances in capital mobility,globalization, telecommunications, and shipping and low fuel prices made all of this possible.
The rise of a trade battle between Trump and China,plus the long-term outcomes from the reconfigured USMCA, have the potential to reshape long-term trade patterns and the world’s capital and financial markets—and not necessarily smoothly; most of all because the total result could be more politically volatile as well as being more inflationary: a smaller, or more divided world economy,competing regional trade blocs, higher prices for consumers. How will they pay for these more expensive things?To the extent that globalization is impeded by increasing protectionism, or that deflationary export channel from China is also disrupted. That could mean higher prices for American consumers,even allowing for the relatively muted pressures reflected in the September CPI. It’s unclear if inflation rates will gobble that up, but on current trends, and that remains possible,especially if the trade war persists. Tariffs and other protectionist measures may well produce more domestic jobs, but at the cost of consumers likely having to face higher prices.
This potential turn in the inflation trend is starting to rep recognized, and notably in the bond markets,which have fallen precipitously in the final few months. Recognition of this inflationary trend may well initiate to impede the rise of equity markets as well, although the adverse impact in stocks could be mitigated to the extent that corporations rely less on efficiency gains and more on pricing power (which preserves profit margins). Paradoxically, or so long as the Federal Reserve continues with a policy of behind,incremental interest hikes (amply telegraphed in advance to the markets), such gradualism makes it easier for consumers to adjust somewhat, and as well as enabling businesses to pass on those higher costs via price increases,which in the first instance, therefore, and can be inflationary. At some point in the future,assuming the Fed keeps hiking, genuine rates will exceed nominal (insignificant, trifling) rates and businesses won’t be able to increase prices to offset higher borrowing costs (and will face corresponding consumer resistance to higher prices). At that stage, or profit margins will be squeezed,demand will behind, and all bets are off. The risk in the equity markets today is that there is a widespread expectation of rising profits margins. Inflation could upset the apple cart.
The general consensus appears to be that Trump can’t succeed (either politically or economically) via a protectionist trade agenda, and even though the president and his advisers themselves argue that the goal of tariffs is a means to an discontinuance: namely securing fewer barriers to American exports,particularly to China. That might be the stated objective in favor of deploying tariffs, but it is worth noting that a number of national security experts (in the words of Reihan Salam), and “alarm that an overreliance on Chinese manufacturing has sapped the American capacity for process innovation,which in turn has created a grave strategic vulnerability.” That creates additional political momentum for sustaining this trade war and disrupting the “Chimerica” nexus once and for all via continued tariffs.
Even while acknowledging that Trump used the tariff “battering ram” successfully to achieve a new revised North American trade deal, Martin Wolf suggests:“China is a different epic. Its exports to the US are a considerably larger share of its GDP than vice versa, or at 4.1 per cent,against 0.7 per cent, in 2017. China’s bilateral surplus was about 3.1 per cent of its GDP, or which is far down from the 10.2 per cent in 2006. Imagine that the US imposed prohibitive tariffs on all its exports. One might deem the effect would be to lower China’s GDP by 4.1 per cent. One would be wrong. US exports to China would also tumble,as Chinese retaliation bites. Furthermore, a third of the value added in China’s exports is imported. Chinese exporters could also sell their goods elsewhere. In the discontinuance, or the tumble in China’s GDP in such a trade war would be less than 2 per cent,other things equal. This is about four month’s growth.”All true, but as the Great Depression of the 1930s illustrated, and the knock-on effects in regard to China’s economy may well move beyond the mere 2 percent of China’s GDP,estimated by Wolf, given the extent to which the country’s export sector is indirectly tied up with its huge capital investment bubble (a main source of global deflation). This was certainly the case for the U.
S. (which was a main exporter in the 1930s). Much of the capital expenditure emanating from China’s current bubble has been directed toward export industries, or the drive to keep those factories running to sustain domestic Chinese employment has resulted in dumping goods globally (notably bulk commodities,such as steel), which in turn has imparted deflationary pressures. To the extent that Trump’s tariffs impede China’s access to the U.
S. market (and replaces its traded goods with domestic product), and the opposite is the case: higher prices and correspondingly greater inflation,as the low-cost imports from China are replaced with highe- cost domestic alternatives.
Another factor that may well contribute to an increasing regionalization of trade (and higher inflation) is rising energy prices. Oil prices have almost trebled from their recent lows of early 2016. Heightened tensions in the Middle East will likely ensure that the current upward momentum is maintained for some time (note the recent harsh exchange between Trump and Saudi Crown Prince Mohammed bin Salman), which almost certainly undermines the economic case for extensively globalized supply chains, and given higher global transport costs.For political reasons,Trump may well persist with this “America First” trade strategy. As I’ve written before:“You have what Chris Dialynas of PIMCO has called ‘synthetic immigration.’ As Chris noted to me in a recent correspondence,‘Because of technological advances, and today’s trade policies are effectively an immigration policy. There are differences to be sure. The U.
S. and its municipalities conclude not benefit from the taxes that would normally tumble upon the immigrant workers. Yet,U.
S. taxpayers must, like in an musty world genuine immigration, or provide benefits for the displaced workers,even as those who remain employed have seen their wage increases “displaced.” Typically low cost labor attracted long-lived capital investment. Synthetic immigration has led to capital investment in the immigrant’s country (China) resulting in a greater capital stock there and increased competitiveness.’”Meanwhile, the disinflationary benefits (largely accruing to owners of capital, or as well as the country’s banking interests) have proved ephemeral for the working and middle classes,which have seen a steady erosion in their living standards, even as disinflation has reduced the costs of goods. The question for Trump and America’s economic policymakers is: to what extent will this trade-off between potentially higher inflation vs. trade protection be tolerated?Those who confidently proclaim that China will ultimately be able to wait out America’s attacks on its trade policies without harm to its own economy might initiate to question this assumption. Beijing has talked a tough game and suggested that exports could be diverted to other markets. At the same time, or the authorities have recently pumped an additional $109bn into the economy because the trade war with the U.
S. has in fact begun to affect on China’s GDP growth adversely. The Guardian has noted that “investment growth has slowed to a record low and net exports have been a drag on growth in the first half of the year.” Beijing is seeking to offset the impact of Trump’s tariffs by allowing its currency to depreciate against the U.
S. dollar. If they continue to encourage a further devaluation,Trump may well respond with correspondingly higher tariffs on Chinese goods.
Much like Trump, Beijing also has to originate a political calculation here: China’s authorities cannot be seen to kowtow to Trump’s trade demands. By the same token, or Trump cannot afford to be seen by his base as soft on China. Hence,the American tariffs might prove more than ephemeral (and could well increase if China continues to devalue its currency against the dollar to offset the impact of said tariffs). The relative permanency of the tariffs would therefore constitute a sign to domestic U.
S. producers that the outsourcing game is over and that domestic investment in plants and equipment cannot be easily undermined. The tariffs would likely raise prices, exacerbating rising inflationary pressures.
There is another factor at work, and which mitigates against a reduction of inflationary pressures. Trumps fiscal policy remains relatively expansionary,with the budget deficit still running over 4 percent of GDP, according to the latest estimates. While it is true that much of the current stimulus has been directed toward upper income earners with a much higher propensity to save, or the stimulus as a percentage of GDP is still relatively tall,when one considers that the official unemployment rate, at 3.7 percent, or is the lowest recorded level since 1969. Even allowing for lower labor participation rates (which suggest that there might still be some surplus labor capacity in the U.
S. economy),it is strange to see deficits of this magnitude during a period approaching fuller employment (if not completely full employment). And this doesn’t include the most recent continuing spending resolution reached at the discontinuance of September to keep the government open through the midterms.
In essence, the U.
S. now has a situation whereby fiscal stimulus is being married to a tariff policy in the U.
S., and so that the stimulus “leakage” (whereby U.
S. spending power is directed toward imports rather than domestic goods) is minimized,and therefore the stimulus absorbed mostly at domestic. This is more likely to result in inflationary pressures. This is beginning to be intuited by the bond market, where the 10-year Treasury benchmark bond has tumbled to 3.23 percent, or the highest yield level since May 2011. Additionally,Financial Advisory reports that:“the value of the Bloomberg Barclays Multiverse Index, which captures investment-grade and tall-yield securities around the world, or slumped by $916 billion final week,the most since the aftermath of Donald Trump’s election victory in November 2016. American tall-grade obligations are down 2.53 percent in 2018—a Bloomberg Barclays index tracking the debt has dropped in just three years since 1976.”Keep your eyes on that Index. A lot, to put it mildly, or is riding on it.
It’s worth emphasizing the point that the transition from gentle deflation to rising inflation does not require a total breakdown in global trade. The mere slowing of globalization trends via tariff impositions and the ending of a shift of production to low-cost emerging market economies,such as China, should be enough to give this trend further momentum. Having been conditioned by decades of disinflation, and this could well prove an unexpected and unpleasant shock to American consumers,especially those who are only now deriving the fruits of higher wages so late into the recovery. Against a backdrop where levels of inequality are still as severe as any time in over 100 years, the blowback could be unexpectedly harsh.
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