Global trade in rude health despite the focus on US tariffs

The "trade war" needs to be seen in the context of the broader US/China relationship. China is becoming more important not just economically but also geopolitically and the negotiations over tariffs have to be seen in that wider context.

President Trump’s recent announcements regarding tariffs on various goods has caused a decline in the stock market and created concerns that the world economy will be negatively impacted by a “trade war” as other countries retaliate. This is a legitimate concern given that, having been in the doldrums in recent years, global merchandise trade has actually been one of the brightest spots on the world economic scene in the last year or so.

The chart below shows the % change from a year ago in world merchandise trade volume from January 2001 through January 2018. One of the remarkable things about the financial crisis and Great Recession of 2008-09 was the extent of the collapse in global trade. It declined by 19% in the first half of 2009. There was then a recovery in 2010 and 2011 off that very depressed level. But after that “dead cat” bounce, trade volume growth was stuck in a range of 0-3% from 2012 through to 2016.

World Merchandise Trade Volume % change on a year ago

Source: CPB World Trade Monitor

That very sluggish performance was one of the things that bearish commentators highlighted as a justification for ongoing extraordinary monetary policy and a general need to be nervous about the strength of global demand. It was also a key reason for the persistence of a deep depression in many parts of the shipping industry for the last decade.

However, over the last year the picture has improved significantly. Indeed, the rise of 5.7% in world trade volume in January was the highest growth rate since the end of the 2010-2011 dead cat bounce. This robustness is one of the indicators that has been telling us that the world is enjoying a period of synchronised economic growth for the first time since 2007.

It is somewhat ironic that it is President Trump’s tariffs which have put global trade on the front pages, and not the good news which is surely equally deserving of attention.

There are so far two sets of tariffs. The first were at 25% and placed on steel and aluminium imports from around the world - but many countries have already been exempted from the tariffs and there was a delay of three months or so from the announcement to the introduction of them. This looks like a now familiar Trump play of speaking loudly and threatening a big stick but then “doing a deal”. The market had shrugged off the direct impact of these tariffs, quite reasonably in our view.

The second tariff announcement, though, was more serious. This was the as yet unspecified threat to impose tariffs on a wide range of Chinese imports totalling $60 billion. The Chinese response was to threaten tariffs on $3 billion of US imports. This too is likely an opening salvo to be followed by a negotiation - but this is a much more serious shift in policy for a number of reasons.

First, this policy is the result of a 215-page report from the Robert Lighthizer, the US Trade Representative, on China’s approach to technology transfer, intellectual property and innovation.

The report was commissioned by President Trump under section 301 of the US Trade Act of 1974 which gives the President (and his Trade Representative) delegated authority from Congress to tackle “unfair” trade practices. It was only ever going to draw one conclusion. But to have this level of detailed analysis of the problem raises the stakes on finding a resolution to the problem.

Second, Trump made it a core part of his campaign that he would reduce the US trade deficit with China by $100 billion in a year. The deficit totalled $375 billion in 2017. With the mid-term elections coming up in November Trump needs to show his core base of voters that he has delivered on this. He can’t afford a trade war, though, as the first and second largest US exports to China are motor vehicles and soybeans. Both are primarily produced in the Midwest and in several states that voted for Trump in 2016 (Indiana, Iowa, Michigan, Missouri, Nebraska for example). China imposing tariffs on US exports would disproportionately impact those states (as well as Illinois and Minnesota).

More broadly, the tariff threat represents an attempt to significantly change the relationship between two countries that have become intertwined by trade, particularly since China joined the World Trade Organisation in 2001. Since then, US imports from China have risen from $100 billion to $506 billion in 2017. US exports to China have gone from $13 billion to $130 billion over the same time so actually their rate of growth has been double that of imports - but the deficit has quadrupled.

Third, and perhaps most importantly, the effort to tackle the trade imbalance between the two countries is part of an evolution in the relationship between them on a number of levels. We need to see the threat of a “trade war” in this wider context, one which is part geopolitical and part existential.

The geopolitical angle is most obvious currently, given the need to work together to maintain peace on the Korean peninsula. The apparent visit to Beijing on 26 March by North Korean dictator Kim Jong-un is a reminder that North Korea is in the end dependent on China for its survival and moreover that the US needs China to be part of the solution to the tension in the region. The US will be having those conversations with China in parallel to its tariff discussions.

There is a possibility that Trump, not by nature an internationalist, will allow China a greater say in how the Korean peninsula tensions are resolved than any of his predecessors would have done in the 65 years since the end of the Korean war. If that happens it will have knock-on implications for how both South Korea and Japan see the US military role in East Asia.

The existential question is whether ultimately it is China and its renminbi (Rmb) that knocks the US dollar off its pedestal as the global reserve currency. Clearly the Rmb is a long way from being a reserve currency, given capital controls and the lack of transparency on currency policy in China.

But a baby step in that direction occurred on March 26 with the launch in Shanghai of an oil futures contract traded in Rmb rather than dollars. China has overtaken the US as the world’s largest importer of oil thanks to US shale oil production. China would, of course, much rather pay for oil in its own currency than in dollars.

The Shanghai contract is on Middle Eastern produced medium sour oil, a different variety than Brent, (primarily traded in London), and West Texas Intermediate, (primarily traded in the US).

What China wants is for Saudi Arabia in particular to accept Rmb rather than dollars for its oil. It is quite likely that will happen for at least some of the purchases given the clout China carries from its need for 9 million barrels a day.

This will be symbolically important given that the US insistence on Saudi pricing oil in dollars in the early 1970’s created the petro-dollar and ensured the dollar’s pre-eminence in global markets even as the Bretton-Woods post-war global currency regime was collapsing.

The US, as the primary military backer of Saudi Arabia, will have a view on any widespread usage of a currency other than the dollar to price the commodity in. This is important given the ongoing doubt about the Trump administration’s support for the deal which the Obama administration did with Iran and which the Saudis would very much like rescinded. Saudi Arabia may not want to annoy the US while that debate is going on in the US administration.

From our perspective therefore we need to look at the announcement of tariffs in the context of the wider US/China relationship. There are a number of negotiations that could be going on at the same time between assorted ministries of each government that could all have a bearing on the tariff negotiations.

Given how important it is to Trump to show some progress on the deficit with China, it could be that getting concessions on that will be his priority. It will be interesting to see if that is matched by some concessions from the US on other things that matter to China in the geopolitical sphere at least, and even the existential.

The bottom line is that to us it seems unlikely that there will be a trade war between the US and China. What there is though is a shift in the relationship between the US and China on a number of levels. The threat of tariffs is potentially a catalyst for a reset of the balance of power, at least in Asia and possibly more broadly.

William Dinning  

Head of Investment Strategy & Communication

Risk Warnings

The views and opinions expressed are the views of Waverton Investment Management Limited and are subject to change based on market and other conditions.  The information provided does not constitute investment advice and it should not be relied on as such.  All material(s) have been obtained from sources believed to be reliable, but its accuracy is not guaranteed.  There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.

Changes in rates of exchange may have an adverse effect on the value, price or income of an investment.

Past performance is no guarantee of future results and the value of such investments and their strategies may fall as well as rise.  Capital security is not guaranteed