By John Richardson
SINCE my post last week –China Becomes Dominant Superpower: Implications for Petchems – more data and analysis has emerged on the potential downside for the US if it ends up in a trade war with China. An example is this article in the New York Times:
- An analysis by the pro-trade Peterson Institute for International Economics concluded that a full-blown trade war with China and Mexico would push unemployment in the United States to nearly 9% in 2020, from 4.9% today.
- Most of Apple’s iPhone are assembled in China. Assembly costs account for less than 4% of the value added of the device. That means China could halt in iPhone production at little cost to itself, while Apple would face a deeply disruptive, expensive effort to shift production elsewhere.
- China could bar state-owned companies from doing business with American businesses in response to a trade war. Or it might limit access to essential commodities, as it did in response to a fishing dispute with Japan by stopping exports of rare earth minerals vital got the electronics industry
“But Mr Trump is a businessman. All of his positions are therefore negotiating starting points rather than firm policy positions. He will govern as a pragmatist,” I have heard many of you say.
People eagerly point out Trump’s decision to reverse course by keeping some aspects of Obamacare as being evidence of his pragmatism.
This thinking overlooks the radical right-wing nature of many of his cabinet appointments – and the fact that like all presidents he will be concerned about his popularity ratings. However economically short-sighted this might probe be, he has promised the people who voted him into power to bring jobs back to the US by penalising countries with “unfair” trading advantages.
As The US Retreats, China Advances
Let’s assume, though, that this analysis is wrong and the president-elect does back away from a global trade war.
To a large extent, the damage has already have been done because of the perception the US is no longer supportive of global free trade – and that its future behaviour in this respect will be much harder to predict. This will push more and more countries towards China, which is moving in exactly the opposite direction. China will thus gain both economically and geopolitically at the expense of the US.
And what we do know for certain is that the Transpacific Partnership (TPP) – the free-trade deal – which excluded China that was led by the US – is dead in the water. It is hard to see how the TPP can survive given that Mr Trump has stuck by his election pledge to pull-out of the agreement.
This is enabling China to more effectively promote its alternative trade deal – the Regional Comprehensive Economic Partnership (RCEP), which excludes the US. Australia, one f the 16 countries that make up the RCEP, has pledged to work hard to conclude this agreement in light of events in the US.
At the moment, the OBOR only includes the Middle East and large swathes of South and Southeast Asia, Central Asia and Eastern Europe. Although of course we do need to put the word “only” into the context into the context that the OBOR in its existing form already comprises 65 countries and some 40% of global GDP.
Africa and Latin America are the obvious next targets because of their cheap labour and their oil, gas and other commodity resources. China is eager to outsource manufacturing to lower labour cost locations as its own wage costs increase whilst it is also short of commodities.
Africa and Latin America need to bridge big gaps in the provision of basic needs such as food, water, sanitation and infrastructure.
China is willing to spend many billions of dollars in these areas via the OBOR. In contrast, the US looks set to withdraw from some of its overseas spending commitments as it becomes more isolationist.
Here is another thing to consider: If the president-elect follows through on his pledge to withdraw from the COP21 climate deal this will be a further reason for developing countries to align themselves economically and geopolitically with China.
Many developing countries are suffering from food and water shortages associated with man-made climate change. Meanwhile, China has reaffirmed its commitment to COP21.
Even if Mr Trump’s recent comments that he needs to be open minded about the issue of climate change leads to a change of heart on COP21:
- The perception has again been established that the US will in general back away from its earlier commitments to mitigate the impact of climate change. A concrete example of this are plans to encourage more domestic oil, gas and coal production through relaxing environmental regulations.
- The president-elect’s policy team looks set to include hard core climate change sceptics.
Carbon tariffs on US exports
The rest of the countries that have signed-up to COP21 remain committed, with regions such as Europe already well down the track of reducing carbon intensity. Take German’s highly successful Energiewende programme as a great example.
Critically in China, too, under the government’s 13th Five-Year-Plan (2016-2020) the country has committed itself to reducing carbon intensity – both for climate change and air, soil and water-pollution reasons.
Climate change is hitting the developing world particularly hard because of lack of money to deal with increased flooding and droughts.
Imagine that the US continues to move away from the global consensus on climate change. US oil and gas production goes through the roof, resulting in further declines in ethane feedstock costs. Environmental regulations are also relaxed for the US petrochemicals industry.
Producers elsewhere face both higher raw-material costs and stricter environmental regulations. They successfully lobby for additional import tariffs on US petrochemicals exports, based on the “carbon” advantage or carbon inefficiency of their US competitors.
The most obvious target for these additional duties would be polyethylene as US surpluses increase over the next 3-4 years.
The same could obviously apply to other manufacturing sectors.
The Pros and Cons of Infrastructure Spending
One can argue that the money that Mr Trump wants to spend on improving US infrastructure will deliver such a positive boost to the local economy that this will more than compensate for any losses in export markets. The US has a vast internal economy.
But what if the money spent on infrastructure leads to inflation, and so much-higher interest rates?
Average rates for US fixed-rate mortgages have since Election Day increased to their highest level since June 2015, in anticipation of higher inflation. Some 70% of the US economy is driven by consumer spending.
The US clearly does not need to improve its infrastructure – just look at the scandal over lead in water in Flint, Michigan as one example of what needs to be done.
It is therefore possible that if infrastructure investments are properly targeted, they will more than offset the negative economic impact of higher interest rates.
But will Mr Trump’s plan to use private rather than public financing of infrastructure really work? Several economists have warned that the private sector will be reluctant to build the bridges, roads, rail networks and improved water supply that the US needs because of poor short term returns on investment.
And for me, debt is a major issue – both in the US and elsewhere. Vast amounts of debt have been built up since the Global Financial crisis as a result of misguided monetary policies.
Higher US interest rates would obviously lead to higher borrowing costs everywhere. Of particular concern is the impact on emerging markets of both higher interest rates and a stronger US dollar.
Yes, the US has vast domestic demand – but it is not an economic island – and so would suffer from a debt-driven global economic recession.
Why This Kind Of Political Risk Analysis is Essential
From 1983-2007 we lived in an Economic SuperCycle where the world’s major economy, the US, suffered just 18 months of recession in 25 years.
Now we are see the reverse of this boom as the Babyboomers move into their low-spending years and a relative shortage of Wealth Creators starts to emerge. This is leaings to a fall in spending as the above chart indicates.
Everything would be OK if mainstream politicians had risen to this challenge, but they haven’t. They have instead supported the misguided monetary policies of the central banks, which has made the problem of too much supply chasing too much demand even worse.
The end-result has been anger and resentment amongst voters at diminished economic opportunities – hence Mr Trump’s victory in the US presidential election and the rise of political populism in Europe.
Sure, Mr Trump might just, at a stretch, turn out to be a pragmatist and a businessman. At an extreme stretch, this could mean “business as usual” in the global economy in 2017. But honestly, seriously, do you want this to be your default and only scenario?
Of course not. This is far too risky. We instead need multiple scenarios that take into account all the political risks resulting from the end of the Economic Supercycle.