This point has been emphasized over and over and over again, but it probably bears repeating in light of Thursday evening’s news that the Treasury is considering employing an extreme measure that will allow Trump to declare a national emergency by characterizing China’s IP theft as an “unusual and extraordinary threat” to national security: doing anything to undercut China’s economy right now is a very bad idea if what you care about is the outlook for global growth.
The Trump administration – and especially Peter Navarro – is playing with fire here and although most of this is pretty clearly down to political posturing ahead of the midterms (more on that in this morning’s note about stocks during midterm years), it’s entirely possible that the U.S. inadvertently pushes the world past the point of no return. Publishing a list in conjunction with the $100 billion in additional tariffs proposed earlier this month as part on an expanded response to the findings of the 301 probe would be one example of Trump perhaps taking things one step too far.
One key thing to understand here – and this is the point made above – is that China is attempting to mark a transition from a smokestack economy to a more modern, consumption-led growth model and that transition is unfolding alongside an exceedingly precarious attempt to deleverage the country’s financial system.
This is a truly daunting task and the whole enterprise amounts to Beijing attempting to keep a variety of spinning plates from crashing down with repercussions that are almost by definition unknowable ahead of time (for instance, there’s no way to know where all of the credit extended through China’s shadow banking complex ended up, so when you start trying to sort out what amounts to a giant string of tangled Christmas lights, you really have no idea what trades you might accidentally unravel).
Just about the last thing you want to do is throw a monkey wrench into that – and that’s exactly what Trump is doing.
Consider this from BofAML from a new note aptly entitled “Don’t bite the supply chain that feeds you”:
So far, China has avoided a hard landing, in part due to a heavy build-up in leverage. But this simply delayed the risk and raised the specter of an eventual credit crisis. In response, the PBoC adopted a tightening bias in 2H16, implementing policies that resulted in higher market interest rates and reduced shadow-banking activity. In recent months, however, we had become concerned that policymakers were too complacent on growth and were running the risk of over tightening. In other words, a potential credit bubble and the policy response are both important domestic risks to growth.
The trade skirmish with the US adds to the downside risks. China has been the main target of US protectionist actions and rhetoric, and has also been the most strident in its response.
Our baseline view on China remains sanguine. But what if growth slows more than we are expecting? Specifically, what are the spill-over risks to the global economy from a hard landing in China? Intuitively we would expect the spill-over to be large.
Yes, “large”. And to understand why that’s the case, you need only consult the following chart which shows you how quickly China’s importance in global trade has grown:
As BofAML goes on to remind you, those numbers “actually underestimate China’s importance because of the integrated nature of global supply chains.”
There’s a lot more in the bank’s analysis, including a test for correlation between economic conditions in DMs and China (they’re increasingly correlated), but the bottom line is that deliberately destabilizing the Chinese economy in the service of some myopic agenda aimed at shoring up the populist base ahead of the midterms in the U.S. is the economic equivalent of criminal insanity.