Ostensibly, trade talks between the US and China are making progress.
Or at least that’s the message Washington and Beijing are keen to project now that 2018 provided a crash course (figuratively and literally) in how sensitive markets are to trade tensions.
Right up until Q4, the Trump administration felt like it could afford to take a hardline stance on the trade dispute. Trump’s fiscal stimulus juiced the domestic economy and shielded US stocks from the deleterious effects of the trade tensions, giving everyone a false sense of security and perpetuating the notion that the rules governing international trade and commerce could be rewritten virtually overnight with no pain for the country doing the rewriting.
Additionally, there’s a solid argument to be made that the president’s political capital depends on him having a battle to fight somewhere. The preservation of the populist “dream state” depends in part on Trump’s base remaining convinced that he’s hard at work fighting for their interests against the myriad external agents he’s successfully made scapegoats of while “explaining” the decline of the American middle class.
But the idea that the US economy and US equities would remain immune from a slowdown in global growth catalyzed at least in part by Trump’s trade war was exposed as a lie in Q4. US monetary policy played a large role in the selloff, but never forget that Jerome Powell’s “long way from neutral” misstep on October 3 came just as the US went ahead with tariffs on $200 billion in Chinese goods, a move many viewed as the first meaningful escalation in the trade war and the first sure sign that Trump was serious about going “all in”. In other words, don’t let it be lost on you that Jerome Powell wasn’t the only problem for US markets late last year (Trump’s protestations notwithstanding).
Trump’s policies have been variously characterized as an attempt to dismantle the post-War world order on a number of fronts and his populist agenda (like those in Europe on which it piggybacked) leans heavily on the notion that globalization is bad and needs to be rolled back. Everyone with any sense knows that’s the furthest thing from the truth, but it plays well with disaffected voters in Western democracies who have seen wage growth stagnate amid rising inequality. Never mind the fact that Trump’s tax cuts were explicitly designed to perpetuate the wealth divide.
Well, as the Sino-US trade discussions go down to the wire ahead of the March deadline beyond which the above-mentioned tariffs on $200 billion in Chinese goods will more than double, it’s worth highlighting a couple of passages from a new BofAML note called: “The world is still flat.”
“The two biggest themes in the global economy at the moment are arguably the global growth slowdown and the US-China trade war. At the intersection of these lies the fate of global trade”, the bank writes, in a piece dated Friday, before suggesting that while “a popular narrative is that globalization peaked” a few years back, “trade is still a critical engine of global growth, for better or worse.”
Spoiler alert: it’s for “better”, not “worse.”
Citing the dollar value of global merchandise trade, BofAML notes that the series dove in 2008 around the crisis and then, after rebounding, “stagnated” between 2011 and 2014, before falling again through 2016. That, the bank writes, “lent credence to the idea that globalization had peaked.”
Of course it recovered following the deflationary doldrums of early 2016 and has trended higher since despite Trump plunging America into protectionism and also despite the recent slowdown in global growth.
After reminding you that the measure itself is flawed because i) it’s influenced by FX fluctuations that in some cases have nothing to do with trade, and ii) it’s measured nominally and is thus influenced by inflation and especially crude, BofAML goes on to caution that “export growth in recent years has been weaker in nearly every major economy than it was in the pre-crisis years”. That said, it’s generally still higher than GDP with a couple of exceptions.
The good news, then, is that “the ratio of export growth to GDP growth remains above one in most of the economies in our sample, and thus exports are still contributing disproportionately to growth in those economies.”
A quick look at the chart betrays the “bad” news. Here’s BofAML:
The ratio of export growth to GDP growth has fallen in most economies. There have been large declines in China and countries that are linked to Chinese supply chains, including Japan, Korea and Indonesia. Therefore, there is strong evidence that much of the low-hanging fruit in terms of replacing expensive DM labor with cheaper EM labor (in manufacturing and services) has been picked.
This is perhaps not as worrying as it sounds. As the bank goes on to point out, common sense dictates that multinationals will invariably “look to eliminate the largest inefficiencies first” and so, the ratios should converge on one over time. Given that the ratios are still above one across developed markets, the implication is that, from BofAML, “multinational firms continue to find innovative ways to exploit gains from trade.” That, in turn, means trade is still critical to supporting global growth.
The critical point, though, comes next when the bank implores you to note that in the chart above, the ratio of export growth to GDP growth rose since 2011 for the eurozone, Russia and Brazil, all of which suffered recessions. Those downturns were cushioned by trade. To wit:
As Table 1 shows, external demand was a countercyclical buffer for these economies when they were in recession. Exports continued to grow at a decent pace, offsetting some of the weakness in domestic demand. Remarkably, the external sector has been the only source of growth for the Euro area economy since 2011: the growth rate of the rest of the economy has been zero. Looking further back, exports also played a countercyclical role in South Korea during the Asian crisis of 1998.
Not to put too fine a point on it, but that seems pretty relevant right now considering the likelihood that Europe succumbs to a bloc-wide recession sooner or later. Italy, you’re reminded, is already in a recession and it seems like Germany might be next.
With ECB net asset purchases having ceased starting last month and a new round of TLTROs still in limbo even as the data continues to come in soft, one can’t help but wonder what a recession across the pond would look like considering the outlook for global trade and the points made in the excerpted passages and table above.
Of course trade can’t buffer a growth slowdown if that slowdown is synchronized. As BofAML goes on to say (underscoring the other takeaway from the table), “in 2008-09, the collapse in trade amplified the global recession, similar to 2001, when goods export volumes were roughly flat even though global growth slowed only modestly and remained firmly in positive territory.” In other words, this becomes a chicken-egg problem if it goes beyond the realm of idiosyncratic, country-specific slowdowns. If trade tensions are the cause of a synchronous slowdown, obviously trade can’t buffer that slowdown.
You can be absolutely sure that Donald Trump doesn’t grasp any of the above and while Peter Navarro and Lighthizer are doubtlessly cognizant of it, they don’t seem to care a whole lot about it. Fortunately, Steve Mnuchin does and so does Larry Kudlow, even though he’s constantly torn between telling the truth and the necessity of staying in Trump’s good graces, because if Larry loses his position in the administration, what exactly does he have left? Certainly not credibility.
And on that note, we’ll leave you with one final passage from BofAML:
So the question before us is whether the weakness in global growth will be broad based or contained to a few economies that are already sputtering, such as the Euro area and Japan. The answer, we think, hinges on the US and China. And the fate of those economies, particularly China, is largely dependent on the outcome of the trade war.