What The Market Wants To Know: Will There Be A Quick Tariff Settlement With China?
- Equity markets are hanging on every shred of evidence as to whether there really will be a trade war between the U.S. and China.
- The market doesn't care what the settlement is, just whether a trade war will be avoided.
- At least until the outcome becomes clearer, I will continue to be cautious about my equity allocation.
The biggest question facing the equity markets over the next few months is whether President Trump is going to settle the trade spat with China quickly and declare victory - or not. By agreeing to a few win-win changes, my guess is that China would be willing to help create the window dressing to allow Trump to say he won, so long as it is not a real victory for Trump. I do not think China will give Trump an actual victory on trade.
Trump wants a quick victory, but China plays the long game. That contrast is common knowledge. “Trump’s protectionist policies,” said one former Chinese trade official, “will be a short wave in the long history of world trade.” See the quote in the FT here.
What does that mean in practice?
What should our expectations be?
My guess is that Trump does not expect the tariffs ever to actually become damaging. He expects a deal before that time. And one may come. (Holman Jenkins, Jr. of the WSJ, for example, seems to think a productive deal could be struck. His interesting opinion piece called “Trump’s Trade Tactic Might Work” is here.) But I do wonder whether President Trump may have picked the wrong adversary in President Xi Jinping. President Xi is a proud man who leads a proud China. I think he will not be afraid to stand up to Trump and the U.S. on trade. He is likely to say (1) that his policies are now aimed in the direction of developing China’s internal markets, (2) that sanctions against Russia (similar in many ways to tariffs) have caused Russia to develop its internal markets earlier and more vigorously than it might have done otherwise, which might not be a bad thing for China to do as well, and (3) that he has good trade relations with Europe, Russia, and the rest of Asia, so some loss of American business may not be a big event for China. Probably, Xi will not say (but he will know) that the pending tariffs are likely to injure some of Trump’s key supporters - they were designed to that.
Lawrence Kudlow, the new White House economic adviser, has said the Administration will seek to put together a “coalition of the willing” to join the U.S. in imposing tariffs on Chinese goods. See Bloomberg.com article here. My guess is that few, if any, major powers will be “willing”. It simply is not in their best interests to do so, and widening the potential trade war is not the style of major players such as Merkel, Macron, and Trudeau, whose nations also may have much to gain by remaining on the sidelines. Britain is a wild card, but it has enough on its plate trying to create new trade relationships with the EU, so I guess it will not be “willing”, either. Putin is licking his chops thinking about increased Russia-China trade.
“The King and I” writ large
It all rather reminds me of “The King and I”, where the king concluded that:
“Is a danger to be trusting one another.
One will seldom want to do what other wishes.
But unless some day somebody trust somebody,
There’ll be nothing left on earth excepting fishes.”
Thank you, Oscar Hammerstein II.
Trump and Xi need each other on Korea. There can be no progress there without the U.S. and China agreeing. As Trump’s threats to use NAFTA to punish Mexico for not building a wall illustrate, nation-to-nation relations tend not to remain compartmentalized. Therefore, continuing trade friction between the U.S. and China is likely to impede progress on Korea. (BTW, to those who think I am just anti-anything-Trump-does, please note that I think he is correct, for example, to agree to meet with North Korean President Kim - and to say that it may be a short meeting. Traditional diplomacy has not succeeded. Maybe a more direct approach, backed by severe sanctions, will succeed. But if not, then nothing is lost by trying.)
Because a Trump victory on trade is something up with which I think Xi will not put, I anticipate that if there is a U.S.-China trade deal, it will be one in which Trump claims victory, but it will be a small win-win. But until such a deal is a reality, the market is likely to remain uncertain, and uncertainty over a period of months is likely to erode confidence and therefore is likely to cause a negative direction overall.
Where NAFTA might fit in
The NAFTA negotiations also are coming to a head. How the two sets of negotiations will interact seems hard to say, except that the NAFTA negotiations look like they are at a much more advanced stage, and therefore, their resolution may precede resolution with China. Progress on NAFTA might calm the market’s fears somewhat, but the downside on NAFTA is far worse in the presence of the ongoing U.S.-China spat.
There are numerous other trades negotiations in various stages. They all will interact with each other somehow. But their interaction seems too difficult to predict.
Whither the market?
On March 23, I published an article suggesting that it was a good time to pare back one’s exposure to stocks because the market was likely to react badly to President Trump’s increasing paranoia, which I saw as being foreshadowed by the nature of his most recent appointees and by his involvement in the Stormy Daniels lawsuit and continuing reactions to the Mueller investigations. I was not predicting immediate stock market carnage. I was only suggesting that the time for caution - by trimming one’s equity allocation - had arrived.
Since that date, the S&P 500 basically is flat, and the NASDAQ is off between 3 and 4 percent - basically not much has happened. The market has yeed and yawed to the tune of reactions to the incipient trade war, but it has remained within a fairly narrow range. As former Treasury Secretary Lawrence Summers observed in a recent FT opinion piece,
“In recent weeks, every time the US has pushed its strategy markets have had mini-collapses, and every time it has appeared to pull back markets have rallied.”
The market’s movements probably will continue to depend more on political factors than on economic news for some time because the economy has a good head of steam and should receive stimulus from reduced taxes and deficit spending, but it appears that most market watchers and pundits currently are concerned more about political factors, mostly in foreign affairs that, combined with the Fed’s tightening, may bring on the next economic downturn. Some market analysts also are concerned about the longer-term negative effects of a growing federal deficit.
Based on this reasoning, I conclude that the biggest question the market will be looking at over the next few months is whether President Trump is going to be willing to settle for a small win-win trade agreement with China. When the market thinks he will not do that, then I think we are in for a very rough ride. When his tweets lead the market to believe he will do that, it will tend to rally. If you, as an investor, think you know the outcome, then maybe you know which way the market will move over the medium term. For my part, I am going to continue to be cautious.
One also should note that the market does not care about the substance of a settlement. The points at issue are not that important.
The other side of the argument
I do recognize that Trump’s supporters believe he is right to threaten a trade war with China. They see it as a trade war that has to be fought - and fought now - because the U.S. now is strong, but if China continues to amass intellectual property capital, then it may surge ahead in that critical area. Some degree of pain now, that argument goes, is worth a longer-term victory. That reasoning seems unrealistic to me.
China’s leaders have been pursuing a policy of learning to compete at the highest levels of business for a couple of decades. They have pursued this policy not only through trade policies but also through forward-looking education policies that now have amassed a large cadre of engineers and mathematicians, many of them trained in the West and most of whom speak English. (Last year, for example, according to the Chinese government, 650,000 Chinese students were studying at foreign universities, most of them in the West. See here.) Long-term technological competitiveness lies in skills. Therefore, it is late in the day to try to contain China’s global competitiveness in technology. What America must do is to continue to develop our own intellectual capital, including through immigration. Immigration from both Europe and Asia has helped to develop America’s scientific capabilities since WWII, from Werner von Braun to Satya Nadella.
That is not to say that the U.S. would not benefit from better enforcement of intellectual property laws in accordance with WTO rules. But a trade war to try to accomplish that seems like an elephant gun aimed at a gnat, especially since the remaining deficiencies in intellectual property laws have so little to do with the balance of trade. (See the Lawrence Summers article cited above for some of the reasons why that is so.)
The Manichaean view of the world, as a struggle between good and evil (ironically, originally an Iranian concept) can have advantages from time to time, but for the long run, it fails. Most of the world - and most people - are neither friend nor foe, neither good nor evil. If we deal with each other with that lack of expectations, there is room for agreement regardless of whether we think we like each other. How does President Trump fit with the Manichaean concept? On the one hand, he wades into affairs as if they all were contests between good and evil. On the other hand, he declares that almost everyone is a friend (Xi, Putin even) or that he has or will have a great relationship with a person (for example, North Korean leader Kim). It is not a simple picture. Pretending to be everyone's friend is not a bad negotiating posture. Let someone else be the bad guy. We will see how the combination works.
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