Donald Trump does not understand the implications of his dangerous game of brinkmanship and the precarious state of the US economy. Let me explain.
On the back of a strong employment report in April, with non-farm jobs rising by 263,000 and unemployment rate falling to 3.6%, and stronger-than-expected first-quarter GDP growth advance report at 3.2%, he somehow believes that the economy is so strong that it would withstand the fallout from a trade war. But he is wrong.
First of all, the manufacturing PMI report is forward-looking, and the April number is pointing otherwise. The headline index fell from 55.3 in March to 52.8 in April. The new orders index fell sharply from 57.4 to 51.7, and even the Production Index fell by 3.5 percentage points to 52.3. Although all numbers are still above 50, the decline hints at falling strength.
The PMI report corroborates my reading that the first-quarter GDP growth is not as strong as it appears. The Advance Report on the GDP says:
"The acceleration in real GDP growth in the first quarter reflected an upturn in state and local government spending, accelerations in private inventory investment and in exports, and a smaller decrease in residential investment."
This clearly offers a warning signal. There is virtually no strength in the domestic private sector economy. In fact, Fixed Investment fell from 3.1% in the previous quarter to 1.5%. Investment in machinery and equipment fell from 6.6% to 0.2%. Personal Consumption Expenditures fell from 2.5% to 1.2%. With all this weakness, it is not surprising that imports fell 3.7%, and since imports are subtracted from exports to arrive at the contribution of international trade to GDP, this adds to the first-quarter "strength." Thus, the strength in the first-quarter GDP is buoyed by nothing but exports and acceleration in private inventory investment.
Note that private inventory investment increases when goods sell less well than expected. Unintended inventory accumulation means the second-quarter GDP is going to decelerate. The economic strength of the economy is now crucially dependent on international trade. But Trump is hitting international trade. So from where is growth going to come from? It is also important to note that residential construction in the first quarter is now into the fifth quarter of negative growth, something not seen in years.
What is even more worrying is the growth of government budget deficit. In the first seven months of fiscal year, federal government budget deficit grew 39 percent, and one projection of this year's deficit is that it will rise to 4.6% of GDP. This is certainly unsustainable. The increase in debt as a result of this will raise annual government spending on interest payments, and will further drive deficits up, closing the loop to the vicious circle now at a formative stage. Should the economy turn south, the deficit-to-GDP ratio will shoot through the roof.
There will come a point when the government has to raise taxes or cut spending. That will further sap the strength of the economy and may lead to recession. If the government does not check the rise of the deficit, the economic expansion may continue a bit longer, but confidence will wane and a financial crisis will break out leading to recession.
China is a huge market, and US cannot afford to lose the Chinese market. American businesses are already suffering as Chinese consumers are shunning American goods even without additional tariffs from China. The collapse in iPhone sales in China is a case in point. In today's competitive world, it will be very difficult for American companies to regain market shares if they are lost.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.