The US-China trade deal: too good to be true?
Sebastién Galy, Sr. Macro Strategist at Nordea Asset Management
The trade deal between China and the United States should be concluded in June and rightfully celebrated, yet it is unlikely to last as the objectives of the two countries are too divergent. Any deal will be more of a pit stop in a repeating process that will most likely last for two decades as China’s population peaks in 2025 and China’s economy becomes more vulnerable with lower potential growth.
Impact: While the China/US trade deal will be celebrated ahead of its signing, the odds are that some doubts about it falling apart in a year or two should then eventually emerge. Such risks continue to suggest holding defensive/value stocks as a hedge within a wider equity, absolute return and flexible fixed income portfolio.
- Strategic competitors: US and China
While the US and China head towards a trade deal, it is unlikely to last for long as neither party agrees on their place within the global architecture. Both see themselves as dominant with China seeming to replicate its 16th century mercantile model. China has a limited window to ramp-up and maintain a sustainable position as its population ages and it approaches the status of a slower growing advanced economy. Globally, China has a secondary Russian partner and an array of allies within emerging markets including via its belt road project. As happened during the cold war, dominated economies will play both sides for the maximum advantage. In some cases, courtesy of defaults, China has acquired strategic assets abroad. From a military point of view, each will strive to maintain a first strike advantage for a nuclear conflict or a conventional one (e.g. the feared dark horse of Huawei), yet any conflict would be very limited in scope and time given the severe feedback loop (sanctions) and limited fiscal and currency space (e.g. Crimea). That leaves most of the conflict and cooperation to be decided by a series of temporary accords. For example, the US apparently agreed that China would ramp up some imports into 2025. The Europeans are following up with their own effort. Economic imperative should generally outweigh other motives.
- When do blocks cooperate?
Major countries tend to cooperate when the alternative is far worse, when their business cycles are intertwined and when they want to create a super-group (e.g. the European Union). They cooperate because they assume that others will continue to do so over time as the gains far outweigh other strategies. If the gains are seen as a temporary reset, the odds of deviating are very strong, which is partly the case for China.
China is building its domestic economy with its own search engines and tech giants much as Japan and South Korea did before it. The difference is that it has the scale of a market to be able to get away with it. The Europeans did the same before by subsidizing the emergence of Airbus (and others). It is unlikely that China will veer for long from a policy of national champions.
China has a key vulnerability relative to the United States amid a large and growing trade imbalance. Negotiations should shrink China’s large trade surplus. In theory, the larger the surplus the stronger the currency, so this would suggest a shrinking of the CNY against the USD, which is free floating. Gains of exchange suggest that the trade balance will stay somewhat one sided. The conclusion is we are faced with a much lighter version of the cold war in which gains of exchange and the search for power are intertwined
- What pulls blocks apart?
Geopolitical blocks are pulled apart by either internal or external dysfunctionality. Excessive competitive pressure can lead down the road to a severe backlash against trade. Some Emerging Market economies have been known to lose focus of inflation when facing a large slowdown. Competition for a common scarce resource, such as energy, can also have deleterious impacts as can new technologies (e.g. fracking).
In conclusion, the US and China are likely to go through a series of agreements and necessity will tend to pull back partners to the table particularly as potential growth weakens more in China.