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Holly LaFon
Holly LaFon
Articles (9686)  | Author's Website |

First Eagle Commentary: US-China Trade Tensions Escalate

The escalation gave investors already wary of weak global economic growth momentum another reason to fret

May 15, 2019 | About:

Key Takeaways

  • Financial markets have grown increasingly volatile, as trade tensions between the US and China ratcheted higher in recent days and the timing of a resolution to the dispute remains uncertain.
  • With the global economy ever more reliant on trade, rising protectionism may weigh on economic growth and productivity for years to come.
  • Facing a number of sizable challenges in addition to its trade dispute with the US, China—and thus the world economy—is vulnerable to a misstep by policymakers in Beijing.
  • We believe volatility soon may become a more consistent feature of the financial markets than it has been for the past decade. Our flexible, patient, highly selective approach to portfolio management seeks to uncover securities that we believe will help investors endure the inevitable vicissitudes of the business cycle and geopolitical turbulence.

Views expressed are as of May 14, 2019.

The long-simmering trade dispute between the US and China has intensified in recent days. Hopes that ne-gotiators would be able to break the impasse between the two sides were dashed last week as the US followed through on its threat to hike existing tariffs on Chinese goods, prompting China days later to retaliate with a tariff package of its own. The escalation gave investors already wary of weak global economic growth momen-tum another reason to fret, driving risk assets broadly lower and volatility higher as investors took refuge in perceived safe havens like Treasuries and gold.

Impact of Tariffs Is Widespread

The face-to -face meeting of US and Chinese trade representatives last week was eagerly anticipated on hopes that an agreement could be struck to end the dispute centered on unfair Chinese trade practices. That positivity dissipated as it became evident that the two sides remained far from an agreement, and with no deal forthcoming the US on May 10 hiked the tariff rate on $200 billion worth of Chinese imports to 25% from 10%.1 Unlike the tariffs imposed on the import of intermediate Chinese goods in July 2018, the items affected by the May hike are split evenly between intermediate goods and consumer goods, increasing the likelihood that US consumers will bear some of the costs of the increase. The Trump administration also formally began the process to impose tariffs on the majority of the $300 billion of Chinese imports not already subject to lev-ies, most of which are consumer goods. In response, China on May 13 announced plans to hike tariffs on $60 billion worth of US imports to as high as 25% as of June 1, with American farmers among those likely to bear the brunt of the impact.2 Global equity markets sold off sharply on the latest escalation of trade tensions between the world’s two largest economies, while traditional safe havens like 10-year Treasuries and gold rallied.

It remains unclear how long this trade dispute will last. We believe the duration will depend in large part on the motivation of the Trump administration. To the extent that the US wants China to buy more US goods and narrow its trade surplus, to curb intel-lectual property abuses and to open up its service sector, an eventual agreement looks possible. However, a resolution would seem to be more challenging if the US goal is—as many Chinese believe—to thwart China’s economic development by curbing the role of state-owned enterprises, subsidized credit and its push to become dominant in advanced technologies.

Estimating the impact of the tariffs is difficult, as the costs will be borne by some com-bination of producers, importers and end consumers. And because many of these goods are produced by complex supply chains linked across multiple countries and companies, costs could be spread out further. Considering only these “first-order” effect of the tariffs underestimates their true economic cost, however, as “second-order” effects can be powerful and may help explain the pullback in risk appetite we’ve seen in global markets. For example, the uncertainty surrounding the recently introduced tariffs and potential for additional future duties may cause businesses worldwide to restrain investment and encourage consumers to become more cautious with their spending. More broadly, given that the US and China comprise one-third of global economic growth, a trade dispute that hurts both countries naturally will reverberate across the global economy Of course, China has not been the only target of the Trump administration’s protec-tionist bias. Last year the US imposed tariffs on all imports of washing machines, solar panels, steel and aluminum, and the administration currently is considering tariffs of up to 25% on all auto and auto parts imports, citing national security concerns.3 Were the US to follow through on this and its threat to subject another $300 billion in Chinese imports to tariffs, its applied tariff rate would be significantly higher than at any point in the past 80 years.4 Given the global economy’s significant exposure to trade—exports now account for roughly 23% of global GDP compared to a mere 7% in the 1940s5— we expect the impacts of such broad tariffs would be widespread, weighing on global economic growth and productivity for years to come. Already, trade tensions have caused a sharp contraction in world exports, as shown in Figure 2. World exports, which were growing around 10% annualized as recently as a year ago after bouncing back from the 2014–16 collapse in commodity prices, are now contracting at a rate of nearly 3%.

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About the author:

Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

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