Last May, I wrote an article about the U.S. vs. China trade dispute called “Game of Trade.” Over the previous five months, a series of significant developments requires us to take a fresh look. No other issue nowadays seems to have more impact over financial markets participants mindsets; any rumor about it may cause panic or euphoria instantly.
The U.S. Federal Reserve bank and other global central banks (i.e., Europe) have just recently acknowledged the issue in the last two speeches where they have cut interest rates. The U.S. vs. China trade dispute is one of the main risks considered in any of the central bank's economic forecasts.
In my last article, I defined four strategic scenarios based on the time used to reach an agreement between the countries, and the intensity of their actions. I suggested this trade dispute will cause more hardship to China in the short term, but it will have a material impact on the U.S. that may increase over time.
Today we are experiencing the “Quick and Harsh” scenario described in the upper left corner where the U.S. is effectively using all available tools to handicap China economy by suppressing all trade of goods, technology exports or imports to China, and potentially any capital flows from the U.S. to China.
Below just a few of these U.S. actions:
· Tariffs on a broad set Chinese goods imports
· U.S. export ban of critical technology components to Chinese companies (i.e., microchips for communications equipment)
· A ban on Chinese telecommunication equipment imports (i.e., 5G technology)
· A demand to U.S. allies to ban the use of Chinese telecommunication equipment if they wish to interconnect to U.S. telecommunication networks
· An informal request from the U.S. president to U.S. companies to avoid investing in China and move out their investments from China
· A new threat to prohibit U.S. pension funds from investing in Chinese stocks, a ban on U.S. financial funds (mutual & ETF) to invest in Chinese assets, and potentially delist Chinese shares from American stock exchanges
The main objective of these U.S. actions is to force China to agree over an ample set of economic and public policies as soon as possible or continue to face harsh consequences.
China economy has been slowing down before the trade dispute due to internally causes: an excess of government and corporate debt, a series of unproductive state companies, and an industrial overcapacity.
China is also facing significant challenges to change its economy from an externally focus and exporter oriented economy to an internal focus and services-oriented economy. Within this context, U.S. actions have contributed to reducing China economic growth faster than expected and caused and interest in China to seek an end to the conflict.
China has implemented also trade tariffs for U.S. imports on politically sensitive areas (agriculture and energy), but the uneven trade flows in favor of China limited its impact on U.S. exports. China has followed a different approach seeking to delay trade discussions, mitigated the effects of U.S. actions to its economy and diversifying its U.S. exports to other countries.
All of the Chinese actions are aiming to drag the situation to the “Slow and Painful” scenario described in the lower right corner of the chart. Time is their best ally. If the economic dispute extends for a long time, there will be global economic consequences that the U.S. will bear as well.
As collateral damage, other Asian and a few European countries are already feeling the economic consequences due to the global reduction on global trade, a commodity bear market, and unstable financial markets.
Sooner than later if there is no reasonable agreement or truce between the parties, the financial transfer mechanisms of currencies markets depreciation, decreasing multinationals corporate profits, and financial market instability may create lasting adverse economic effects to every global economy.
The great news is that global central banks are well aware of the situation, and they have started to take prompt action to counter the downside scenarios cutting interest rates, flushing markets with liquidity and promising to do whatever is necessary to keep the economic growth.
If there is will to act these political issues might quickly be addressed, just recently the U.S. and China took several actions to create goodwill on each side. These actions may set the right conditions for a reasonable understanding.
In October both countries high-rank trade delegations will start trade talks again, let us hope that a mutually beneficial interest prevails over their differences and that they will achieve a balanced and acceptable deal.
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