Under attack

The trade war is leading some firms to crimp investment

Much depends on whether hostilities between America and China intensify

“THERE’S TARIFFS on games and tariffs on toys—try explaining tariffs to your little boy. Santa’s workshop is struggling, you’ll find yourself saying. I think the reindeer are backed up with their sleighing.” Wendy Lazar, who runs a company called I Heart Guts, submitted this peeved poem to the United States Trade Representative (USTR) in June. As an importer of children’s toys from China, she was complaining about how the trade war could squeeze her firm.

She is not alone. In boardrooms across America, business people are scrambling to assess the impact of the latest escalation in the commercial confrontation between the two superpowers.

For most firms the easy bit is calculating the immediate financial impact of more tariffs on demand, prices and costs. That can be done in a spreadsheet. Far harder is working out how to rejig your strategy and long-term investment plans to adapt to a new world of enduring trade tensions. Fund managers and Wall Street traders have begun to reach their own conclusion—that investment may slump, possibly triggering a recession. Hence the violent moves in markets since the first week of August, with a rush towards safe bonds and a sell-off in equities.

That sell-off picked up pace on August 1st when President Donald Trump’s administration announced the imposition of tariffs on $300bn of Chinese goods, at a rate of 10%, starting on September 1st. On August 13th the USTR announced a delay covering about two-thirds of the goods in question, including mobile phones, smartwatches and toys, which would be subject to duties starting on December 15th.

As Mr Trump explained later that day, the move would allow American shoppers to splurge in the run-up to Christmas. The press release announcing the delay arrived at 9.43am; between 9.40 and 9.45 shares in Apple rose by 3%, and the S&P 500 share index jumped by 1%. But by the following day the stockmarket—and the iPhone-maker’s share price—slumped again as investors fretted that a global downturn might soon be on the cards.

America’s expansion may be cooling as it enters its second decade, but GDP still grew at a respectable pace of 2.1% in the second quarter of 2019, and the unemployment rate is a brag-worthy 3.7%. The direct effect of the tariffs should be small: in 2017, before hostilities began, goods trade with China amounted to just 3.2% of GDP. Even including the additional levies planned for December, they represent a tax rise offsetting only a fifth of the cuts introduced by the Tax Cuts and Jobs Act of 2017.

What really matters, though, is the wider effects of the uncertainty created by the trade war on corporate behaviour. Most companies make plans over a five- to ten-year horizon and invest in assets with a life of 10-20 years. But with each new tariff announcement, the rules for trading their products become less stable. And the scope of the trade war has expanded beyond goods to technology and currencies. Perhaps the international banking system, shipping companies or foreign joint ventures could be next. The most sophisticated firms try to gauge such risks.

The high level of uncertainty is measurable. A study from 2016 by Scott Baker of Northwestern University, Nick Bloom of Stanford University and Steven Davis of the University of Chicago quantified policy uncertainty in America using newspaper reports. Their index of trade-policy uncertainty has soared in recent months (see chart).

And such increases in uncertainty tend to have real effects. The researchers found that increases in their index were associated with dampened investment and slower hiring. More recently, Ryan Sweet of Moody’s Analytics, a financial firm, finds that changes in business confidence and economic-policy uncertainty appear to predict changes in managers’ capital spending.

Given all this, how is investment in America holding up? In the second quarter non-residential business investment shrank at an annualised rate of 0.6%. The question is to what extent the trade war is the culprit, rather than industry-specific factors, domestic economic trends or the global manufacturing cycle. To get a sense of this The Economist has analysed around 2,400 listed American companies in 42 sectors, taking into account both their investment levels and how dependent their sector is on Chinese inputs.

Firms with a higher degree of Sino-reliance do seem to have scaled back investment. The 20 sectors most exposed to inputs from China accounted for a third of total investment by the 2,400 firms. In total these sectors saw aggregate capital spending drop by 1% in the past four quarters compared with the prior year. Meanwhile the other 22 sectors, which are less exposed to China, saw investment rise by 14%. The analysis is simple: other factors may well have played a role.

But business executives too report an effect on investment. A survey compiled by the Federal Reserve Bank of Atlanta in January found that trade tensions had crimped investment by 1.2%. Tariffs were mentioned in a quarter of all earnings calls among companies in the S&P 500 index in the second quarter of 2019, according to figures from FactSet, a data-analytics firm.

One of the sectors most exposed to China is chemicals. In July Jim Fitterling, chief executive of Dow, a big producer, told investors on an earnings call that he would keep capital spending “tight” until he got “better visibility”, adding that he thought a trade deal was needed to “get some confidence back in this market”.

Wall Street economists are also crunching data on how trade-policy uncertainty is altering companies’ behaviour. In June researchers at Goldman Sachs had been sceptical that the trade war was hampering investment, pointing out that overall policy uncertainty was low. But more recently they have altered their view, finding that, after adjusting for underlying trends, sectors that sell more to China (rather than those that buy from it) were seeing slower investment growth than those that were less exposed.

Goldman’s economists also found that tariff announcements were associated with worsening financial conditions (higher borrowing costs, lower equity prices or a stronger dollar).

Expectations of interest-rate cuts by the Federal Reserve have only offset half of the shift in financial conditions. Overall the analysts reckon that, including indirect effects, the hit to GDP would be 0.6%—material, but not enough to tip America into recession.

The overall picture, therefore, is that there is now good evidence that the trade war is leading some firms to crimp investment. Pessimists worry that the knock-on effect from this capital-spending stumble could be far-reaching and more painful than the likes of Goldman expect. In the long run it could sap productivity. In the short run it could cause firms to scale back hiring.

That could then damage consumers’ confidence.

Much depends on whether hostilities between America and China intensify. On August 13th Mr Trump said that he had a “very, very productive call” with China’s leaders. But few on the ground take seriously the prospect of a lasting reconciliation. Jake Parker of the US-China Business Council, a lobby group, reports that his members have realised that the threat of future levies would still lurk even if a deal were struck and tariffs lifted. Blows to China’s economy could also spill back to America.

And Mr Trump has plenty more ways of injecting fear into the economy. He must decide whether to reinstate onerous restrictions on American companies that do business with Huawei, a Chinese telecommunications giant, by August 19th. His labelling of China as a currency manipulator could ignite a currency war.

If the sickness that is now visible in most trade-exposed sectors spills over to the rest of the economy, that would set off a downward spiral that not even lifting tariffs, and allowing in Ms Lazar’s stuffed toys, would reverse.

This is a currency war Donald Trump was never going to win

The US cannot unilaterally weaken the dollar

Megan Greene

© Getty Images/iStockphoto

President Donald Trump’s tweeted demands for a weaker dollar, and his subsequent designation of China as a “currency manipulator”, have sparked fears that his trade battles are morphing into a currency war. The last time we had a global competitive devaluation was in the 1930s, as the world descended into the Depression. But today, currency values are set in huge global markets rather than against gold. That leaves the US alone on the battlefield, armed with only the equivalent of a pea shooter.

Naming China as a currency manipulator is a dead end. Under US law, the next step is for the Treasury department to consult with the IMF, which just gave China’s currency practices a clean bill of health. Even if Steven Mnuchin, US Treasury secretary, were somehow able to prove that China is manipulating its currency, the punishment is “expedited negotiations”, hardly the big stick the president is looking to wield. The US could create sanctions in the form of tariffs, but threatening to do what you’re already doing is limited in its power of persuasion.

Mr Trump has also put Japan, Germany and Italy on the manipulation watchlist. Yet as a haven currency, the yen is strengthening because of the trade war, not depreciating. And Germany and Italy do not have their own currencies to manipulate. The dollar is near an all-time high because the US is growing faster than any other developed economy. Theory suggests cutting interest rates will lower the value of a currency, but since the Federal Reserve reduced its benchmark rate on July 31 the dollar has only strengthened.

A president concerned about a “big currency manipulation game” could engage in direct currency intervention. The Treasury secretary can deploy the exchange stabilisation fund, or ESF — which holds roughly $95bn — to sell dollars and buy foreign-denominated assets. But that is peanuts compared with the more than $5tn traded on average each day in global foreign exchange markets. The previous three times the US has intervened to affect the dollar’s value, it was joined by G7 allies. This time, it would act alone. Unconvinced that the US government has the firepower to weaken the dollar, markets would bet against the intervention and force the government to burn through all its available funds.

In prior interventions, the Fed has matched the Treasury’s contribution, providing a little more ammunition. This time the central bank’s participation is not a foregone conclusion, given the Fed’s concerns about its independence and the impact of a currency war on global financial stability. Even if it did match the ESF, the total amount of funds available would be only about $190bn.

The Fed would be likely to sterilise the intervention, selling Treasury notes to absorb the additional dollars in the market in order to head off the inflationary threat from increasing the money supply. This means short-term interest rates stay the same, so there is little reason to expect exchange rates to move. Some economists argue that intervening to weaken a currency sends a strong signal that monetary policy will ease. But, as the Fed has signalled easing, so too have other central banks.

Intervention against the onshore renminbi is even more problematic. The Chinese government controls that market, and the US cannot buy a currency that is not for sale. The US could intervene in the offshore renminbi market (based primarily in Hong Kong), but it is not very deep or liquid. Offshore renminbi pressures are sometimes transmitted to the onshore currency by companies that have access to both markets, but the Chinese central bank can sustain a wedge between the value of the two.

The US could buy euros and yen and hope other currencies strengthen via knock-on effects. But with growth flagging in both Japan and the eurozone, any US currency intervention is likely to lead to retaliation.

The global competitive depreciation of the 1930s eventually sparked monetary easing that arguably boosted demand and helped many economies grow their way out of the Depression. Now, rates are already low and there are few signs that the cost of borrowing is a constraint on economic activity.

The US cannot unilaterally weaken the dollar. By trying, it could spark a global recession, raise political tensions and upend financial markets as countries try to depreciate their currencies against everyone else’s. Showing up alone on the battlefield with the equivalent of a pea shooter is bad enough. Creating a circular firing squad in the process is even worse.

The writer is a senior fellow at Harvard Kennedy School

As Global Order Crumbles, Risks of Recession Grow

Investors and business cope with new normal of resurgent nationalism, retreating globalization

By Greg Ip

Italy’s Matteo Salvini, leader of the anti-EU, anti-immigrant League party, is seeking to bring down his own coalition. Photo: luca zennaro/epa/Shutterstock

When assumptions about how the world works are shattered, a global downturn is often the result.

The world learned in the early 1970s that the era of cheap oil was over, in the early 1980s that countries could default, and a decade ago that American mortgages and global banks aren’t safe.

Today, a similar rethink of globalization is under way. From Washington to Buenos Aires, nations’ mutually reinforcing commitment to open markets is disintegrating. In response, investors are rearranging portfolios, businesses are rethinking investments and policy makers are struggling to respond—all of which are pushing the global economy closer to recession.
Investors believe central banks—the last bastion of the technocratic, globalized elite—can use their limited ammunition to stave off recession. Yet central banks may be dragged into the competitive fray.

Nationalism and populism hit the headlines in 2016 when Britons voted to leave the European Union andDonald Trumpwas elected U.S. president. This was, initially, seen as a backlash against technocratic elites’ indifference to cultural and economic anxiety brought on by globalization, free trade and uncontrolled immigration.

In the past month it has become clear that nationalists aren’t simply correcting globalists’ excesses; they aim to supplant them altogether. After two years of fruitless efforts to negotiate an exit from the EU with most commercial relations intact, Britain now has a prime minister,Boris Johnson,prepared to make a clean break by Oct. 31 no matter the economic cost.

Mr. Trump’s early protectionist strikes at traditional allies were contained by countervailing forces at home and abroad. But the collapse of trade talks with China foreshadows a more fundamental unraveling of rules of economic engagement between the world’s economies. Having abandoned for now efforts to write a new rulebook, the U.S. and China have resorted to ad hoc, brute-force tariffs, devaluation and retaliation, which Tuesday’s surprise tariff reprieve simply underscored.

Elsewhere, Italy’s deputy prime minister, Matteo Salvini, leader of the anti-EU, anti-immigrant League party, is seeking to bring down his own coalition in hopes new elections will put him in control of the government. A trade war is brewing between American allies South Korea and Japan over ancient, unhealed wounds. Argentina’s peso and stock market crashed this week when Peronists, whose history of populism and protectionism saddled the country with its current woes, became the favorite to form its next government.

For the past two years, the U.S. and world economies shrugged off nationalism and populism. Protectionism was contained and more than offset by positives such as Mr. Trump’s tax cut and deregulatory drive. It can no longer be ignored: Businesses and investors, unsure of what if any rules will govern international commerce, are retreating from risky investments.

In Britain, Brexit uncertainty has brought business investment to a halt, contributing to—likely temporary—second-quarter economic contraction. Germany, perhaps the most trade-sensitive of the major economies, may be in recession: Its economy contracted in the second quarter, according to figures released Wednesday. Both the U.S. and China have seen exports drop and growth slow. American manufacturing has been hit by the slump in exports and investment.

The stock market’s wobbles have been amplified by companies most exposed to the world economy, according toParag Thatteof Deutsche Bank .The 100 most globally exposed blue-chip companies’ profits are down 3% in the past year, while profits of the most U.S.-focused are up 5.5%, he estimates.

Globalization has suffered temporary setbacks in past decades. This time feels different. The U.S., which led in creating global institutions such as the World Trade Organization, now leads in crippling them. In the latest issue of Foreign Affairs, trade economists Chad Bownand Douglas Irwin note that Mr. Trump’s use of national security to justify tariffs and quotas on steel, aluminum and auto imports broke with 75 years of U.S. practice: “The Trump administration recently stood alongside Russia to argue that merely invoking national security is enough to defeat any WTO challenge to a trade barrier.”

The U.S. has in the past used its economic, military and moral weight to promote economic integration among and tamp down tension between allies. “We would have put our arms around the shoulders of the conflicting parties and said, now come on guys, let’s talk this through,” saysDan Price,who served as an economic diplomat in the Reagan administration and both Bush administrations.

Mr. Trump by contrast has cheered Britain’s split from the EU and done little to contain the flare-up between Japan and South Korea. Says Mr. Price, “Once people think there is no one looking after the collective interest, that there is no moderating force in the room, once you have the U.S. by its example legitimizing unilateralism, it removes the inhibitions from others.” 
This hasn’t become a crisis or recession because the leverage and financial interconnections that propagate panic across borders are largely absent while healthy labor markets have buoyed consumers. Unlike in the 1970s and 1980s, interest rates are low, even negative.

But disruptive unilateralism could eventually extend to currencies and monetary policy.

China let the yuan drop after Mr. Trump ratcheted up tariffs. Though justifiable based on economics, investors saw it as a sign that China wasn’t seeking a truce in the trade war, saysBarry Eichengreen,an economic historian at the University of California, Berkeley.

“Trump doesn’t like it when the currencies of countries like China, Korea and Vietnam decline against the dollar. So he is likely to threaten additional tariffs.” And to the extent that trade policy is the primary burden on global confidence now, central banks “can do little more than begin to stanch the bleeding.”

Trump’s One-Way Economy

If these were normal times, recent global developments would be showing up as sharply rising risk premia. But with monetary policymakers trying to sustain the current growth cycle in the face of disruptions from an incompetent US administration, these are anything but normal times.

Jim O'Neill


LONDON – Nowadays, when people ask me how I am, I answer, jokingly, that I’m doing great, so long as I ignore Donald Trump’s presidency in the United States, Brexit, the crisis of the United Kingdom’s major political parties, and the performance of Manchester United.

But recently, the litany of unfortunate circumstances has gotten so long that the joke is hard to pull off. One now must also list the political crisis in Hong Kong, a burgeoning diplomatic and economic dispute between Japan and South Korea, the Indian government’s revocation of Jammu and Kashmir’s autonomy – and India-Pakistan tensions more generally – and growing turmoil within South Africa’s ruling African National Congress.

Making matters worse, this has been a particularly rough summer in terms of the weather: heat waves across Europe and the US have served as a forceful reminder of the growing effects of climate change on our everyday lives. Add to all this other persistent sources of global uncertainty – from the Middle East and Russia under President Vladimir Putin to social-media disruptions and antimicrobial resistance – and you have a recipe for despair.

If these were normal times, recent global developments would be showing up as sharply rising risk premia, especially given that global growth has slowed substantially over the course of 2019. But these are not normal times, owing primarily to the current state of monetary policymaking. Here, one must wonder if Trump has been escalating his threats of additional tariffs against China as a way to pressure the US Federal Reserve to reduce interest rates. After all, his recent Twitter tantrum on this issue came shortly after the Fed’s decision to cut its policy rate by 25 basis points. In Trump’s view – and in the view of the markets – that cut apparently wasn’t large enough.

I sometimes wonder if Trump isn’t like a James Bond villain, pursuing a secret, unnecessarily convoluted master plan for world domination. There certainly isn’t any evident logic behind most of what he does. To be sure, when it comes to foreign policy, his populist posturing may be intended to goad other leaders around the world into similar behavior. Indian Prime Minister Narendra Modi’s moves in Kashmir, as well as the Japanese and South Korean governments’ tactics toward each other, seem to come straight from the Trump playbook. Politicians around the world are no doubt telling themselves that if such behavior is acceptable for the US leader, it is appropriate for them, too.

The political logic of Trump’s domestic strategy, however, is harder to explain. Much of it is about shoring up his voter base for the 2020 presidential election. But to win a second term, he will need to peel off more voters at the margins, and it is not clear that his current approach to domestic policy will win over those who do not already support him.

As always with an incumbent, much will depend on the economy. Though the US unemployment rate remains very low, the growth cycle has slowed and is now increasingly vulnerable. Worse, the US economy seems to have developed a one-way relationship with broader financial conditions, by which I mean short-term interest rates, bond yields, stock prices, the value of the dollar, and home prices. The US economy would suffer if these financial conditions grew tighter, but it would barely benefit if they were to loosen.

It is not clear that Trump and his advisers follow these financial conditions particularly closely. They seem desperate for a dramatic easing, yet Trump’s threat of additional tariffs on Chinese imports has rattled global markets – including the shares of many US multinationals – and led to tighter financial conditions in the US, owing to the rising value of the dollar. To offset that effect, both short- and long-term US interest rates would need to fall significantly. And, to be sure, there are some days when financial conditions do loosen, because the prospect of new tariffs, and thus higher consumer prices, leads investors to pour into bonds, thereby offsetting the tightening effects of a rising dollar and weak equities.

Looking beyond the daily movement of the markets, it is possible that Trump is counting on the Fed to become a hostage of financial conditions, especially if bond yields drop and the yield curve inverts. That could prompt it to pursue larger rate cuts than previously indicated. But further monetary easing would do very little to mitigate the risks to the economy, because these risks are not emanating from monetary-sensitive sources.

Moreover, Trump’s unpredictability has heightened risks for exporters and anyone else responsible for making long-term investment decisions. The only way for monetary-policy loosening to work, then, is if consumers take on a larger role in driving growth. And yet consumption already accounts for 70% of US GDP, and the trade war is driving up consumer prices, potentially setting the stage for rising unemployment.

This brings me to a point I have made many times before: global economic growth in this decade and the next is going to depend on Chinese, not American, consumers. At some point, the US, whether under Trump or someone else, must accept this fact and recognize it as an opportunity. The rise of the Chinese consumer could help to address many of America’s own economic problems, if only America would stop standing in the way.

Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK Treasury Minister, is Chair of Chatham House.