US President Donald Trump's unorthodox trade views will drive trade tensions at least through to the remainder of his term, posing considerable risks to the global trade framework.
Negative knock-on effects for the US economy and for financial markets - which President Trump includes as measures of his success in office - will ultimately help push the US towards conciliation with its key trade partners.
The coming quarters will be marked by an ongoing cycle of escalation, de-escalation and re-escalation in trade tensions as the Trump administration manages trade spats on multiple fronts.
Trade deficits are inherently bad and the result of poor US trade policy. This will lead the US to pursue concessions from and potentially raise trade barriers on traditional partners (e.g. the EU, Mexico, Canada) alongside adversaries (China).
Protectionism benefits US industry. This could result in trade barriers enduring for a prolonged period of time, especially as the Trump team has not laid out explicit goals or terms that would be sufficient for them to pull back on tariffs.
The US should use its economic power to barter better trade deals, leading the Trump administration to favour bilateral deals over multilateral ones.
The current rules-based international trading system disadvantages the US.
This backdrop underpins our view that a cycle of escalation, de-escalation and re-escalation of trade tensions - particularly between the US and China - is the most likely scenario over the coming quarters. We believe that negative effects on the real economy and financial markets, which Trump includes as measures to gauge of his presidential success, will ultimately limit the degree of escalation in trade tensions. However, the guiding principles of Trump's team, as stated above, suggest that trade protectionism will be an enduring thread running through the administration's term in office.
China remains the primary target, in line with our long-held view ( see 'Trump Presidency: Three Scenarios For China', January 6 2017 and 'Protectionism Update: Calm Before The Storm?', October 27 2017). This is most strongly illustrated by the US's pursuit of an escalating number of tariffs on Chinese goods imports for alleged violation of US intellectual property rights, and justified through reference to the rarely-used section 301 of the 1974 Trade Act. Tariffs of 25% were imposed on USD34bn of Chinese goods on July 6, with another USD16bn currently undergoing public comment and hearing period. On July 10, the US introduced another list of Chinese goods to the value of USD200bn that may be the subject of a 10% tariff, and President Trump has since threatened to impose tariffs on all Chinese imports, totaling USD505bn.
These actions mark a sharp shift from the policies pursued under previous administrations, which aimed to expand trade cooperation and new free trade agreements - particularly the Trans-Pacific Partnership - in part as a means to pressure China into correcting perceived trade malpractices and adhering to World Trade Organization (WTO) rules.
Traditional US allies will not be spared amid a focus on reducing the goods trade deficit. The EU, Mexico and Canada, among other allies, face higher tariffs on their exports to the US, as their bilateral trade surpluses are seen as part of the problem by the US administration. In addition, Trump appears to view these relationships as more transactional than other presidents. While the US has yet to individually target these countries in the same way that it has with China, it has not excluded them from blanket tariffs on steel and aluminium either ( see 'Quick View: US Tariffs To Fuel Further Market Volatility Ahead', June 1). Additionally, in pursuit of ways of boosting domestic manufacturing, the US is now rethinking its support for investment protections like dispute settlement mechanisms in free trade agreements (FTAs). Such protections are included as part of ongoing renegotiations of the North American Free Trade Agreement (NAFTA) with Canada and Mexico.
Recent negotiations between the US and EU appear to have de-escalated trade tensions between the two parties, with the US agreeing to suspend a proposal to introduce 25% tariffs on US autos imports from the bloc. Trump and European Commission President Jean-Claude Juncker also agreed to work towards zero tariffs and zero non-tariff barriers on non-auto industrial goods, as well as increasing trade in other areas including soybeans and liquefied natural gas as well as looking to 'resolve' the current steel and aluminium tariffs imposed by the US in May. This is also a further indication that the US is pursuing a strategy of bilateral trade negotiations rather than multilateral negotiations. While the July 25 agreement marks a reprieve in the trade spat between the world's two largest economies, it is likely that US-EU trade tensions will re-escalate in the coming quarters, if patterns in recent US engagements on the geopolitical or trade fronts are representative.
A lack of clear goals raises the risk of a prolonged trade war. While the use of tariffs has been billed by the US as an effort to bring China and other countries to the negotiating table in order to lower the barriers to trade, the Trump team has not presented clear terms or goals that it would accept as prerequisites for removing import duties ( see 'China-US Trade Tensions: Risks Skewed Heavily To The Downside', July 5). Trade negotiations are usually lengthy processes, and with a lack of clear goals to guide counteroffers and no bilateral discussions currently underway with China, a quick solution looks illusive. The US agreement with the EU announced on July 25 de-escalates trade tensions, but continued uncertainty around US goals here hinders the prospects for a lasting resolution until more information is forthcoming. On a macroeconomic basis, the US's low savings rate and a strong foreign appetite for US assets, coupled with the Chinese yuan's sharp depreciation ( see 'Downward Revision As Chinese Yuan Faces Intensifying Downside Pressure', July 20) will make a reduction in the goods trade deficit unlikely in the near term. The yuan's recent sell-off could also prompt the Trump administration to put additional pressure on China via tariffs, as it may see the currency's weakening as a form stimulus for the Chinese economy.
Preference towards biltareralism vs. multilateralism: In multiple instances, President Trump has expressed his preference for bilateral trade deals, through which he argues the US can get a better deal. We believe this is indicative of his belief that the US should use its economic power for leverage to achieve concessions from trading partners, in direct conflict with one of the primary objectives of the rules-based trading system.
Blocking appointments to the appellate body: While the US has long held grievances with the WTO and its dispute settlement body, often over the use "zeroing" in anti-dumping cases, the Trump administration is ramping up obstructionism. The US is currently blocking appointments to the WTO's Appellate Body that oversee trade disputes. Now, with three of the seven seats vacant and another exit set for September, the institution's operational effectiveness is on the verge of being crippled due to a lack of quorum.
The use of "national security" justification, and potential flouting of the rules: While the General Agreement on Tariffs and Trade (GATT) allows for "security exceptions", members have seldom implemented import restrictions for national security reasons. Critics of the move claim that the administration's true aim is solely protection of US industry. A number of countries have since filed complaints against the US at the WTO. While these cases will likely take 2-3 years to be resolved, leaving plenty of room for negotiation in the interim, we believe the US would likely ultimately lose these cases. Subsequently, if the US, one of principle architects and participants in the rules-based system, were to ignore the ruling, it would considerably erode the effectiveness of the system.
The Trump administration's attempt to upset the norms around global trade is likely to have a lasting effect on any future framework. It is too early to quantify the extent of the impact, but the imposition of tariffs and an increasing preference for bilateral trade negotiations as a means for larger countries to extract trade concessions could conceivably become much more frequent in the years ahead. Such a scenario is particularly apt against the backdrop of increased populist rhetoric across both developed and emerging markets. While this would not immediately sound the death knell for the current system of international trade, its gradual erosion over a multi-decade time frame is not out of the question.