Jan Dehn, head of research at Ashmore Group, examines the potential implications for Europe if Trump’s tariffs are all realised:
US tariffs against China took effect recently. China responded immediately by putting into effect tariffs against US imports of agricultural goods and other categories of US imports. However, China also responded in a more constructive manner by sending officials to Europe in a bid to deepen trade ties between China and Europe. China is arguing that US protectionism could get worse and may impact Europe too, while China is committed to continuing to open its own economy to international trade. So far, the US has threatened to impose as much as USD 1trn of tariffs on goods traded with China and other key trading partners, including Europe, Russia, Mexico and Canada. If the US protectionist threats are realised, all of these countries will be affected as will the US itself, but the rest of the world can insulate itself from US protectionism to a large extent if they continue to deepen trade ties among each other.
Europe should turn to China
Sadly, Europe has so far displayed the usual dithering in the face of the mounting threat to global trade emanating from the US. This dithering is partly due to the complexity involved in reaching agreement on anything across the 27 independent nations making up the European Union, but there is also a strong element of ‘raging against the dying of the light’ in Europe’s hesitation. Europe finds it difficult to face up to the profound changes unfolding in the global economic and political landscape, both in the US and within Emerging Markets (EM), notably in China. However, the fact that the process of shifting economic and political ties away from the US towards China is difficult does not make it wrong. Specifically, there are three strong reasons why it is in Europe’s interest to begin to diversify economic relations away from the US and towards China (and other EM countries).
- The first of these reasons is that Trump’s political fortunes have picked up of late and may yet improve further. The US economy is growing strongly at the moment, which certainly helps Trump, even if the source of growth is unsustainable (a fiscal stimulus implemented at the top of the business cycle). Trump may too do well even if the economy falters, since Trump’s entire political strategy is based on exploiting widespread discontent which is rooted in stagnating productivity and rising inequality. These conditions have given rise to broad mistrust of conventional mainstream politics, which Trump deftly exploits by deliberately opposing – attacking even – all the core policies, which sit at the very heart of Western establishment politics, including free trade. These policies (which also include the North Atlantic Treaty Organisation (NATO), the United Nations (UN), the Human Rights Council and the Paris Climate Agreement) have been put in place because they are critical to maintaining peace and prosperity. However, should US popular anger deepen further, say, if the US business cycle weakens in the coming year or two, Trump may well double down on disassociating himself with conventionality. The other reason for expecting Trump’s policies to be around for some time is that the Democratic Party is sorely lacking in ideas and leadership, wherefore Trump currently looks like a shoe-in for a second term in office. In short, Trump and his policies are not going away and Europe needs to face up to this fact.
- The second reason why Europe should begin to diversify its economic and financial ties away from the US towards China is that US consumption will not be the driver of global growth that it once was. The extraordinary environment of ever falling interest rates, which prevailed in the nearly four decades since the early 1980s, enabled US consumers to fuel global demand by borrowing heavily at ever lower cost. Many of the goods consumed and much of the financing to pay for the resulting deficits came from China, as well as from Europe, which is why both China and Europe run large trade surpluses with the US. China in particular has maintained high savings rates for many years, in effect suppressing domestic spending, in order to make the US consumer boom possible. However, this regime of high US spending financed by high Chinese savings effectively ended in 2008/2009. Since that crisis, the global economy has been able to sustain a twisted encore version of the pre-crisis regime only by means of extraordinarily low interest rates and Quantitative Easing (QE) policies. However, these policies are nearing their end and big changes are afoot. As the economic consequences of low productivity and high levels of debt reassert themselves with rising interest rates in the years ahead, US consumers will be able to spend far less and the US economy as a whole will need to rely more on exports in order to grow, if there is to be any growth at all. Export-led growth will not only require significant depreciation of the US real effective exchange rate, which can only come about via recession or currency debasement due to the steady structural decline in US productivity, but, importantly, it will also require a global environment receptive to free trade. This is why Trump’s protectionism is so deeply inappropriate at this time. As far as Europe is concerned the message is clear: US demand cannot be expected to continue to sustain European exports.
- The final reason why Europe should turn towards China is, of course, that China is likely to develop in exactly the opposite direction of the United States in the coming years, that is, Chinese consumption will increase and China will move forward with trade and capital account liberalisation. Why is China taking this path? To start with, China has a savings rate of almost 50%, which means that Chinese consumption has a lot of room to expand over the next few decades. China will actively promote domestic consumption, because, unlike Europe, China has understood the direction of change in the US; there is no future in exporting to the US. The rise in Chinese consumption in the coming decades will be nothing short of awe-inspiring. China’s economy could overtake that of the US within just a few years, but with Chinese consumption rising at an even faster pace than growth, it follows that Chinese consumption could be the biggest economic force the world has ever known. Incidentally, Asian economies have been aware of this fact for some time, which is why erstwhile US allies such as South Korea and Philippines are already turning toward China. The good news for Europe is that it is going to become steadily easier to do business with China, because China is continuing to open its economy. Indeed, the entire thrust of China’s current growth strategy is to turn the Chinese economy into something akin to the US economy in the post-World War II period, that is, an economy based on consumption with a current account deficit financed from overseas with Renminbi gradually becoming the dominant global reserve currency. The process of making this happen requires China to ‘go the extra mile’ in terms of overcoming deep-seated suspicions in the West about China’s intentions. Since China can only overcome these suspicions by embracing the very policies, which Trump is currently rejecting, including free trade, environmental awareness, etc, Europe is actually taking a far smaller gamble in turning towards China than many perceive.
The world is in midst of profound changes, which are difficult grasp, let alone adjust to. New political and economic opportunities are becoming available, but politicians often choose to rely on experiences, which are rooted in the past rather than gleaned from their insights about the future. The post-World War II US hegemony is rapidly being undermined by the US itself. This means that the past no longer offers insights, which are relevant to the future. Until politicians embrace the new realities of the future, uncertainty inevitably ensues, which perversely often triggering a doubling down on obsolete practices. Reluctance or inability to adjust to change can even lead to crisis. Be that as it may. Crisis eventually forces politics to conform new economic realities and when this happens, a new dawn will begin.
Europe’s politicians must today face the choice of sticking with an increasingly protectionist US, which may already be past its peak, or beginning to deepen ties with an increasingly open China. We do not trust Europe’s politicians to make the right choice yet, but institutional asset managers can do so, because it is within their powers to avoid the mistakes of the past, provided that they make forward-looking asset allocation decisions.
This is precisely what investing is all about; at root investing is a forward-looking exercise. By allocating capital to reflect the future rather than the past, investors can prosper where politicians fail.