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Trade wars: A pause or is the end in sight?


How history can provide answers to today’s tariff stand-off

This article originally appeared in the 23 September 2019 edition of Investment Week. Click Here to view the original article.

To understand the support for tariff wars which has been led by US President Donald Trump, especially from his core base and so-called disenfranchised part of the electorate, we have to look back at some significant structural shifts that happened in the US and most G7 economies over the past 40 years.

In the late 1970s, more than half of the US wealth was controlled by the bottom 95%, while the top 1% owned about 7%. Inequality began to rise in the 1980s and was further accelerated by the 2008 Global Financial Crisis.

Bold tax reforms initiated by the Jimmy Carter administration in the 1970s, and later implemented by Ronald Reagan’s government, kicked off the socalled
“wealth accumulation” phase in the developed world.

Deregulation initiatives aimed at the financial services industry, as well as tax cuts for the wealthy, started successfully feeding through to financial assets such as the stock market and real estate. But this had only a temporary impact on the real economy.

Most central banks and G7 governments underestimated the massive leap in technology at the end of the 1980s and the accelerating globalisation at the end of the 1990s. The widespread adoption of personal computers in the workplace, enormous upgrades in the telecoms sector and the internet in the late 1990s undermined the bargaining power of labour in G7 developed countries.

The fall of communism in 1989 and China joining the World Trade Organisation in 2001 turbocharged the globalisation process, and disrupted most supply chains and manufacturing industries in the developed world.

The US Federal Reserve also started losing its ability to stimulate the economy as most of its actions targeted financial assets, which in turn led to wider wealth disparity.

Back to the present

Where do tariff wars fit into this? Protectionism, populism and calls for fiscal stimulus are nothing new. The Global Financial Crisis marked the end of the “wealth accumulation” phase for most G7 economies.

Similar to the post-Industrial Revolution era in the 18th century, when millions of agricultural workers found themselves displaced by steampowered machinery, more government regulation, immigration controls and an increase in workers’ bargaining power are once again dominating our politics.

The developed world is about to enter the so-called “wealth distribution phase”, a phrase popularised by a famous investment strategist Kiril Sokoloff. However, it does not necessarily mean we will all of a sudden see a rise in socialism and communism. Tariffs and populism are symptoms of the current paradigm shift.

With the election of Trump in 2016, the US signalled to the world its domestic issues would take precedence over its interest of the global economy. By targeting China with trade tariffs, Trump’s administration unintentionally started disrupting the global supply chain and possibly bringing other frontier markets to the table.

China’s main exports to the US are still mainly manufacturing goods, not services or commodities. Chinese producers will most likely end up paying for those tariffs as they no longer have the definite competitive advantage they had 20 years ago in the form of cheap labour.

The competition for less sophisticated manufacturing is fierce. Either the Chinese will absorb those tariffs or the capital will move somewhere cheaper.

Countries such as Mexico, Bangladesh or Vietnam could benefit from this disruption. Other manufacturing-based economies that failed to diversify away from China’s supply chain are likely to suffer in the short term.

Another unintended consequence of US-China tariff wars could be a flood of Chinese products, initially destined for the US, into other developed economies. After almost a decade of failed attempts to reflate their economies, most European central banks could once again face a wave of deflationary forces coming their way.

The Trump question

That brings us back to Trump prioritising domestic problems over the wellbeing of the global economy. The US President wants to continue with his tariff wars to appease his support base. He needs to be seen as a protectionist president.

As long as the US economy stays strong, Trump’s administration will continue to impose tariffs on China, no matter the consequences for the rest of the world – including Washington’s closest allies and trading partners.

We could see a brief pause in Trump’s rhetoric if the US economy enters a recession. But we could also see him doubling down on protectionism because that is what populists do.

However, it is hard to imagine we will see a single deal that will put an end to these tariff wars. Gradual de-escalation driven by a series of small deals aimed at addressing structural imbalances is the most likely outcome.

Artur Baluszynski is director and head of research at Henderson Rowe.

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