The Chief Economist’s Note

The dangers of over-interpreting a US-China trade deal

We seem to be moving towards an agreement between the US and China on trade. What would this mean for the global economy?

The finer points of the deal are still unclear, but it is likely to involve Beijing agreeing to increase its imports from the US in several areas (soy, oil, natural gas, wheat, corn etc.) in exchange for Washington removing the threat of a further increase in tariffs on Chinese goods and possibly rolling back those that have already been imposed over the past year. As things stand, it’s unclear whether some of the more thorny issues like enforced technology transfer will be tackled to any significant extent.

The fact that a full-blown trade war between the world’s two largest economies appears to have been averted is clearly a good thing. But the abrupt ending of talks between President Trump and Kim Jun Un last week serves as a timely reminder that enthusiastic briefing ahead of summits doesn’t necessarily translate into policy action. More fundamentally, even if a deal between the US and China on trade is ultimately agreed we don’t expect that a trade truce will now provide a substantial shot in the arm to the global economy.

After all, while world trade growth has weakened sharply over the past few months, this doesn’t appear to have been caused by the protectionist measures that the US and China have imposed on each other since the start of last year.

For one thing, every major economy has experienced a sharp drop in trade growth in recent months, not just the US and China. What’s more, this weakness has extended to goods that have not been affected by tariff action. (See Chart 1.) Given this, a subsequent truce is, on its own, unlikely to reverse the deterioration in the recent trade data.

Chart 1: Percentage Point Change in Annual Global Export Growth by Product (USD, Q4 2017 – Q4 2018)

Percentage Point Change in Annual Global Export Growth by Product (USD, Q4 2017 – Q4 2018)

Admittedly, concerns about the prospect of a trade war between the world’s two largest economies may have had an indirect effect on global growth in recent quarters. For example, in several countries business investment has been notably weaker than indicators such as capacity utilisation would otherwise have suggested. (See Chart 2.) One reason for this may be that firms have scaled back investment plans due to worries about rising trade protection. If that’s the case then investment should rebound as these concerns fade.

Chart 2: Euro-zone Investment and Industrial Capacity Utilisation

Euro-zone Investment and Industrial Capacity Utilisation

However, concerns about trade are unlikely to be the only factor holding back investment – political uncertainties (Brexit, Italy, Gilets Jaunes etc) and, more recently, a general deterioration in the outlook for global growth are likely to have played a role too. These concerns will persist even if Beijing and Washington agree a trade deal. Moreover, the fact that the White House is apparently pushing for the inclusion of a clause that would reinstate higher tariffs in the event of China’s non-compliance means that uncertainty over trade may linger even if a deal is struck. It’s also possible that, having reached an agreement with Beijing, Washington could shift its focus to other areas of concern over trade. The threat of US levies on foreign cars and car parts remains. Europe may soon find itself in the firing line.

Meanwhile, we doubt that a US-China agreement will have much impact on financial markets either. Growing optimism about a trade truce appears to have been a significant factor behind the rebound in equity markets since the start of this year. We suspect that a deal is now priced in to most asset markets.

Stepping back, unlike many analysts, we never thought that a US-China trade war posed a major threat to the near-term outlook for the world economy. Instead, as I outlined last week, the weakness in the global economy that we anticipate over 2019-20 is due primarily to country-specific factors that we believe will cause each of the world’s major economic regions to slow. So while a deal between the US and China on trade would clearly be good news, we won’t be rushing to change our forecasts.

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