China, Cars and Congress: Three Risks to the 2019 Trade Outlook

(Bloomberg) -- If 2018 was the year that Donald Trump gave the world a new taste of an ancient phenomenon -- trade wars -- then 2019 is shaping up to be the one in which the combat risks being fiercest.

President Trump is as unpredictable a leader as a major economy has seen in generations. For that reason alone there are myriad scenarios -- from de-escalation to all-out economic war between the world’s two largest economies, the U.S. and China -- within the realm of the possible. Yet there are also three clear battlegrounds on which Trump’s trade wars will be fought in 2019. And if things go wrong on any of the three the results could roil the global economy.

While Trump and Chinese President Xi Jinping agreed during a December steak dinner in Buenos Aires to kick off 2019 with an uneasy truce and a pause in their tit-for-tat tariff war it may not take long for their conflict to resume. The big question looming over the world’s two largest economies going into 2019 is how they can find a solution to what remain major differences on trade.

Trump and his hawks have repeatedly set a high bar for Xi by insisting they want to see “structural” changes in the Chinese economy to rebalance the trade relationship. But it’s not clear that Xi will ever be willing or able to make those sorts of concessions.

Washington says it wants to see an end to the vast web of subsidies and cheap, state-directed loans that has fueled China’s economic rise and the international march of its state-backed champions. It wants to see wholesale reform to China’s intellectual property regime and an end to state-directed cyber-theft.

Blunt Edge

It also knows it is asking for the moon. “If China were to say, well, we’re going to stop doing all that stuff, it would be left with an economy that would effectively lose its edge,” Peter Navarro, the White House’s most strident China hawk told a Washington think tank, in November.

Still, Trump has been facing pressure from financial markets and farmers to strike a deal and has already demonstrated an ability to spin modest achievements on trade as epochal victories. There’s reason to believe he could do the same with China. But that also carries political risk for him going into 2020 with Democrats eager to poke holes in his populist trade appeal in key swing states in the Rust Belt.

For that political reason alone, the most likely scenario when it comes to China calls for an enduring frozen conflict rather than a grand armistice. That would mean the U.S. tariffs imposed in 2018 on $250 billion in Chinese imports -- and the vast majority of the Chinese retaliation to those -- remaining in place.

It would also mean the rolling out of new export controls strictly limiting the sale of key emerging technologies to China and continuing scrutiny of inbound Chinese investment into the U.S. That result may be better than a hot war. But it wouldn’t remove the possibility of the world’s two leading economies slipping into a new Cold War as many experts ended 2018 fearing.

Autos Conflict

If there’s one Trump trade conflict in 2019 that risks overshadowing the spat with China it’s the one over autos. The outcome of this conflict may also serve as a telling reminder of how Trump has set about rewriting America’s longstanding economic and strategic relationships and the shadow that casts over the global economy.

Trump’s ordering up of a national security investigation into U.S. imports of cars and parts followed the model he used to impose steel and aluminum tariffs in 2018. And he has since made repeated threats to levy a 25 % import tax on cars from Europe and Japan.

Whether an imported Subaru or even a Porsche is a threat to U.S. national security is clearly debatable. But the investigation fits with what the administration insists is its broad definition of national security to include “economic security.”

A strong manufacturing base, it argues, is as important to national security as a flotilla of aircraft carriers. Canada and Mexico have secured exemptions from any new tariffs as part of the renegotiated North American Free Trade Agreement.

Fragile Talks

The EU and Japan, meanwhile, have drawn promises of temporary exemptions from the auto tariffs while they negotiate trade deals with the U.S. The negotiations with the EU and Japan are fragile, however. And Trump is not a patient man.

Before the end of 2019, therefore, there is a real risk that at least a substantial portion of the more than $140 billion in finished cars and parts that the U.S. imports from Europe, South Korea and Japan could be hit with tariffs. Such a move would be disruptive in itself.

But there’s a risk, too, of a broader hit to supply chains if the tariff hits parts, which could affect both U.S. and foreign carmakers that now manufacture in the U.S. Congress Trump has claimed his renegotiation of Nafta, now rebranded the U.S. Mexico Canada Agreement, or USMCA, as a major victory for his belligerent approach to tariffs and trade.

2019 Hostilities

Experts continue to debate just how much of a meaningful change the new deal marks and what its economic impact will be. But no one doubts that Trump is facing a fight in 2019 to get the pact ratified by Congress. Particularly with hostile Democrats controlling the lower House of Representatives and thus wielding the power to block ratification.

Trump has responded by vowing to pull out of the existing Nafta altogether if Democrats don’t ratify the USMCA, a move that would again leave immense uncertainty hanging over the North American economy. And reinforce the fears that in his trade wars Trump’s most damaging trait may be his unpredictability

Click here for Bloomberg Economics’ comprehensive look at the year ahead.

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