An Inconvenient Reality for Investors: China-U.S. Ambiguity
(Bloomberg Opinion) -- The U.S. stock market spent much of Friday trying to figure out what to make of the hike in tariffs on China that was announced a minute after midnight on Thursday night by the Trump administration. No recent historical precedents nor near examples were available to investors to figure out whether these tariffs would end up being permanent, part of a destination of lower and even less predictable global growth — or whether the new tariffs would one day be looked back upon as temporary and reversible, part of a negotiation process that led to fairer and still free trade and put the global economic system on firmer footing.
What should be clear is that the risks are increasing each day that a China-U.S. trade agreement remains elusive.
In the run-up to Friday’s opening bell, U.S. futures were indicating that markets would open virtually unchanged. A few hours into the trading session, however, stocks were down some 1.5% (as measured by the S&P and Dow indices), worried about the administration’s signal that it was in no rush to conclude a deal with China (and Beijing’s indications of pending retaliatory measures). Relative to the overall U.S. economy, many of the S&P 500 companies are a lot more closely interconnected with China on both the revenue and cost sides.
After languishing with losses for most of Friday’s session, stocks rallied to end the day almost half a percent higher. And the catalyst for this turnaround was comments by U.S. Treasury Secretary Steven Mnuchin that the day’s negotiating session had gone well.
This roller coaster illustrates an inconvenient reality for investors and traders. With no recent history of a major trade war and with limited information on the interactions between President Donald Trump and President Xi Jinping, market participants had no alternative but to react to whatever signals they got from American and Chinese policymakers, no matter how short-term or serially inconsistent they seemed.
Remember, this latest trade skirmish between the world’s largest two economies raises questions about both the journey and the destination for markets, including the possibility of a tit-for-tat process that sees the tariffs imposed by both parties increased to very high levels. It’s also not clear how long this stage will last, let alone whether it gives way to an agreed mutual de-escalation or, instead, become a permanent part of a larger global trade war.
As I have written, perhaps the most useful way to consider these questions is through the prism of game theory.
The reality of China-U.S. economic relations is that, after years of pent-up frustration with Chinese trade practices, forced technology transfers and intellectual property theft, the Trump administration has decided, in the language of game theory, to play an inherently cooperative game uncooperatively. While both sides incur economic damage in this world, that suffered by China is a multiple of what the U.S. experiences. Moreover, this could seriously complicate China’s bigger development challenge — that of powering through the tricky middle-income transition — and so it becomes in China’s interest to defuse the trade tensions by providing concessions to the U.S. (an approach that Canada and Mexico adopted last year).
But there are also complications. Verification procedures, particularly on curbing intellectual property theft, are far from simple to design and will require careful monitoring until sufficient confidence-building steps are in place. Left in place, tariffs have a way of becoming structurally embedded in a trading system. Economic considerations are increasingly supplemented by deeper national security ones.
The more the Chinese financial markets and the economy suffer, the greater the temptation for the U.S. to use tariffs as a means to “contain” what once seemed like China’s inevitable economic rise. Already, U.S. firms have started to diversify their supply chain away from China. The impact would be even more important were the U.S. to develop a united front with Europe to combat their common China-related trade grievances.
With all that, the most likely outcome is still one in which the two parties iterate to a deal because of Chinese concessions. But the probability declines over time and a qualifier cited earlier becomes more important. The longer it takes to get to a deal, the lower the probability that such a deal will constitute a decisive end to trade tensions. Instead, it is more likely to be a cease-fire. And, of course, the longer China waits to accede to U.S. demands, the greater the risks to its development process, the bigger the threat to the global economy, and the harder the challenge for central banks and other countries — particularly emerging economies.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide.”
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