The end of the beginning

To paraphrase Winston Churchill, this past week may mark not so much ‘the beginning of the end’ as ‘the end of the beginning’.  After several months of skirmishing, the shift from Trumpian rhetoric to policy action is speeding up and we look to be moving into a more consequential period.

The Trump Administration’s ‘America First’ agenda is hitting its stride, with all the grace and precision of a wrecking ball.  US tariffs on a range of Chinese goods were imposed after a deadline passed last Friday.  And on Wednesday, Mr Trump announced tariffs on a further US$200 billion of imports in response to China’s retaliation. China (or the EU) does not look like it is about to back down, despite the costs involved.

Also this week, Mr Trump continued his sharp criticisms of NATO (partly for show, but in a way that diminishes the grouping) as well as leaders of allies like Germany and the UK.  The trans-Atlantic relationship is facing deep economic and political challenges. The President is a unilateralist, and does not place value on long-standing alliances around the world.  And next week’s summit with Mr Putin in Helsinki may yield further significant changes in US positioning.

The speed with which the international rules-based economic and political system, underwritten by the US, is being challenged is striking (WTO, G7/G20, NATO).  In addition to Europe, where domestic challenges are also complicating cohesive EU policy, this change is also playing out in Asia as countries from Japan to South Korea and Singapore re-think their relationships.  The transition to a more complex, multi-polar global system is accelerating.

However, these economic and political developments are not yet evident in the global economic data.  The small advanced economy leading indicator index that I calculate monthly shows a levelling off in economic activity at relatively strong levels; but there is not real evidence of a slowdown. These small economy ‘canaries in the mine of the global economy’ indicate that the global economic recovery continues, even if it is less synchronised than at the start of the year.

World trade growth, PMI readings, and industrial production are all looking decent, although they are off their peaks from 2017.  Europe is a bit weaker than it has been, although I wouldn’t overstate this, but the US continues to move forward, aided by the support of unsustainably loose fiscal policy.  There is economic softness in China, but Chinese import demand is holding up – a key transmission mechanism between the health of the Chinese economy and the global economy.

But we should not forget that the strong growth and intense globalisation over the past few decades has rested on an open, rules-based international economic and political system. The global economy and markets are often resilient to geopolitical shocks such as wars, but may be less resilient to regime change over the next few years.

Indeed, investor sentiment continues to turn negative.  And this week has seen weaknesses in a range of assets, from equities to industrial metals like copper, partly on growing concerns about the likelihood and costs of a prolonged period of trade tension.  As I have noted before, US/China trade tensions are not easily resolved: in addition to the difficulties with managing the bilateral trade deficit down, the tensions reflect structural concerns about the emergence of a strategic rival.  And trade tensions often develop into something more complex, including investment restrictions.  Ongoing escalation seems more likely over the next year than a grand bargain (or a declaration of victory).

The pressures from these economic and geopolitical tensions will be further complicated by an interaction with macro pressures from normalisation of US monetary policy.  Upward pressure is likely to continue on the USD, reinforced by increasingly loose fiscal policy.  This will make it difficult to reduce the US current account deficit, contributing to sustained trade tensions, and will also generate heightened risks of currency wars.

Indeed, the RMB has been under downward pressure (from 6.30 in April to almost 6.70 yesterday).  This is likely more due to economic softness in China and a strong USD than being a deliberate play to devalue the currency in advance of a trade war.  However an ongoing depreciation would likely create new problems.  It is instructive that the US/Japan trade tensions through the 1980s culminated in a massive exchange rate realignment in the Plaza Accord.

Many economic institutions and norms – from central bank independence to exchange rate management – are malleable in response to pressure.  Indeed, NEC Chair Larry Kudlow recently called for the Fed to move slowly in raising rates.  It may not take much more for the US to start applying pressure on other countries to strengthen their currencies.

The global economy – and global markets – cannot shrug off these political and institutional challenges for much longer.  We are likely moving into a period of economic and political turbulence.  I think of this as similar to the 1970s: a period of economic and political regime change, characterised by markedly higher economic and market volatility.

In such an environment, it is countries that are resilient to shocks and responsive to new opportunities that are likely to do well.  Many small advanced economies have a strong record of responding effectively to emerging challenges and opportunities, and are relatively well-positioned for this more complex world.  The quality of national decision-making, not simply the level of external exposure, will be the key driver of success.


Dr David Skilling

Director, Landfall Strategy Group


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David Skilling