Andrew Sheng, Distinguished Fellow of Asia Global Institute, says the reversal of globalisation is a major risk to global growth. If deals are not struck on Brexit and the trade war, steps such as competitive currency devaluation could lead to a 1930s-style recession.
Two major divorces are in the making in March. The obvious one is Brexit, which officially occurs on March 29. The other is the deadline for the US-China trade negotiations on March 1, when US tariffs on US$200 billion worth of Chinese imports are set to increase from 10 per cent to 25 per cent. Even though progress is likely, as both sides want a deal and the market is expecting one, the gap between the two sides is still daunting.
Both negotiations have profound implications for the future. Like all divorces, the disagreements are acrimonious, with repercussions for everyone else involved.
So far, Britain seems to be bracing for a major slowdown, deal or no deal. The British statistics office reported that the country’s economy grew only 0.2 per cent in the fourth quarter of 2018, with growth falling in December.
As Bank of England governor Mark Carney warned in his global outlook this week, global expansion is now weakening and risks are intensifying because worldwide monetary policy has been tightening, trade tensions increasing and China’s economy slowing. The more important risk he identified is the reversal of globalisation, caused by the growing imbalance on trade due to the continued US current account deficit even as the US dollar has been more dominant than ever.
Interestingly, China is no longer the major buyer of dollars, as its foreign exchange reserves have remained flat. The US current account deficit will be funded more by Japan, through its quantitative easing, and the euro zone. Expect US trade pressure also on Japan and the euro zone.
The second risk to globalisation is social, with greater imbalances in income and wealth in many countries, because the benefits of free trade are shared unequally. Overall, consumers benefit from global trade, but many workers in advanced countries have either lost their jobs or seen a fall in real wages.
The third globalisation risk is the loss of control and of trust in democracy and sovereignty in many countries. Part of the problem is that barriers to trade have increased three times as much for services as for products. This hurts countries that are strong in the services trade, such as the US and the UK.
The effects of growing protectionism will be widespread. The Bank of England estimates that an increase in tariffs of 10 percentage points between the US and its trading partners would take 2.5 per cent off US output and 1 per cent off global output through just the trade channel alone. If non-trade factors are taken into account, such as tighter financial conditions, greater uncertainty and permanent tariff increases, the output losses could double, to 5 per cent for US gross domestic product and half that for global GDP.
Despite the recovery in advanced economies, business sector investments have not increased commensurately. UK business investment growth has fallen by 3.7 per cent in the past year despite a recovery in overall growth, profits and accommodative monetary policy. Carney’s conclusion is that “it isn’t easy to win a trade war”.
What is true of US-China trade disputes is also true of Brexit. The barriers to reconciliation are huge because there are now fundamental differences in outlook on both sides of the Atlantic, English Channel and the Pacific.
Business confidence has suffered because in the case of investors in Britain, no one can predict with any certainty what deal, if any, is going to be struck.
Either way, investors will take a low-risk approach by avoiding long-term investments and sticking to cash. There is little doubt that in the short term, Britain will be the loser, but with a flexible exchange rate that keeps sterling competitive, it will be able to cushion any long-term trade shocks.
Meanwhile, the euro zone, which sells a large portion of its cars and other products to Britain, will also have to deal with a trade shock, on top of the internal complexities of keeping the European Union intact. The “yellow vest” protests in France have weakened the ability of the French government to meet German demands for stricter fiscal discipline, at a time when Italy’s populist government is refusing to toe the EU line on expenditure and immigration.
In the Pacific, the longer the US-China trade war persists, the worse the investment climate will be overall. The major trading partners of both nations do not wish to choose between them, given the huge potential size of the China market and limited growth prospects of the mature US market.
What is unspoken at present is that if no deal is struck, devaluation of the renminbi cannot be ruled out. No one wants to go down this route because competitive devaluation as the solution to a trade war could lead to another global recession reminiscent of the 1930s.
So even though the West worries about the risk of China’s debt overhang, the reality is that if China truly undertakes the structural reforms that almost everyone agrees on, it will emerge more productive than before, even in the face of higher trade tariffs. With a balanced current account, China has both the fiscal space and the monetary policy potential to undertake the necessary reforms and boost domestic consumption at the same time.
However, even if China buys more from the US, the rest of the world would worry that the increase in imports comes at its expense. Thus, not only will the trade war directly affect US consumers negatively, it will hurt trade and jobs in the rest of the world.
This is why feuding parties need to be realistic and come to terms that cannot be ideologically pure on either side. For American hawks to expect that the US can enforce standards on China is as realistic as China imposing ideas on US hawks. Negotiations are now down to the wire, with no illusion that a solution will be found in the medium term. Expect nothing but higher political risks soon.
Andrew Sheng writes on global issues from an Asian perspective
This article first appeared in the South China Morning Post on February 16, 2019. The views expressed in the reports featured are the author's own and do not necessarily reflect Asia Global Institute's editorial policy.
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