America: from safe haven to den of thieves?

Published: Jul 2019
Two containers hitting each other. One symbolises the US and the other China

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President Trump’s protectionist tendencies and fondness for tariff wars are creating great uncertainties for global markets and corporates. With a number of major battles looming between the White House and Democrats, matters could become even more fraught.

Concerns over the US economy are mounting, that much is clear. The main investment banks now think that there is a substantially higher chance of a US recession late this year or early next year.

And with various political issues on the runway for the coming month, it could turn out to be a hot summer in Washington. How the White House handles them could either cheer up the markets or plunge them into deeper gloom. One of them concerns the long running squabbling over a badly-needed act that is meant to boost the US infrastructure.

Also, the debt ceiling needs to be raised again in the autumn or will need to be temporarily suspended. Furthermore, Trump remains resolutely on the tariff warpath so there could well be more market moving events related to that.

Drilling down into the potholes

One of Trump’s election promises was to improve roads, ports, airports, and so on. But he has suddenly linked his preparedness to bolster infrastructure to the willingness of the Democrats to stop the investigations into his conduct. He says he is only prepared to be “constructive and cooperative” if they desist.

Congress and the White House also need to come to an agreement on a new (temporary) budget over the coming months. If they do not do so, the doors of US federal buildings and national parks will again be shut, as happened early this year for 35 days.

Since the Republican-dominated Congress enacted the Budget Control Act 2011, which was signed into law by Democratic president Obama to end the Debt Ceiling Crisis, negotiations on federal spending have also turned into an exercise to prevent enormous automatic ‘conjoined’ cutbacks on defence spending as well as non-defence discretionary federal spending.

The idea was to force the two parties to meet each other half way; the Republicans will throw a fit if defence spending is cut substantially, whereas the Democrats will be apoplectic if other public spending goes down the drain. That is to say, the Act is not really intended to be executed but merely to serve as a ‘ploy’ to encourage both parties to come up with well-balanced measures that counteract a mushrooming budget deficit and national debt.

Nevertheless, the so-called sequestration did come into force in 2013. Consequently, spending on domestic programmes has been substantially reduced over the 2012-2015 period. Ever since, Congress has managed to raise the automatically imposed spending ceilings and to alleviate the sequester pain. And it has to act again in early October. And as we have seen in the past, the prospect of ill-considered cuts is no guarantee that politicians will go all-out to avoid them.

If the negotiations fail, the Pentagon’s budget will be cut by US$71bn from early 2020 onward. Simultaneously, social and similar spending will be reduced by US$55bn. The White House and Congress have already indicated they would prefer to negotiate a deal that is valid for two years so as to avoid going through the same rigmarole during the 2020 election campaign.

We have the impression that an agreement will be reached on time. However, it is worth remembering most analysts had not expected the shutdown at the start of this year to become a reality, either.

Through the debt ceiling

Roughly at the same time as the budget expires, the US will reach its legal borrowing limit. The debt ceiling was reinstated earlier this year – having been suspended for 12 months – and was tapped again straight away. Thanks to various special measures, the Treasury Department can still pay its bills, but it will run out of money in October/November.

So, unless the ceiling is raised, America might have to default on its public debt. We think there is a low chance that this will happen in reality although the debates on the debt ceiling and budget have merged from time to time. The discussions around the debt ceiling should, however, be taken very seriously.

Trade war hots up

There is a very real chance that the global trade tension will continue to mount. The world scratched its head again as Trump threw together import tariffs and immigration in order to ratchet up the pressure on Mexico to put a stop to illegal immigration across its borders.

Things appeared to be heading in the right direction for a while, as Washington decided to postpone for six months the introduction of import duties on cars from the EU and Japan while it cancelled tariffs on Canadian and Mexican aluminium and steel.

Next thing we knew – in early May – Trump again went all-out with tariff increases on Chinese products, the threat to expand levies to all Chinese imports, and a boycott of Huawei as he also put pressure on other countries to ban Huawei.

Congress has tried to rein in Trump earlier via a Resolution of Disapproval after he declared an emergency at the US-Mexican border. However, he vetoed the resolution and the Democrats did not manage to muster enough Republican votes to overturn the veto.

Inflated ego or justified self-confidence?

Trump’s policies are making more and more Republican politicians uneasy but a true tipping point is nowhere in sight. The ranks have remained closed and Trump clearly feels he has the upper hand vis-á-vis Mexico (and Canada). Trump also believes he can trump China. Based on the data he has a point. Twenty-five percent of Chinese exports go to the US whereas 8% of US exports end up in China. Plus, less than 1% of the US economy is linked to exports to China while 5% of the Chinese economy depends on sales to the Americans.

This does not take into account that international production chains are intertwined so much that the US is connected with China in far more ways. The Chinese are sitting on a gigantic mountain of US treasuries, which they could deploy as a weapon. Add to this that Trump is more beholden to his voters in the first instance – as he is operating within a democratic system and faces an election in 2020 – compared to Xi Jinping in China. On top of this, Xi acts as a strongman who can ill afford to lose face while it is easier for China to underpin its economy with monetary and fiscal stimulus.

The trade war is part of a power game between the US and China that could go on for years, with a real risk of the world again being divided into two blocks. To sum, global trade tensions will likely continue for a long time to come.

New era

President Trump often appears to view the stock market as a success benchmark, yet he is now focusing on immigration and trade and is combining them regardless of the fact that markets have been protesting.

Some experts are saying that Trump heralds a new era as they refer to the past two centuries. Global exports increased fiftyfold in real terms between 1815 and 1913. Everything changed, however, in the aftermath of the First World War and during the Great Depression. Americans came up with the protectionist Smoot-Hawley Act; the British no longer did everything to promote free trade; and Germany set up the Reichsmark Block. We are seeing similar fragmentation now with a paralysed WTO, Trump’s aversion to multilateral agreements, and China’s eternal preference for bilateral negotiations. These developments create more uncertainty for businesses as enterprises lose their appetite for investment.

All of this implies that significant political risks are attached to the US and they could have a strong impact on the rest of the global economy. A government shutdown looms after the summer; not long afterwards politicians will have to take action to stop America from officially becoming a defaulter. Meanwhile, trade and geopolitical tensions are mounting while Trump is convinced that he can score at the upcoming elections with hard-line standpoints on immigration and trade. We do not think an infrastructural package will bring substantial relief.

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