Will Donald Trump spark a trade war with China?

For better or worse, Donald Trump has got what he wants. 2017 is going to be all about him.

Throughout a contentious election campaign in 2016 the 70-year-old gold-topped billionaire thrilled his supporters with talk of bringing jobs back to the US, ripping up free-trade agreements and investing in infrastructure. He also boasted that by cutting “job-killing restrictions” he could raise US economic growth to 4% a year.

In the months since Trump’s presidential victory the US equity market has rallied on the back of investor hopes the new US president and a Republican-dominated Congress would swiftly implement business-friendly regulations. The S&P 500 rose to a historical high of 2,316.1 on February 10.

However, to the consternation of some, Trump the president is proving to be very much like Trump the candidate.

“Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families,” the newly inaugurated president declared to a half-filled National Mall in Washington on January 20.

Set against this protectionist language and Trump’s chaotic first few weeks, the run-up in shares appears premature. His policies are also inflationary, which could well cause interest rate hikes and a continued strengthening of the US dollar.

Elsewhere in the world, the European Union is facing several elections this year that could act as an indicator of the health (and indeed existence) of the political and economic organisation. Meanwhile China is seeking to both attract capital and control its outflow. That difficult balancing act is likely to have consequences for Beijing’s goal to get its local stocks included in global stock and bond indices.

We asked economists, fund managers, strategists and other experts their opinions on these issues and others. The coming months will reveal whether investors have a year to crow about, or if they need to nestle in against some foul conditions.

Will Donald Trump spark a trade war between the US and China?
Answer: No

For all the unpredictability of President Donald Trump, most market participants don’t believe China and the US will engage in an all-out trade war in 2017. Both side have too much to lose.

Trump’s open speeches and the views of the politicians he is picking for his cabinet means challenges to China are likely. “Trade policy and China are among the key issues Trump would like to get credit from for his administration,” said Zhichao Wei, senior economist at China Asset Management (ChinaAMC).

However, most feel the US president is engaging in ‘The Art of the Deal’ rather than the ‘Art of War’, using bellicose rhetoric as a negotiating tool as he attempts to tilt global trade imbalances in the US’s favour.

Trump has plenty of flexibility to impose tariffs on Chinese imports or US companies that head offshore if he desires it. One option would be to use an existing war in Afghanistan or Iraq as a pretext to invoke The Trading with the Enemy Act of 1917, which would enable him to bypass Congress.

Meanwhile the Republican establishment, which controls both houses of Congress, is pushing forward with tax changes more extreme than Trump’s. The proposed Border Adjustment Tax, for example, would impose a 20% tariff on US imports and effectively subsidise exports to the tune of 7% to 14%. By contrast, Trump’s transition team is rumoured to be considering a 10% tariff on profits rather than sales. Ultimately, the mere threat of such tariffs may persuade more companies to stay in the US.

How will China react? Economists believe it cannot win a trade war and will not want to risk one in a year when it holds its 19th party congress. So it may end the year in a slightly worse position.

But Beijing has some ‘Trump cards’ that should dissuade the new US administration from carrying out its most extreme proposals. This includes potentially threatening to dump US Treasuries, restrict the export of rare earths, or devalue the renminbi. A drop in the Chinese currency would not be good for financial markets.

China could respond to growing US protectionism by overhauling its own burdensome tax regime. In addition to standard corporate tax, Chinese companies face local government surcharges that can add up to 13% of revenues and employee benefits.

Some business leaders argue it has become more cost effective to manufacture in the US than China. Fuyao Glass has already established the world’s largest auto-glass factory last October in Ohio. Others may follow suit.

China could also attract foreign investment through de-regulation. A State Council Circular in mid-January suggests it is poised to reduce ownership restrictions across swathes of the economy, code for effective privatisation.

While a trade war is unlikely, strategists feel the risk of increasing frictions haven’t been fully priced into other export-dependent countries such as Korea and Taiwan, or India with its enormous IT and pharma sector. Policy announcements are proving more important than macroeconomic indications when the very concept of globalisation is coming under stress.