President Trump’s off-the-cuff remark yesterday that a trade deal with China could be delayed until after the U.S. elections in 2020 spawned a large stock market sell-off. While markets have since recouped some of the losses amid hopes that a deal will be reached, the reaction to Trump’s statement raises the specter of what might happen if there is an impasse.
Previously, investors hoped an accord would be reached whereby China purchased more agricultural goods from the U.S. while the Trump administration rolled back some of the tariff hikes it had implemented. If not, the round of tariff hikes totaling $156 billion that were slated for December 15 would go into effect and virtually all imports from China, worth about $550 billion, would be subject to duties of 15 percent to 25 percent.
Trump’s remark should not be dismissed. Throughout the negotiating process, he has suggested that a deal is about to be consummated, only to pull the rug at the last moment. Investors have been caught off guard each time, because they believe it is rational for both sides to reach an agreement before economic damage is inflicted.
But this is not how the president views the situation. He believes the U.S. has the upper hand in negotiations, because China depends on the U.S. as an export market and its domestic economy is slowing more than official statistics indicate. In his view, time is on the side of the U.S., and if China perceives he needs a deal before the election, he is prepared to call its bluff.
From China’s perspective, there are two key stumbling blocks to an agreement on the first phase of a trade truce. One is that President Trump’s desire for it to purchase $40-$50 billion of agricultural goods is unrealistic, because the targeted amount far exceeds China’s needs. The other is that China wants the U.S. to rescind earlier tariff hikes as part of any agreement, whereas U.S. negotiators believe such action would undermine their bargaining power.
Investors therefore need to weigh the consequences that the current stalemate could persist. Over the past three months, the S&P 500 Index has risen by more than 10 percent to record highs, largely in anticipation of a trade deal being consummated. With S&P earnings relatively flat over this period, it has resulted in stock market valuations becoming stretched. Therefore, a market pullback is likely if a deal is not consummated.
The extent would hinge on the impact a prolonged conflict has on the global economy. Since it was launched in the spring of 2018, global growth has decelerated close to a post-crisis low of 3 percent in the third quarter of 2019 from a peak of 4 percent in the first quarter of 2018. The principal reason is that the costs and uncertainty associated with tariffs have stalled business investment globally and disrupted supply chains. Looking ahead, the IMF estimates that by 2020 trade tensions between the U.S. and China will have reduced global growth by 0.8 percent, or about $700 billion.
Over the last year and a half, the U.S. economy has also slowed by a full percentage point to 2 percent recently from a peak of 3 percent. Some of this slowdown reflects the waning influence of the round of tax cuts that were enacted at the end of 2017, as well as tightening by the Federal Reserve during 2018. Thus far, the impact of tariff hikes has mainly been felt by U.S. manufacturers, farmers and businesses that have borne the brunt of the tariff hikes.
American consumers could feel more of the impact in the coming year, because the initial rounds of tariff hikes were targeted by the Trump administration to have a limited impact on households. But the latest round of hikes that were implemented this summer and which are scheduled for this month will mainly affect consumer goods. (Note: The administration consciously delayed the round so that it would not impact Christmas spending.)
If the trade war is extended into 2020, investors will have to assess whether consumer spending, which has been the linchpin of the U.S. economy, can grow unabated or will succumb to the fallout from the conflict. Should consumer confidence falter, it would likely be accompanied by stock market weakness.
In that event, Trump, of course, could turn on a dime and make conciliatory gestures to China. The open question is whether investors would once again take the bait or force the president to deliver the goods.
Nicholas Sargen is an economic consultant, author of “Investing in the Trump Era” and a lecturer at the University of Virginia Darden School of Business.