After the latest round of trade talks in Shanghai ended fruitlessly, the Trump administration issued its newest threat to impose tariffs on an additional $300 billion dollars of Chinese imports. The Chinese government offered a strong response, devaluing the yuan and halting the purchase of U.S. agricultural products. This last string of actions and retaliation is being interpreted as a sign that the U.S.-China trade war is here to stay, with damage continuing well into 2020. This is not a good sign for the global economy. Global trade continues to decline and key economies – including China – are showing serious signs of weakness. These and other indicators suggest that, sped by the ongoing trade war, the next global recession will arrive in the not-too-distant future.
The most recent chapter in the trade war opened with the leadup to the G20 Summit in Osaka. The U.S. and China declared a brief truce, with the Trump administration allowing U.S. companies to do business with Huawei and holding off on its threats to impose further tariffs. Both nations promised to participate in a new round of negotiations after the summit, leading to a meeting between high-level Chinese and American representatives in Shanghai at the end of July. The U.S. insisted that China had agreed to buy more American agricultural products, with China merely confirming that such purchases had been discussed, but no major progress seemed to have been made. As most analysts predicted, the talks produced no real results except for a commitment to even more negotiations.
This brief moment of peace was shattered in the first week of August. As it has done seemingly-countless times, the Trump administration threatened to levy 10% tariffs on an additional $300 billion in goods, accounting for all of the U.S.’s remaining Chinese imports. In and of itself, this might not be cause for alarm. But China responded in an entirely new way, with the People’s Bank allowing the yuan to devalue to 7 to the U.S. dollar, a rate not seen since 2008. The U.S. replied by declaring China to be a “currency manipulator,” a largely-symbolic move that nevertheless provoked the ire of the People’s Bank. China further dug in by halting the purchase of U.S. agricultural goods by a number of Chinese companies.
Many months of uncertain progress toward some kind of agreement were undone in less than a week. The U.S. reneged on its promises not to impose additional tariffs on Chinese goods, and has now set a September deadline that increases the chances of those tariffs actually coming into effect. Previous indications that the U.S. and China might be able to come to terms on yuan stabilization are now out of the question. China has definitively signaled that it is prioritizing the health of its export industries, even though devaluing the yuan poses serious risks to the stability of the Chinese financial system. China has also doubled down on striking against the already-damaged U.S. agricultural sector, with key commodity crop prices already at record lows.
Unfortunately, the domestic political incentives to continue and even escalate the trade war are rising. President Trump faces a difficult challenge in the 2020 election and will want to blunt attacks on trade from a likely-protectionist Democratic opponent. President Xi is facing down serious unrest in Hong Kong. Neither will want to lose face against a foreign rival. This poses a troubling question: what weapons remain in the arsenal of both sides? The U.S. can continue ratcheting tariff rates up to astronomical heights and sanctioning Chinese companies. China can continue to allow the yuan to devalue and cease all U.S. agricultural purchases. But if the trade war were to escalate even further, we could enter the realm of far more dangerous tools: bond sell-offs and perhaps even outright aggression.
The deepening of the trade war poses a significant challenge to the health of the global economy. The economies of both developed and developing nations are already slowing. China, which has been facing headwinds since 2016, is struggling, and not just because of the trade war. The Chinese economy faces serious financial issues in the shadow banking sector and growing drag from unprofitable ‘zombie’ companies. Given that China’s massive deficit spending over the past few years effectively propped up the global economy, the economic weakness of China alone would seem to point to an upcoming recession.
The one ‘bright spot’ in the picture for global capitalism appears to be the United States, but a closer look reveals reasons for concern. The profits of multinational corporations have taken a serious hit as a result of the trade war. With the exceptions of real estate, financials, communications, and healthcare, earnings have also fallen in all other U.S. corporate sectors for two consecutive quarters. Indeed, as many as 30% of firms are currently making a loss. The expectation of profits drives capitalist investment – as profit rates fall, so does investment, leading to recession. If earnings continue to fall over the next couple quarters, we can expect a new recession to follow.
This is why the Federal Reserve and other central banks have taken the remarkable decision to lower interest rates even in the absence of a technical recession. This is an indication that central banks recognize the enduring structural weaknesses of the global economy, along with the fact that the U.S.-China trade war is not going to come to an early end. As I have argued elsewhere, the U.S. and China have fundamentally divergent interests regarding the terms of trade between their two countries. These differences are not going to be papered over any time soon, unless one of the two nations is willing to significantly limit its ambitions.
When, then, can we look for a resolution of the present impasse? The 2020 election will change the American political landscape significantly, whether Trump wins or loses. A new global recession could push both sides to the negotiating table, or it could provoke another wave of retrenchment and protectionism. In any case, the next year should see no end to the cycle of pressure tactics and retaliation, rattling an already-shaky global economy. Instability and uncertainty are here to stay; observers would be wise to prepare for difficult times ahead.
