By Eric Vandenbroeck and co-workers

The Trump Tariffs Wars

The 6 June issue of The Economist showed a telling image and commented that America is deploying new tactics, poker-style brinkmanship, and new weapons that exploit its role as the nerve centre of the global economy to block the free flow of goods, data, ideas and money across borders. This pumped-up vision of a 21st-century superpower may be seductive for some. But it could spark a crisis, and it is eroding America’s most valuable asset, its legitimacy.

There is a small window for a trade truce, but with a deliberate attempt by the White House to cripple Chinese tech giant Huawei Technologies Co. the White House has narrowed the middle ground. And for every U.S. action designed to coerce Beijing into making greater concessions, there will be a Chinese reaction that pushes the economic giants further apart in the negotiation. For example, U.S. trade assaults on China will prompt Beijing to increase financial support for strategic sectors, such as the semiconductor industry, directly violating a U.S. demand to reduce state support and level the playing field for foreign businesses. Chinese tariff retaliation and possible boycotts of U.S. goods will counteract Washington's demand for China to buy more American products to reduce the U.S. trade deficit. Chinese attempts to push back against the United States by selectively blacklisting and fining American firms only feeds into a familiar White House complaint: that China actively discriminates against foreign businesses.

A potential Chinese restriction of rare earth exports will amplify threats to U.S. commerce that the White House is citing to legally justify Section 301 tariffs in the first place. And the unavoidable depreciation of the yuan from the stress of the trade war will be used by the White House to name and shame China as a currency "manipulator" bent on disadvantaging U.S. exporters. This burning economic dispute is meanwhile unfolding against a backdrop of rising security tensions in the South China Sea and growing pushback against Beijing in China's periphery, where the United States has the potential to apply sanctions against the Chinese government and its affiliates in the name of protecting human rights and democracy. This geopolitical climate does not bode well for Trump and Chinese President Xi Jinping to reach a breakthrough in negotiations if and when they meet at the G-20 summit in Japan in late June. For now, the most likely outcome from the meeting between Chinese President Xi Jinping and US counterpart Donald Trump. Thus Beijing will keep the door open for future dialogue, and Trump still has the option of buying more time in the negotiation before resorting to all-encompassing tariffs. But the window for a truce is closing fast, and Xi and Trump will have enough political backing to prolong their economic war for a number of months.

While Mexico has been among the main beneficiaries of the U.S.-China trade war, Trump's tariff threats against Mexico could resurface around 22 July and again on 5 Sept., when the Mexican government is supposed to deliver to the White House its progress report on curbing illegal border crossings. Already on the edge of recession, Mexico will be careful to avoid a confrontation with the White House in an effort to steer clear of costly tariffs. After more than a quarter of a century of tariff-free trade on the U.S.-Mexico border, the economic impact of just 5 percent tariffs on Mexican imports, as Trump earlier threatened, would be tantamount to ripping up the North American Free Trade Agreement and returning to average World Trade Organization-level tariffs for most sectors. Supply chain disruptions would reverberate across the auto, electronic, industrial and food sectors. Furthermore, U.S. agricultural producers would be singled out for retaliatory tariffs, and Congress could even regain momentum to challenge the president's trade authority, though a veto-proof majority on such a measure would be far from assured. Even if Trump avoids the heavy economic and political toll that comes with disrupting North American trade through tariffs, the uncertainty that comes with merely keeping the threat alive will continue to erode investor confidence.

The threat of auto tariffs will meanwhile continue to loom large as Trump waits for U.S. trading partners to come to him with a "solution" by November, in the form of voluntary export restraints and/or acceptance of U.S. quotas. While Japan has a better chance of negotiating a trade compromise with the White House that includes agriculture and autos, EU leaders, too divided and consumed with horse-trading over political positions in the European Union for most of the quarter, will resist the White House's ultimatum on restricting auto exports to the United States. As a result, there won't be much movement in Continental trade negotiations with the Trump administration. The psychological impact of Trump's tariff weaponization strategy will linger for a fair amount of months.

The White House has already raised the WTO's hackles by stretching the definition of national security to justify a variety of tariffs, all while discrediting the global trade body's authority to arbitrate trade disputes. With a Dec. 10 deadline pending for the United States to lift its siege on the WTO Appellate Body or else drive it into paralysis, European leaders will prepare for the worst and work on convincing other WTO members to sign onto an ad hoc solution that would have former WTO appeals judges settle trade disputes under WTO arbitration rules until a compromise, likely with the next White House, can be found.

The European Union's creative workaround at the WTO points to a growing assumption among U.S. allies and adversaries alike that negotiation with the current White House may be futile. Erratic U.S. negotiating tactics and the elusiveness of a final, negotiated settlement will bruise business confidence and investor sentiment globally. Hamfisted diplomacy will also convince a number of powers, including China, Europe and Iran, that seeing out the result of the 2020 U.S. election makes more strategic sense than entertaining heavy concessions in a negotiation with the Trump White House over a deal that may or may not last.

 

Risk Bludgeons

In the face of yet another major tariff escalation, China will erect stronger capital controls and draw on its reserves to defend its currency, the yuan. China’s Central Bank will intervene to avoid a steep and sudden devaluation because a depreciation beyond 7 yuan to the dollar will exacerbate China’s economic slowdown and place greater stress on emerging market currencies. Heavy downside risk from the White House’s trade wars will drive the U.S. Federal Reserve to ease interest rates the coming months.

According to the IMF:

A variety of competing factors will slow but not quite stall the global economy in the coming months. The European Central Bank has already abandoned plans to tighten monetary policy this year as crises of the European Union’s own making roil the bloc. We do not think this quarter will end in a no-deal Brexit, but an escalation of political chaos in the United Kingdom, along with a drawn-out confrontation between Rome and Brussels over Italy’s expansive fiscal policies, will continue to sap at European growth amid rising global trade frictions.

For energy markets, between the opposing forces of slowing consumer demand and the threat of military conflict in the Persian Gulf creating a sharp supply disruption, oil prices will remain in flux. When the Organization of Petroleum Exporting Countries meets early in the quarter (with its expanded retinue of crude-producing partners, a collective known as OPEC+), Saudi Arabia and Russia will drive an agreement to extend production cuts into the second half of the year as the world’s biggest oil producers try to contend with rising U.S. inventories and weaker global demand.

 

Great Power Competition Drives Global Tech Fragmentation

If Xi and Trump agree to de-escalate the trade war this quarter, the White House could offer a selective and partial relaxation of export controls on goods and/or licenses that fall outside of highly strategic applications, specifically, dual-use technologies that could be used for security, surveillance or defense purposes. Pressure from affected U.S. businesses and ongoing court challenges could also have the effect of weakening U.S. restrictions against Huawei.

Regardless of their country of origin, global tech companies will find themselves on the firing line as the U.S.-China trade dispute heats up. Uncertainty surrounding the U.S.-China trade negotiation and the viral nature of U.S. export law, in which even a minimal amount of U.S. components, software and technology could subject a company to sanctions, will accelerate Chinese efforts to shore up indigenous semiconductor development. Huawei will further seek to roll out an independent operating system for smartphones to maintain the company's global market share. China will struggle to reduce its reliance on major international chip providers, such as Intel Corp., Samsung Electronics and the Taiwan Semiconductor Manufacturing Company (TSMC), that are now liable for U.S. sanctions. But over time, the rise of Chinese competitors in the chip manufacturing sector and the rollout of Chinese software alternatives, such as Huawei's mobile operating system challenger to iOS and Android, are likely to contribute further to the fragmentation of the global tech sector. Ongoing U.S. diplomatic efforts to pressure countries in Europe, Latin America and Southeast Asia into imposing similar bans against Huawei equipment on national security grounds are already stalling. This is because most countries are unwilling to tolerate the much higher costs and implementation delays for 5G networks that would come with blacklisting Huawei. But the broad reach of U.S. export controls against Huawei will now give many of these governments and relevant telecommunications partners pause as they weigh a much bigger compliance risk in dealing with the Chinese firm.

Even as its efforts to defang Chinese tech leaders gain momentum, the U.S. government has also made a point of targeting the exact Silicon Valley tech giants that Washington relies on to outperform China in a global race for technological supremacy. In line with Stratfor's 2019 Annual Forecast, bipartisan momentum is quickening behind U.S. efforts to scrutinize Big Tech over antitrust, privacy and free speech concerns. Google and Facebook are likely at the top of the list for the Federal Trade Commission and the Justice Department, which share oversight duties over the United States' largest tech firms. U.S. tech companies will also remain a prominent target in the European Union, where Ireland has launched a probe into Google for violating the European Union's General Data Protection Regulation on privacy protections.

 

Iran

The Trump White House is operating under an assumption that its ability to choke off Iranian exports and inflict heavy economic pain on the Islamic Republic will drive Tehran to the negotiating table or, better yet, instigate a grassroots overthrow of the clerical regime. Neither is likely to happen, though, and certainly not this quarter. At most, Tehran could rely on third-party mediators to establish a deconfliction channel with the United States as military frictions rise. Trump appears well aware of the political flack he would receive by committing the United States to yet another massive military conflict in the Middle East and so is likely to exercise some restraint in trying to avoid a costly military scenario with Iran. But there are a number of triggers that will arise this quarter, such as Iran telegraphing threats to shipping in the Persian Gulf and restarting parts of its nuclear program, that will embolden White House hawks to argue for punitive strikes against Iran.

Potential next steps of Iran

A lingering threat of military confrontation between the United States and Iran will detract from Washington's focus on its burgeoning great power competition with both China and Russia. Beyond high-stakes economic battles, the potential for skirmishes between the United States and China in the South China Sea and in the Taiwan Strait will rise as the U.S. Navy and Coast Guard steadily expand their footprint in China's near abroad. Russia, meanwhile, will oscillate between instigator and mediator in multiple theaters that have the potential to dominate the White House's attention. While Russia already provides significant political and economic backing to Iran and Venezuela, it can always dial up military support should it see an opportunity to generate leverage against a highly distracted White House. U.S. attempts to coax Russia and China into a trilateral strategic arms control treaty are unlikely to gain much momentum this quarter as arms buildups continue on all sides.

 

The way forward with Iran

The alternative to today’s course is talks between America and Iran. Just now that looks far-fetched. Iran’s foreign ministry says American sanctions imposed on Ayatollah Ali Khamenei, the supreme leader, and other top officials this week mark “the permanent closure of the path of diplomacy.” Rouhani has suggested that the White House is “mentally handicapped,” after which Trump threatened “obliteration.”

But optimists will remember similar clashes between America’s president and Kim Jong Un, North Korea’s despot before they met in Singapore and “fell in love”, as Trump put it. When he is not threatening to annihilate the mullahs, Trump is offering to talk without preconditions and to “make Iran great again”. He does not want the prospect of war in the Middle East looming over his re-election campaign. Likewise, in Iran the economy is shrinking, prices are rising and people are becoming fed up. The pressure is growing on Khamenei to justify his intransigence. Love could yet bloom.

America might coax Iran back to the table with a gesture of good faith, such as reinstating waivers that let some countries buy Iranian oil. Iran, in turn, could promise to comply with the nuclear deal again. Behind the scenes, its leaders have expressed a willingness to sign something like the old agreement with additions, such as extending parts of the deal beyond 2030. Negotiations would never be easy; the Iranians are infuriating to deal with. But that would let the president claim victory, as he did with the United States-Mexico-Canada Agreement, which his administration signed last year and which looks a lot like its predecessor, the North American Free Trade Agreement.

What if a deal that also curbs Iran’s missile program and restrains it in the region? As Trump seems to realize, biting everything off in one go is unrealistic. A new deal cannot solve all the problems posed by Iran or normalize ties with America after decades of enmity. It may not even lift all America’s sanctions. Neither did the first agreement. But, if done right, a deal would put Iran’s nuclear program back in a box, making it easier to tackle all those other problems without causing a war.

 

N.Korea and Venezuela

Unlike most countries dealing with the current White House, North Korea is trying to accelerate negotiations while Trump is still in office. Now that the United States has little choice but to plan for a military contingency around Iran, Pyongyang will have more room to push the line on missile testing while trying to break through a stalemate in negotiations. North Korean leader Kim Jong Un remains confident that Trump would rather keep North Korea in diplomatic limbo and call it a foreign policy win than return to a military confrontation with Pyongyang.

When compared to a prospective nuclear-equipped nation, Venezuela inevitably falls much lower on the list of U.S. foreign policy priorities. Even as the persistent threat of another coup attempt and the specter of greater Russian involvement in Venezuela will vie for Washington’s attention, the White House is unlikely to risk a messy military intervention at this stage to force regime change. A steady intensification of U.S. sanctions and ongoing backchannel dialogue with military leaders to try and crack the rule of President Nicolas Maduro will be the White House’s preferred method of managing Venezuela as the country descends further into chaos.

 

The Trade War with China going forward

Trump's administration’s China policy reflects Trump’s belief that China has long taken advantage of the United States, especially on trade. Whatever the merits of that position, a response focused on changing China’s behavior is woefully inadequate. U.S. primacy was born not by defensive protectionism but by building the greatest economic engine in human history. Keeping ahead of China is much more about the US than about China.

A good place for the next president to start would be by reviving U.S. participation in the Trans-Pacific Partnership. A stronger TPP with U.S. involvement would be the ultimate tool for checking China’s unfair trade practices. It would signal to Beijing that it can only shape Asia’s economic future by respecting intellectual property, dismantling bloated state-owned enterprises, and playing fairly with other countries. Trump’s decision to scrap the TPP, in 2017, conveyed exactly the opposite message, assuring China’s leaders that they could double down on the old ways of doing business without consequences.

 

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