There is a ceasefire in the US-China trade war. So who waved the white flag first?
- China may scale back the rhetoric of its global ambitions, recognising that discretion may be the better part of valour in a long-term game
- Likewise, Trump may be less confrontational, now that the soft underbelly of the US economy has been exposed
Who really waved the white flag first in the ceasefire of the US-China trade war?
US President Donald Trump would never admit the funk he is in, but has more reason than Chinese President Xi Jinping to be scared of the ending of the war he started.
Bluster and bravado aside, the truce suggests a growing awareness within the Trump camp of the need to reach a deal with China – and soon!
There is real cause for alarm, and that is the ticking bomb at the heart of the world’s largest economy – the stock market.
A common and mistaken assumption is that the US entered the trade war in a stronger shape, whereas China’s economic health was deteriorating and unable to withstand a broad and protracted economic war.
America’s economy is powered to a much greater extent by a single giant dynamo – akin to a nuclear reactor – at its heart: the stock market.
It is a monster relative to the size of the US economy and in global terms. US equities were valued at a combined US$32 trillion in early 2018, almost double the size of the world’s largest economy. By contrast, China’s market-to-GDP ratio was just 71 per cent.
Why should this matter, beyond giving Trump the reason to brag about size? It matters a great deal because a stock market the size of America’s is a gigantic money or wealth machine that supports consumption and investment – and therefore economic growth – proportionately.
The word “proportionately” is important because the greater the capitalisation-to-GDP ratio, the greater the potential leverage on economic vitality. In the US where massive central bank liquidity has fuelled equity investment, this positive leverage has been huge.
Conversely, when stock prices start going south, they exert a tremendous negative impact on the economy. This is surely why Trump seemed so anxious to keep his trade deal with Xi Jinping on track, even to the point of offering to intervene with the US Justice Department in the case of a detained Chinese executive.
Stock markets are political in a way that other organs of the financial system are not. It is odd how often this is overlooked. Economic data – trade or employment figures – in general are greeted with a yawn by most people, unless they show a sharp rise in joblessness. Inflation data can occasionally excite, but again only if they show a sharp rise.
Bond yields can rise or fall without raising too much delight or dismay to any but the professional investors. Even currencies need to jump or plunge to grab attention. But stock market movements rivet many people, especially when Wall Street dives as it has recently.
Trump was happy to brag when the stock indices soared to records on interest rates that by some estimates have been at their lowest level since the 16th century in real terms. But he forgot how vulnerable he was to a market reversal.
As he went into his trade war declaring that it’s “easy to win,” Trump expected the booming US economy to carry him to victory, while an anaemic China would quickly beg for mercy and concede. Instead, both sides have come out with white flags fluttering.
Japan’s economy, the world’s third largest, is vulnerable in this regard. The ratio of stock market capitalisation to GDP is 127 per cent, again much higher than in China’s case. Hong Kong’s ratio is much higher still, but that is mainly due to its being an offshore financial centre.
What is a stable market valuation-to-GDP ratio? Some estimates suggest a ratio of between 75 to 90 per cent of GDP is sustainable over the longer term. Yet globally, the ratio was closer to 120 per cent as of late 2017, according to the World Bank.
The global figure is very much influenced by the price of American stocks, because of the sheer size of the US market. Despite recent corrections, the US market capitalisation still exceeds the 2000 level when irrational exuberance died and the dotcom bubble burst.
None of this is to say that China is not vulnerable economically, not least the size of corporate and government debt, especially borrowings by local government. But China has more fiscal leeway to deal with such problems than many market economies.
The Chinese stock market tends to be more volatile than Western markets but it is important to remember that the leveraging impact of this volatility on the Chinese economy is not as serious as in the US, because of the lower proportionate value of stocks to GDP.
Trump has been foolish to gamble on his economy’s inherent strength to carry him through a trade war that was reckless from the start. Apart from slumping stock valuations, the legacy of this war has been falling business confidence, which also weakens his hand.
For now, Wall Street may experience a modest relief rally at Trump’s white flag. But this does not detract from the fact that US stocks remain overvalued by historical fair value standards and will no doubt continue to correct toward equilibrium.
It would be absurdly naive to think that US animus toward China can be dissipated through an expedient truce, or that China will do anything for a quiet life and abandon its challenge of America’s technological supremacy.
China may scale back the rhetoric of its global ambitions, recognising that discretion can be the better part of valour in a long-term game.
Likewise, Trump and company are likely to be less confrontational, now that the soft underbelly of the US economy has been exposed.
Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs