Chinese President Xi Jinping and US President Donald Trump, each accompanied by senior officials (with uber China-hawk Peter Navarro present), will dine together Saturday on the sidelines of the G20 conclave in Argentina. Market participants are intensely focused on the leaders’ meeting as a potential inflection point in the escalating economic tensions between the two countries.
And while many have expressed hopes that at least some tentative thawing in relations will emerge as a result of tomorrow's meeting, Goldman Sachs disagrees, and in a Thursday note said that a continued escalation of the U.S.-China trade war would be the "most likely" outcome of the meeting.
In previewing the three possible outcomes of the Saturday dinner, Goldman writes that it sees three basic scenarios for what happens after this weekend.
- The first and in Goldman's view most likely outcome, is continuing on the current path of “escalation”— tariff rates rise to 25% on all imports currently under tariff, and tariffs are extended to remaining Chinese imports.
- A close second is a “pause”, where existing tariffs remain in place but the two sides agree to keep talking with escalation put on hold.
- A “deal”, which Goldman thinks is unlikely in the near term, would involve complete rollback of the current tariffs.
The reason why Goldman is surprpsingly pessimistic on the outcome is because there has been a growing sense among US policymakers that China has benefited disproportionately from the bilateral economic relationship, effectively supporting a hard line stance against Beijing.
This view has been articulated forcefully by President Trump, who has said for example “China has taken advantage of the United States for many, many years”, but has adherents in both political parties.
- Most obviously, the US trade deficit with China has widened to new highs .
- The US endured a huge retrenchment in manufacturing employment after China’s entry into the WTO, in contrast to expectations at the time.
- Foreign companies operating in China have repeatedly expressed frustration with the business environment and perceptions of a non-level playing field.
- Meanwhile, China has seen enormous improvement in material standards of living over the past two decades (accounting for the bulk of the reduction in global poverty over this period)—reflecting in part the spillovers from strong export growth.
Goldman also notes the political and policy divergence between the two countries. Here, the willingness of the US and other developed democracies to include China in international economic frameworks such as the WTO reflected in part an expectation that economic development would eventually lead to some form of political liberalization. But recent events have suggested divergence rather than convergence of political models and goals, for the following reasons:
- Domestically, President Xi effectively consolidated power and the two-term limit on the presidency was abolished earlier this year. A range of other policy changes have generally been perceived as increasing Communist Party control, for example increased efforts to establish Party committees in private and foreign enterprises.
- Internationally, China has adopted a more forward-leaning posture economically (e.g. with the Belt and Road Initiative, as well as efforts to negotiate a regional trade agreement) and geopolitically (e.g. South China Sea, etc).
Critically, these concerns appear to be shared by US politicians and bureaucrats well beyond President Trump. For that reason, in the view of many foreign policy practitioners, the US-China relationship may be more challenging to manage than in the past. If so, the past year’s disruptions to long-established economic relationships—and the possibility that they return in the future—may continue to influence firms’ investments in China even in the event of a near-term “deal” on trade policy.
In its take on the economic consequences of the G-20 event, Goldman predicts that Chinese export growth will likely weaken in coming months on payback from recent “front-loading”, and—unless a deal is reached—over time by some US substitution to non-Chinese suppliers. And while the bank expects these effects to slow Chinese growth beginning in early 2019, renminbi depreciation this year is likely to mitigate the impact. Meanwhile, continued tariffs will weigh on Chinese domestic demand—in the short term, via increased uncertainty and negative effects on confidence, which are bad for investment and durables consumption; in the long term, by potentially encouraging some relocation of production.
Finally, Goldman writes that the assets most sensitive to the trade outcome are likely to be the renminbi and equities.
In a “pause” or “deal” scenario Goldman expect USDCNY to remain below 7; “escalation” would likely result in moderate renminbi depreciation over the next few months (to the 7.3-7.4 range).
Equity market valuations are likely to be quite sensitive as well; Goldman models the relationship of equities with policy uncertainty and estimate that the MXCN price-earnings ratio could increase to 12 by year-end 2019 in a “deal” scenario (relative to a base-case target of 11) or fall to roughly 10 in an “escalation” scenario.