Regarding the background of the current U.S. strategy — Tetsu Emori's Real Trading Strategy March 26, 2018
Tetsu Emori's Real Trading Strategy 2018-03-26 10:35
Broadcaster: ECM
We have summarized the background of the current U.S. strategy that cannot be fully covered in the daily newsletter.
Please read it.
Until now, I believe the Trump administration has been operating policies with stock prices in mind. However, looking at the current response, it seems to be prioritizing pushing a hardline stance toward China.
Regarding the administration's members, it was announced that National Security Adviser H.R. McMaster will resign on April 9. His successor is expected to be former UN Ambassador John Bolton, regarded as a hardliner on foreign policy. McMaster has been the White House's coordinator for foreign and security policy, and his departure could affect responses to North Korea. McMaster is an active-duty Army general, and with his resignation he is said to retire from the military as well. McMaster was appointed to replace the late Flynn, who resigned in February last year amid questions about Russia's influence on the U.S. presidential election. With this resignation, the Trump administration will have its third national security adviser in just over a year since taking office. This does not inspire market confidence.
Now, regarding the tariff issue,President Trump has decided to impose trade sanctions on China based on Section 301 of the Trade Act for intellectual property rights violations. This will apply tariffs on a broad range of products from China, totaling about $60 billion per year.President Trump ordered the U.S. Trade Representative (USTR), which has been conducting a substantive investigation into trade with China since last August, to publish a list of products that could be subject to sanctions within 15 days.
Additionally, aside from sanctions under Section 301,there is a possibility of filing a WTO complaint against China. The U.S. 2017 trade deficit with China stood at $375.2 billion, accounting for half of the total and the largest on record. The USTR views practices such as forced technology transfers by U.S. companies operating in China as infringements of intellectual property rights. The Trump administration has pledged to correct the trade deficit and, by actually imposing sanctions, aims to reduce the deficit with its largest deficit partner, China, by raising tariffs. Section 301 allows the president to take sanctions if unfair trade is found. In the 1980s, when U.S.-Japan trade frictions intensified, sanctions were used as leverage to obtain concessions in trade negotiations with Japan. However, the economic scale today is vastly different, so a direct comparison is not possible. This time the impact will be much larger.
Meanwhile, under Section 232 of the Trade Expansion Act, starting on the 23rd, tariffs of 25% on steel products and 10% on aluminum products will be applied on grounds of national security. The USTR indicated before the Senate Finance Committee on the 22nd that exclusions from these tariffs would be temporarily limited to Canada, Mexico, the EU, Australia, Argentina, Brazil, and South Korea. Japan, however, stated that it is not on the exclusion list. As a result, Japan will not be exempt from the new tariffs, and the higher rates will apply. Such unilateral sanctions are likely to conflict with WTO rules, and the gap between the protectionist United States and its trading partners may widen. While China remains the main target, the U.S. has also classified many allies as tariff targets. For now, exclusions may apply to the EU, Korea, and others later depending on negotiations, and it seems the effort will pursue both security and economic aims. Furthermore, the U.S. has said it would like to begin Free Trade Agreement (FTA) negotiations with Japan at an appropriate time. At the same time, the U.S. is considering tariff exclusions for specific products that are difficult to source domestically, and applications have been accepted by the U.S. Department of Commerce since the 19th. This process is expected to determine exclusions within up to 90 days.
Now, what are the reasons behind the Trump administration's hardline stance thus far?
These measures result from a convergence of factors, but they stem not merely from aiming to win Pennsylvania; they originate from the domestic structural conditions in the United States. In other words, as the economy expands and demand grows, domestic production has fallen while imports have risen. Additionally, employment in the steel and aluminum sectors has also declined, which likely pushed toward these measures.President Trump, who campaigned on reviving domestic industry and reducing the trade deficit, had to take these steps to fulfill his promises.
Treasury Secretary Mnuchin emphasized that the steel and aluminum import restrictions are “not protectionism. They are the result of unfair trade practices.” He also stated, “The United States seeks free, fair, and reciprocal trade,” and that even if a trade war develops, “given the size of the U.S. market and economy, President Trump is not afraid.” Furthermore, “the bigger losses will be borne by the other party,” and “the trade war is not our objective.” In short, in trade, the United States simply wants to be in a dominant position—nothing more, nothing less.
Fundamentally, the decline of the U.S. steel and aluminum industries is due to two factors: a drop in the competitiveness of U.S. companies and a large supply driven by China’s excessive production capacity. China exports surplus steel and aluminum, which has driven out the U.S. market. If tariffs are applied to these Chinese products, their competitiveness will inevitably fall. However, even with these measures, estimates suggest the impact on final product prices will be limited. In that sense, consumer impact may not be large. If so, it would make it even easier to pressure China.
However, these policies were intolerable for Gary Cohn, the pro-globalization head of the National Economic Council. Since they disagreed, his resignation was hardly surprising.
By the way, there is a very interesting fact: since President Trump’s inauguration, stock market trends have resembled those under past Democratic administrations. Considering the reasons, the policies Trump intends to pursue may have been the ones a Democratic administration would have pursued. Hillary Clinton, who was the opponent in the presidential race, opposed the TPP. If Clinton had become president, she might have pursued similar policies. With this backdrop, it is conceivable that current stock market movements under the Trump administration resemble those under Democratic administrations.
In any case, given the United States’ trade and economic structure up to now, addressing the growing trade deficit is required. Trump was elected to do this, but his election was not the direct reason. Be that as it may, his campaign tapped into the Rust Belt’s sentiments and ultimately won. Considering the midterm elections, pursuing policies that appeal to them with a similar strategy makes sense. In terms of tariff levels, many U.S. imports are lower than European imports, and Europeans complain, but some items show less improvement from the U.S. side; cars are a typical example. In fact, Europe has higher automobile import tariffs than the United States. When you think about it this way, the U.S. argument is actually coherent. It’s understandable that President Trump can take a tough stance.
If you look at the world’s trade balance, the United States bears almost all the deficit. Therefore, it is natural that the U.S. would push ahead with its current strategy. Of course, this is done while overlooking domestic competitiveness. In any case, for the United States, there are plenty of levers to challenge the imbalance.
China joined the World Trade Organization (WTO) in 2001, but market opening has not progressed significantly since then. That means China has notable weaknesses. They say they will “put up with it until the United States stops raising tariffs,” but if they fight this head-on, China is likely to lose. Yet China is shrewd. They are unlikely to yield to the U.S. policy this time. If that is the case, the U.S. can respond by devaluing its currency further, effectively deepening a dollar depreciation policy. This would indirectly impose tariffs on imports by making them more expensive for U.S. consumers, thus reducing competitiveness. They say they will rectify the trade imbalance and may pursue it with force. But currency depreciation movements are not supposed to be coordinated under G20 agreements.
Nevertheless, the U.S. dollar remains the anchor currency. Only the United States can eventually issue dollars. It can do as it pleases. China has been raising interest rates following a rate hike at this FOMC, signaling a desire to join the ranks of developed nations. However, under Xi Jinping’s centralized rule, it is not easy to persuade other nations to accept such a stance. The currency issue is indeed tricky. In the past, exchange rates were explained by balance of trade. There were times when that was true. But now the scale of capital flows has grown so large that exchange rates cannot be explained by economic structure alone. When this happens,capital movements will determine exchange rates, capital will flow to higher-interest-rate countries, and funds will come in regardless of the real state of the trade deficit. In such a situation, exchange rates can no longer be explained by trade alone. Of course, the trend of the U.S. deficit can continue.
As a result, a stronger currency would accelerate the hollowing-out of domestic manufacturing, while a policy of currency depreciation would work to correct that distortion. The Trump administration is attempting to address the trade imbalance with the “numbers logic” of tariffs. If that proves difficult, there is a possibility of transforming this policy into the “price logic.” If that happens, exchange rates would be heavily affected.
It’s worth recalling that Japan experienced a super-strong yen in the 1990s, which forced imbalance corrections via exchange rates. And this time, the target of the United States is not Japan but China. China has studied Japan’s past mistakes from various angles, so it will likely take measures to avoid the errors Japan made in the 1990s. With that in mind, the current U.S.–China trade war could last longer than expected. America’s anger toward China goes beyond trade alone. The North Korea issue also played a role when China did not function as expected. With the U.S. economy hurting, it tried to leverage China in its North Korea policy. When that strategy failed, it turned to attacking China. China is expanding its influence in Asia, and military spending is rising, pressuring a response from China regarding Pacific security.
In this context, Korea’s talks with North Korea were a timely boon for the United States. Going forward, watching how Asia’s situation unfolds will be a significant economic factor as well. Unfortunately, Japan has done nothing about this, which suggests it is quite anxious. It seems Japan wants to draw closer to the U.S. to try to resolve the abduction issue, but from North Korea’s perspective, that is now a closed matter. The honest desire is that this issue not be brought up again.
As for the steel and aluminum import restrictions this time, Japan has fallen into the target group. This was somewhat surprising, but ultimately the opposition to these restrictions centers on the defense industry. In other words, if Japan buys fighter jets from the United States, this tariff issue would be resolved. At any rate, the underlying intent here is to tie this to Japan’s arms imports.That is most favorable to the United States. The defense sector is a major source of funding for both the United States and Russia. Because the United States is a defense-led country, the defense industry must remain strong, and for a president to survive, he must gain the support of the military; President George W. Bush faced such issues. In any event, the tariff issue is a lure to get Japan to purchase weapons.
Thus, the current tariff issue ties together a multitude of factors. As the United States and North Korea move closer through South Korea, Japan becomes weaker, and relations with China grow more adversarial. Meanwhile, South Korea—whose economy is strained—also stands to benefit from this framework. But North Korea is struggling as well. It has long unsettled the international community with nuclear development and missile tests, and to break the current stalemate it will likely seek to maintain its regime through talks.
Not only the United States is approaching North Korea; Russia is as well. They are after resources. A fierce scramble for resources seems likely.
The tariff issue is a matter that needs to be looked at more broadly. I want to make that clear.
Given this situation, it may be difficult for financial markets to stabilize quickly. However, they will eventually recover. For now, I’d like to wait for market calm.
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