For months, financial markets have been bracing for President Donald Trump to follow through with threats of tariffs against China. So it came as little surprise when the U.S. implemented duties on $34 billion in Chinese imports on Friday, as planned, and Beijing retaliated proportionately.Now comes the hard part for forecasters.

No Spillovers

Economists feel they have a good handle on the direct impact of higher duties. Tariffs raise the price of imported goods, in turn inflating costs for businesses. Those companies can fully absorb the increased cost, or pass some or all of it onto consumers. The bottom line: someone pays, prices rise, demand is hurt.

The Trump administration is currently reviewing another round of tariffs on $16 billion in Chinese goods. If the U.S. stops at duties on $50 billion in imports, and China does likewise, the hit to both countries’ economies will be modest, Bloomberg Economics projects.

Call that the neat-and-tidy trade war: both countries come to their senses, and financial markets bend but don’t break.

Spillovers Galore

However, Trump said last week that he may expand tariffs to more than $500 billion in Chinese goods, to basically cover all imports from the Asian nation into the U.S.

Economists say they can’t fully measure the indirect impact that could occur as the trade war escalates. A decline in U.S. financial markets could be one such element. Factor in a significant slump in equities prices, with the knock-on effect of falling wealth, and the likely hit to U.S. growth widens to 0.4 percentage point, according to Bloomberg Economics.

Chinese stocks and the currency have already taken a beating as concerns about the onset of the trade war gathered. The Shanghai Composite Index is in its longest losing streak in six years, and the yuan posted its worst quarter since 1994 last month. Policy makers have been out in force trying to shore up sentiment.

Business and consumer confidence is another “X factor.” Business contacts in some U.S. districts monitored by the Federal Reserve indicated they’d scaled back or postponed capital spending because of uncertainty over trade, according to minutes of the June meeting of the Fed’s rate-setting committee.

“The risk is you start to see more businesses reacting negatively by constraining their investment,” said Gregory Daco, chief U.S. economist at Oxford Economics. “You’re starting to see some anecdotal evidence of businesses putting their capital expenditure plans on hold.”

In a severe scenario, declining business investment and lower consumer spending would decrease demand, which might prompt other countries to lash out with more trade barriers, creating a vicious cycle of mounting protectionism and slowing growth.

It’s difficult to measure how the “second-order” effects of a trade war would hurt the global economy, said Atsi Sheth, a managing director at Moody’s Investors Service.

“We haven’t had a real trade war at this scale in a long time,” Sheth said. “The last 50 years have been about more integration. So we don’t have very good episodes to choose from in the past that would inform us.”

Breakdown of Relations

Then there’s the unpredictability of the politics.

For now, China has avoided upping the ante. “Our view is that trade war is never a solution,” Premier Li Keqiang told reporters during a visit to Bulgaria on Friday, after the first round of tit-for-tat duties. “It benefits no one.”

“The reaction from Beijing has been restrained,” said Gene Ma, chief China economist at the Institute of International Finance. “Internally, they have a policy to contain this issue. They’ve decided this should be dealt with as a trade issue, not a geopolitical issue.”

That could change, especially if Trump continues to accuse China of trading unfairly and stealing American intellectual property. U.S.-China relations have arguably slumped to their lowest point in years, despite praise by Trump for President Xi Jinping and a prediction that the pair would “make great progress together!”

If Trump doesn’t relent, Beijing may lash out with other measures, such as swamping U.S. firms operating there with red tape, or using a weaker yuan as a weapon.

The longer the spat drags on, the harder it will be to unwind, said Bill Reinsch, senior adviser at the Center for Strategic and International Studies. While the short-term damage of the tariff back-and-forth isn’t too painful, the cumulative impact is significant, he said, adding that he foresees a long-term dispute, not a quick resolution.

Trump “only has one strategy, which is to hit harder,” Reinsch said. “It’s like two 8-year-olds having a staring contest. He’s betting that the Chinese will blink.”

Source:Bloomberg by Andrew Mayeda and Jenny Leonard

Trade wars are good, and easy to win — that’s a Donald Trump assertion which is giving succor to dollar bulls.

They see the greenback as a better haven than gold should the tariff tit-for-tat intensify. Four months after the U.S. president shocked equity markets with his vision of higher duties on imports to America, investors are discovering catalysts that should help the nation’s currency withstand trade turbulence better than gold.

“The dollar has become the main destination for safe-haven investors,” Ole Hansen, head of commodity strategy at Saxo Bank A/S, said by email from Copenhagen. “Geopolitical risk is on the rise, bonds and stocks have sold off and yet gold continues to drift lower.”

The prospect that import tariffs will reduce the biggest economy’s current-account deficit at a time when the Federal Reserve raises interest rates has created a rare opportunity. The dollar can be used both as a haven and in carry trades, according to Andreas Steno Larsen, a global currency strategist at Nordea Bank AB in Copenhagen.

The currency’s hold over gold is strengthened by the fact the metal is usually priced in dollars — they’re inversely correlated.

Bad Half

With bullion last week posting its worst first-half performance in five years, investors are recalculating how they weight traditional assets. The push is coming from a confluence of events, from Trump’s antagonistic stance toward America’s trading partners, to the fact that the Fed is winding down quantitative easing earlier than its counterparts in Japan or Europe.

The global stocks benchmark MSCI All Country World Index just notched its first back-to-back quarterly decline since 2015, and emerging-market equities posted the first drop in six quarters. Meanwhile the dollar is outperforming most major currencies. As the world’s most liquid bond market offers higher yields, the appeal dwindles for holding an asset bereft of an income stream such as gold.

Meanwhile, the currency strengthened its grip over gold prices, overshadowing other drivers including falling physical demand in India, industrial-demand expectations and dwindling investment flows in exchange-traded funds. About half of gold’s fluctuation since January could be explained by movements in the greenback, regression analysis shows. That’s a stronger bond than in any year in the past decade.“We’ve seen a very tight relationship between gold and the dollar recently,” Carsten Menke, a commodities strategist at Bank Julius Baer & Co. Ltd., said by phone from Zurich. “It’s very difficult to make money trading gold when the dollar is rising.”

At the same time, the 120-day correlation between the Bloomberg Dollar Spot Index, which was up 1.7 percent this year through July 3, and the S&P 500 turned negative in February. A stronger-than-noise reading of negative 0.3 meant the benchmark indexes moved in opposite directions more than not. A rallying dollar may itself be a headwind to stocks.

A “significant” driver of the dollar’s gains this year has been reduced risk appetite, spurring a tide of capital to dollar assets as emerging markets seize up, according to Jane Foley, head of currency strategy at Rabobank. That said, “the sheer liquidity associated with the dollar means that for some investors it will always be a safe haven,” she wrote in a recent note.

The U.S. is expected to start enforcing fresh tariffs on a range of Chinese goods on Friday, with the Asian nation poised to retaliate immediately. China exported more than $500 billion to America last year.

Friends in a Crisis

Of course, the metal and currency don’t always move inversely. During times of acute panic, such as the Greek debt crisis, they may rise together.

A long-dollar bet isn’t risk-free. Should the Federal Reserve be ready to call halt on the tightening cycle or company results start to disappoint, investors may want to reconsider, according to Wayne Gordon at UBS Wealth Management, who favors an allocation to gold.

“As we expect the pace of growth in the U.S. to soon peak and a recovery in Europe, I’m not certain the dollar would be the best place to be,” said the Singapore-based executive director for commodities and foreign exchange, who’s predicting the dollar will weaken by about 10 percent against the euro by mid-2019. “We remain convinced of broad dollar weakness in the longer term.”

For the moment though, those trusting in gold are keeping the faith — even if only in the long term.

“We don’t want to get ahead of ourselves in calling for the death of gold as a safe haven, given that it has worked quite well for thousands of years,” Matt Maley, an equity strategist at Miller Tabak & Co., wrote in a note. “But it is weird that it acts so poorly recently when other safe havens and defensive plays have been acting so well.”

Source:Bloomberg By Eddie van der Walt ,Sid Verma, and Ranjeetha Pakiam With assistance by Rupert Rowling

Chinese President Xi Jinping has an ambitious master plan for his country’s transformation into a wealthy, technology-driven global economic power. And U.S. companies need not apply.

That’s why the current trade rumble between the U.S. and China, in which the Trump administration is threatening to slap tariffs on $34 billion of Chinese imports and Beijing promises to respond in kind, is far more than just a spat over market restrictions, intellectual property rights and the epic U.S. deficit.

On a deeper level, the standoff reflects an escalating economic and military rivalry between a status quo power and one of the most remarkable growth miracles in history. It’s a clash between two divergent systems, (one state-directed, the other market-driven) with markedly divergent world views and national aspirations. That strategic tension seems likely to intensify, regardless of how the current brinkmanship over tariffs plays out.

It’s also a battle for global influence. Whereas the U.S. has long sought to spread democracy and free markets to other nations, China’s ruling Communist Party is just starting to pitch its heavy-handed growth model as an alternative for developing nations. And Xi is backing it up with hundreds of billions of dollars in loans for infrastructure projects from Asia to Europe and beyond.

In the U.S., a bipartisan consensus has begun to emerge that now is the time to stand up to China, even if many oppose President Donald Trump’s tactics. Senate Minority Leader Chuck Schumer, a Democrat, has attacked Trump for not being tougher on China, saying last week that failure to change Beijing’s behavior now could hurt the U.S. economy “for generations to come.”

With a roughly $13 trillion economy and expanding wealth, China is now going head-to-head with the U.S. in advanced manufacturing and digital technologies. It also has the wherewithal to make rapid technological progress in defense, particularly with air-to-air missile systems that pose a strategic challenge in Asia for the U.S. and its allies.

Xi is playing a long game, pursuing what he calls the “Chinese Dream,” or “the great rejuvenation of the Chinese nation.” To get there, he has set targets to double his country’s per capita gross domestic product (from 2010 levels) to $10,000 by 2021 and refashion China into a tech powerhouse, competitive in robotics, new energy-vehicles, chips, software and other bleeding-edge industries under his Made in China 2025 program. A separate development strategy envisions China ruling in artificial intelligence by 2030.

The aim is to produce global champions — not just national ones — and Xi’s government is ready to use the commanding heights of its one-party state to steer subsidies and use preferential policies and ambitious local content rules favoring Chinese companies to get there. At stake are industries that make up about 40 percent of China’s value-added industrial manufacturing sector, according to an analysis by the U.S. Chamber of Commerce, citing data by the Rhodium Group, a research firm.

The Trump administration views such deficits as alarming and Chinese trade practices as brash mercantilism, even a national security threat. U.S. Defense Secretary Jim Mattis labeled China a “strategic competitor using predatory economics” in January as he unveiled the Pentagon’s National Defense Strategy.

Xi views his economy’s shift into higher-tech manufacturing not only as a crucial part of its development, what with surging labor costs, a rapidly aging population and high corporate debt levels — but also as a fulfillment of China’s destiny. That process is well underway: China is set to overtake the entire euro area this year, according to data compiled by Bloomberg.

Talks to avoid a trade war have stalled in part over U.S. demands that China reduce state support for high-tech industries. While China has signaled a willingness to buy more American goods to balance out the deficit, it has refused to trade away what it views as an essential part of its economic future.

Tech companies are on the front lines of this contest for global supremacy. Back in 2013, Chinese investigators started making life difficult for American tech “guardian warriors” like Google, Intel Corp., Apple Inc. and Microsoft Corp. after a magazine with ties to the Communist Party sounded the alarm about their dominant role in Chinese networks and business.

The U.S. has been just as inhospitable to Chinese tech concerns, with telecommunication makers like Huawei Technologies Co., ZTE Corp. and China Mobile Ltd. being viewed as national security risks. The Trump administration has also weighed restrictions on Chinese companies and start-ups in sectors ranging from aerospace to robotics.

This week’s tariffs, however, may show which side has the stronger hand. The first batch will take force Friday barring any last-minute deal. Trump has threatened duties on another $200 billion worth of Chinese goods if Beijing imposes countermeasures.

Xi is betting that Trump will back down as price increases in politically sensitive states make him worry about losing the next election in 2020. Xi enjoys something closer to life-time job security, thanks to the repeal of Chinese presidential term limits in February.

The sharp downturn in Chinese stock markets amid rising trade tensions is scarcely a threat to his rule. His party-led government has a big say over strategy and investments plans at giant state-owned enterprises, which control 40 percent of China’s industrial assets and some of the world’s biggest banks.

Still, anti-trade rhetoric underpinned Trump’s election win, and if anything the former New York real estate developer has doubled down on using tariffs in spats with both foes and allies. Although polls suggest Trump faces difficult mid-term elections in November, a fight to replace a U.S. Supreme Court justice may prompt his political base to overlook slightly higher monthly bills.

Economists and trade experts who testified in June before the U.S.-China Economic and Security Review Commission, set up by Congress to track the national security implications of trade with China, say tariffs are likely to inflict a lot of economic damage on both economies and depress global trade.

Great Unwinding

China will also return the favor — Beijing has announced plans to target U.S. auto, aircraft, plastics and chemicals sectors — and “the imposition of tariffs will not solve the underlying Chinese distortive behavior,” warned Linda Menghetti Dempsey, vice president of International Economic Affairs at the National Association of Manufacturers.

Instead of using tariffs, the U.S. could’ve sought to join with the European Union and Japan to bring a case against China at the World Trade Organization. But that’s unlikely after Trump slapped tariffs on EU nations and Japan, while also undermining the WTO. His withdrawal from the 11-nation Trans-Pacific Partnership trade deal removed another key device to alter China’s behavior.

Some prominent academics are calling for more drastic measures to undercut China’s practice of trading market access for technology transfers, such as unwinding Asian supply networks in high-end tech sectors.

Just Beginning

Harvard Business School Professor Willy C. Shih favors tax incentives, and even setting up import processing zones in the U.S. to repatriate offshore suppliers for the likes of Intel, Apple and Microsoft. “It would strengthen our ability to sustain the most advanced semiconductor fabs in the United Sates,” Shih said.

In the end, the U.S. and China economic rivalry probably won’t be decided by administrative law judges or trade negotiators, but in the global marketplace. Right now, the U.S. still enjoys a lead in many tech and manufacturing sectors, particularly aerospace and biotech.

Yet the days when China could be dismissed as merely a low-wage assembly center for Western manufacturers are long gone. This is a country on what it views as a historic mission to become a 21st century economic power, and the contest is just beginning.

Source:Bloomberg

Chinese operators face tight constraints — ranging from official scrutiny of trade invoices to detailed justification for certain overseas transactions — put in place years ago to stem an exodus of funds. The cost of the 2015-16 shore-up-the-yuan campaign was high: the central bank burned through $1 trillion of foreign-exchange reserves, and took some criticism in international forums for how it managed the exchange rate.Fears of fresh domestic jitters might have contributed to verbal intervention on Tuesday, when the People’s Bank of China assured the yuan will remain “basically stable.”

“They’re concerned about any vicious cycles that might develop with the weaker currency spilling over,” to local stocks and “more worryingly to capital outflows,” said Adarsh Sinha, co-head of Asia currency and rates strategy at Bank of America Merrill Lynch in Hong Kong. “We haven’t really seen signs of big capital outflows yet, but if that did happen, that would be a bit of a problem.”

Sinha, whose team cut its forecasts for the yuan this week, said “I’d be watching the balance of payments data quite closely to get a sense of are capital outflows accelerating.”

Bank of America Merrill Lynch now sees the yuan dropping to 6.95 per dollar by year-end, versus a previous forecast of 6.80. It was at 6.6280 as of 2:07 p.m. in Shanghai. On Tuesday, it slid through 6.7 for the first time since August 2017.

With President Donald Trump’s administration scheduled to start collecting tariffs on a swathe of Chinese imports July 6, speculation had risen that China was guiding the yuan lower as a weapon in the trade battle, helping maintain the competitiveness of its exports. The danger of reigniting capital outflows argues against such a policy, the idea of which was rejected by the PBOC Tuesday.

“The currency is certainly not a weapon that the Chinese want to use as part of the arsenal in the trade war, because it’s a weapon that could pretty badly backfire,” Eswar Prasad, a trade policy professor at Cornell University and former head of the IMF’s China unit, said on Bloomberg Television.

Back in 2015 and 2016, it took much more than verbal intervention to quell the capital-outflow pressure. One school of thought even says it took an unpublished agreement among Group of 20 policy makers meeting in Shanghai to calm currency markets, in part through less-aggressive expectations of Federal Reserve monetary tightening.

Such a deal might be tough to envision this time around, given the U.S.-China trade tensions. That increases the importance of China’s capital controls as a brake, alongside outright intervention to sell dollars against the yuan.

Morgan Stanley, for one, sees the controls as proving their worth. “China’s more regulated capital account suggests that a repeat of 2015/16 is unlikely,” the bank’s currency strategists, led by Hans Redeker in London, wrote Tuesday.

If Chinese companies and individuals, fearing a loss of purchasing power, again desert the yuan for the safety of dollars, some metrics to monitor include the following:

• The monthly foreign-exchange reserves release; next due July 7
• The PBOC’s monthly foreign-exchange positions data; next due around July 15
• The PBOC’s monthly data on foreign-exchange settlements on behalf of clients, due July 19
• Quarterly current-account data, especially the “net errors and omissions” column that can include money outflows; next due late September

The PBOC has also sent signals it will let the market have a greater role in determining the exchange rate, as opposed to the opaque “counter-cyclical” factor introduced to steady the yuan last year, according to Cliff Tan, head of global markets research at MUFG Bank Ltd.

PBOC Governor Yi Gang’s endorsement of a “floating currency exchange-rate mechanism” indicated that “the reformers are fighting back” in China, Tan said.

Capital controls might make them all the more confident if traders start testing the yuan’s downside again.

Source:BLOOMBERG

The announcement tamped down fears of an abrupt escalation in the trade war between the U.S. and China that had roiled financial markets on Monday. Stocks in the U.S. and Europe rallied after the announcement, with the S&P 500 index up 0.7 percent at 11:00 a.m New York time on Wednesday.

The administration decided not to employ the International Emergency Economic Powers Act of 1977, or IEEPA, that would give the president broad authority to curb Chinese investments in the country. That option was favored by trade hawks inside the administration, including White House adviser Peter Navarro.

Reports that administration officials were considering IEEPA were refuted by Treasury Secretary Steven Mnuchin and Trump Monday after the market swoon. The Treasury Department moved ahead announcement of its plans to address investments two days earlier than scheduled.

The decision comes amid U.S. government allegations that China engages in widespread theft of intellectual property. The inter-agency CFIUS panel, if bolstered by Congress, can address those concerns while maintaining an open investment climate, Trump said in a statement.

Measured Strategy

The president’s choice shows that he is favoring a more measured strategy that requires coordination with Congress, rather than working solely through the executive branch. It’s also a win for proponents of a conciliatory tone in negotiations with China such as Secretary Mnuchin, who told reporters on Wednesday that moves to strengthen CFIUS aren’t intended to single out Beijing.

“This is not intended to target China,” he said. “It’s fair to say that certain countries will get a heightened review — I don’t think we need a list of special countries.”

Read more from QuickTake on CFIUS

While the action does not single out China, the president is still very much focused on Beijing’s practices that were outlined in the U.S. Trade Representative’s Section 301 report, according to an administration official who briefed reporters on the condition of anonymity. The report alleged China engages in infringement of intellectual property and forces companies to transfer technologies.

Mnuchin has been closely involved in drafting the CFIUS legislation. Trump on Wednesday increased pressure on Congress to approve the legislation, officially known as the Foreign Investment Risk Review Modernization Act, or FIRRMA, saying lawmakers must act fast.

“Should Congress fail to pass strong FIRRMA legislation that better protects the crown jewels of American technology and intellectual property from transfers and acquisitions that threaten our national security — and future economic prosperity — I will direct my administration to deploy new tools, developed under existing authorities, that will do so globally,” Trump said.

Broadcom, Qualcomm

Only five takeovers of American firms have been blocked by U.S. presidents on national security grounds since 1990. Trump has blocked two since he became president, most recently in March when he rejected Broadcom Ltd.’s hostile takeover of Qualcomm Inc.

That move sent a clear signal to overseas investors that any deal that could give China an edge in critical technology will be swatted down in the name of national security.

Implementation of the new CFIUS law may take up to 18 months because separate bills in each chamber of Congress need to be reconciled, and the government needs to write regulations, according to Derek Scissors, a China analyst at the American Enterprise Institute in Washington.

Asked about the timing of legislation, Mnuchin declined to provide a specific timeline but said the administration “will have a pilot program up and running quickly that will address critical technology.” The Treasury chief also acknowledged that the executive branch depends on the legislation for more resources and funding for implementation.

“The new congressional legislation strengthening CFIUS could still have a chilling effect on Chinese investment depending on how it is implemented,” said Robert Kahn, a professor at American University who previously worked at the International Monetary Fund.

Source:BLOOMBERG  By Saleha Mohsin and  Jenny Leonard  ,Justin Sink