China-US trade war is a great big diversion

By Paul Gambles

It seems like every time I read the newspaper or watch the news at the moment, all I see is the latest on the China-US trade war.

This story becomes particularly annoying when a non-expert journalist attempts to explain what’s happening and what it all means. When there are such complicated discussions, with far-reaching consequences, however, even specialists find it hard to anticipate exactly their impact in normal times. Considering that these times are anything but normal, with a crisis only a Trump-tweet away, it’s verging on the impossible.

For example, a trade war may have a negative effect on world trade. But then it may turn out to be advantageous for the emerging markets in Southeast Asia, as the US looks to do business elsewhere. The same may also be said for Canada, as China looks for other western destinations. Who knows?

Yet, complexity isn’t the only reason not to let trade talks dominate and investor’s thinking. The fact is, the China-US trade issue is merely a sideshow. Historically, trade wars don’t cause economic events, they are a symptom of an already deteriorating situation. For example, the USA’s 1930 Smoot-Hawley Tariff Act is sometimes cited as a cause of the Great Depression. But the Fed’s tightening policies, massive drops in crop prices and debt-laden speculation on Wall Street had already happened before Washington, and much of the rest of the world, resorted to beggaring neighbours. What’s more, as Ha Joon Chang and many others have shown, protectionism, far from being disastrous, is what fuelled the respective actual and economic empires and industrial and financial revolutions of the British and American centuries.

But what about today? US employment figures may look good on the surface but scratch a little and you’ll see a different reality. In mid-May, the US Bureau of Labor Statistics reported that real average hourly earnings for all employees decreased 0.1 percent from March to April, seasonally adjusted. Despite a brief jump in the second half of last year, this is a phenomenon which has persisted for the last four years.

When the April US monthly jobs report came out, analyst Danielle Di Martino Booth of Quill Intelligence put it down to the bulk of jobs created being either part-time or lower-paid. Not only that, but real average hourly earnings of employees also fail to take into account a couple of important factors – namely how many employees there are and how many hours they’re working. A numerator without a denominator is meaningless.

When we dig deeper, we find that the US labour force participation rate declined by 0.2 percentage points to 62.8 percent in April, meaning that it was at the same point as in the previous April. The rate has been depressed since it peaked at the time of the 2000 Dotcom bubble burst and has remained stagnant for the last six years. Hardly green shoots of recovery.

So, fewer Americans are participating in the workforce. But what does this mean in terms of actual numbers of Americans earning income? From 2010 to the end of 2018, the US civilian labour force increased by around 10 million people – over 1 million more Americans each year earning (and spending) income.

However, this year has seen a fall in those numbers by the best part of 1 million. What’s more, in the ‘blue-collar’ sector, where the relationship between income and spending has been tight, that falling number of employees is being given fewer hours to work.

By contrast, Canada’s labour participation rate over the same timeframe has gone in the opposite direction:

Back in the US, April’s y-o-y GDP growth rate was around the same as it has been since 2010 – with the exception of a significant dip in 2015-2016 (Canada’s is half a percent less), US trade data shows a slowing down; corporate earnings are lower; capital expenditure is down; so are auto sales; credit impulse and debt servicing is weaker.

If all that doesn’t tell us enough, there are the markets. Global equity markets are lagging US equities, which is dangerous because the latter seems to be quasi-Pavlovian, reacting automatically to Trump’s latest Twitter tirade. Meanwhile, the scarcity (or at least the high cost) of US Dollar liquidity is making it hard for stimuli applied in Emerging Markets, including China, to gain hoped-for traction.

These issues can be conveniently ignored, as the Federal Reserve seems to be doing. However, they’re not transitory problems, they’re fundamental. Mere patience won’t solve them – the Fed needs to get ahead of the curve if it’s not already too late. China’s stimulus programme is struggling, showing that no-one else is big enough to do it without America’s help. The trade tantrum has highlighted these issues, which is why we’ve moved our position from late-cycle we may experience some turbulence to buckle up, it’s starting to get really bumpy.

Maybe this situation will eventually cause the Fed to blink or US President to change his Twitter tone. I can see US 10-year Treasury bonds going up to 2.60 before dropping. In fact, the bond market could force the Fed’s hand to add stimulus – it seems to be the strongest force apart from Trump’s tweets at the moment. The problem is that the smart money may have already left the risk markets and the global economy by then.

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