A trade war truce? The US and Chinese economies need one, but they also need domestic reforms to stave off global catastrophe

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The world economy is on the brink of something nasty. Stock market valuations have seemed overstretched for a long time and pessimists have been looking for a good excuse to sell for months. It has been a tough call considering the deluge of cheap money flooding the markets and the bullish rip tide dominating sentiment in recent years.

It is no surprise that investors are harking back to events leading up to the 2000 and 2008 market crashes. Trade tensions, growth worries and mounting financial uncertainties are bad enough, but the added threat of an all-out currency war could be the final nail in the coffin.

There is time to pull back from the brink, settle differences and let wounds heal. After all, the global economy has a great capacity for recovery, as the world showed in the wake of the 2008 crash. With the right kind of mutual commitment, the world can mend fences, trade flows should bounce back and global financial stability can find its footing again.

Except Washington and Beijing are so deeply at loggerheads, the chances of an early reconciliation look remote. What’s even more worrying is that the US election cycle could be impeding matters now, leaving investors to wait until 2020 for a peaceful accord.

It is a high-risk strategy if US President Donald Trump drags things out until the last moment to seal a deal with China, paving the way for a timely stock market revival and thus a second term in office. Given the fragile state of global confidence at the moment, market patience is running thin.

Brinkmanship politics is the last thing the global economy or world financial markets need at this stage. The risk of more tit-for-tat trade protectionism, the threat of a full-scale currency war and the continuation of political hostilities all add up to a very dangerous environment, not just for the US and China, but for the rest of the world, too.

It is a less-than-zero-sum game, which brings us a step nearer disaster in leaps and bounds. We could be closer to a new crash than we think.

Top-heavy price/earnings valuations, accompanied by a general loss of economic momentum, suggest equity markets are more prey to stronger corrective forces.

It is not just that urgent concessions are needed the trade front, but that the US and China must make vital adjustments to their own domestic economies to ensure the best possible environment for sustainable recovery and global financial stability going forward.

Source: Refinitiv and Institute for Supply Management

To avoid the risk of the world slipping back into recession, key policy modifications are needed on both sides. It’s a tale of two economies, crying out for change.

Trump can’t rely on the US fiscal-led recovery lasting forever. A US Treasury yield curve inversion may be signalling the spectre of slower economic growth ahead, but it disguises a much bigger problem waiting in the wings.

US fiscal policy is far too expansionary thanks to Trump’s lavish budget handouts, creating potential disaster down the road in terms of the explosion of US government debt, which has now surpassed US$22 trillion.

At some juncture, this will overwhelm global savings capacity, forcing up long bond yields and causing a crowding-out effects for other markets. Domestic demand must be tempered with monetary measures taking the strain of any future stimulus.

Beijing must redouble efforts to revitalise domestic recovery and avoid unnecessary actions which end up inflaming Washington, especially the use of currency devaluation as a tool to boost exports. A much weaker renminbi would be fruitless when global trade is slowing and might even jeopardise Beijing’s 6-6.5 per cent growth target if trade hostilities worsen as a result.

Beijing should focus inward and expand domestic demand using much more effective fiscal and monetary expansion. It has the means and just needs to marshal its resources.

Time is running out. A trade truce between the US and China is long overdue.

David Brown is chief executive of New View Economics

Source:www.scmp.com/comment/opinion/article/3022372/trade-war-truce-us-and-chinese-economies-need-one-they-also-need

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