• Economic Research
  • Fixed Income
  • Equities

When is a trade war not a trade war?

The latest feud between the US and China has sparked fears of an all out trade war, with much at stake for both countries and the wider world.

5 minute read

a picture of Donald Trump
Drop of Light / Shutterstock.com

Concern the US is heading for a trade war with China has escalated in recent weeks, prompting stock markets around the world to take fright and a flurry of alarming headlines. With huge implications for financial markets, investors are watching closely to see whether both sides continue to up the ante or a negotiated solution can be reached.

Washington and Beijing have exchanged a series of tit-for-tat measures against one another after Donald Trump, on March 8, signed orders to impose a 25 per cent tariff on imports of steel and a 10 per cent tariff on aluminium.1 A fortnight later, Trump’s administration announced punitive tariffs on about $60 billion of Chinese goods in retaliation for what it says has been the massive theft of intellectual property from US companies.2

The following day Beijing, which says it is “not afraid” of a trade war,3 retaliated. It drew up a list of 128 products that will face duties of up to 25 per cent if the two sides are unable to resolve their differences.4On April 4 it said imports worth roughly $50 billion would be targeted.5

Trump’s riposte didn’t take long to arrive, with the US President a day later instructing the US trade representative’s office “to consider whether $100 billion of additional tariffs would be appropriate …and if so, to identify the products” upon which to impose them.6

Good trade war, bad trade war

According to Aviva Investors’ senior economist and strategist Michael Grady, these developments were in many senses quite predictable. Given that Trump campaigned on a protectionist platform, the real surprise is that it look so long for events to unfold.

Xinxin Li, a partner at New York-based economic and political advisory firm Observatory Group, identifies two plausible scenarios for how things play out from here. In both cases, the outcome depends on the path Trump chooses to follow.

Under the first, which he labels a ‘good trade war’, Trump will use the threat of tariffs to push China to liberalise its economy by, for example, reducing the role of state-owned enterprises, pushing financial reform, and giving more access to foreign goods and companies. He argues this would likely give a strong helping hand to Chinese reformers such as Liu He, economic adviser to President Xi Jinping.

But if Trump wants to cut the trade deficit with China quickly, a ‘bad trade war’ is likely to ensue since from China’s perspective there is not much more to buy from the US, as US goods don’t enjoy a comparative advantage except in limited areas.  

“A deficit reduction of $100 billion per year is almost a mission impossible. The Trump administration will have to go back to high tariffs on Chinese goods, if it sticks to this target. It will likely trigger a tit-for-tat retaliation from China,” Li says.

A deal is likely

According to Grady, gauging where the process is heading, and what the end result will be, is not straightforward with such an unpredictable US president.

On the one hand, Trump suggested on April 4 he was spoiling for a fight when he tweeted in reference to the trade deficit with China: “When you’re already $500bn DOWN, you can’t lose.” On the other, six days later he tweeted: “Very thankful for President Xi of China’s kind words on tariffs and automobile barriers...also, his enlightenment on intellectual property and technology transfers. We will make great progress together!”7

Ultimately, Grady believes while Trump’s public rhetoric may remain robust, a deal is likely to be struck, with both the US and Chinese administrations having suggested they are prepared to negotiate.

He says there are huge advantages to the US of having an open trading system despite Trump’s protestations to the contrary. US consumers have “massively benefitted” from the decline in traded goods prices and these benefits are being threatened because of Trump’s fixation on restoring manufacturing production in the US.

“Undoubtedly there have been some losers as a result of bringing China into the global trading system, but the focus should be on compensating those losers rather than trying to reverse the broader benefits of free trade,” he argues.

Importantly, Grady believes that although Trump will want to be seen to have extracted concessions from China, he will not want to hurt his popularity at home by triggering punitive tariffs, for example on US agricultural exports. China has threatened to slap a 25 per cent tariff on US exports of soya beans. Worth $14 billion, the crop is the highest valued US export to China.8

“Politically the best outcome will be to look like he’s been tough with China, without actually imposing economically-material tariffs,” says Grady.

Concern a trade war with China could hurt American farmers has already prompted Trump to scramble for ways to protect them. He is considering dusting off the Commodity Credit Corporation, a programme created during the Great Depression to aid farmers. And he has also signalled he may look to re-join the Trans-Pacific Partnership, the free-trade agreement he pulled out of during his first week in office.9

Trump needs to tread carefully

Much could depend on November’s US midterm elections. With polls suggesting the Republicans will struggle to keep control of the House of Representatives,10 Grady says Trump is likely to try to find the most politically-expedient route. That means treading a careful line between appealing to his blue-collar voters who are generally supportive of increased protectionism, and not alienating the Republican-voting farming communities likely to be impacted by retaliation from China.

Trump’s need to appease American voters is in stark contrast to Xi. While China may have more to lose economically from a trade war, Trump has more to lose politically and, with its threats to target one of Trump’s key constituencies, China has shown it is well aware of that.

Nevertheless, Grady argues that the threat of an all-out trade war cannot be dismissed entirely. In the event one were to erupt, it could have a material impact on economies and financial markets. For instance, there are concerns in some quarters that if Trump decides to pursue an aggressive trade war against China, Beijing might opt to reduce its vast $1.2 trillion dollar holdings of US government bonds.11

James McAlevey, senior fixed income portfolio manager at Aviva Investors, believes such fears are overdone since there is nowhere China could re-invest such a large amount of money. “The US Treasury market is unique in terms of the liquidity it offers. No other market comes close, so we see virtually no prospect of large-scale Chinese selling,” he says.

Nevertheless, he believes the trend of recent years, which has seen China and other Asian nations scaling back their purchases of Treasuries, is likely to persist and could even accelerate.

“It’s another reason to be wary of Treasuries. That’s especially true of the long-end of the curve, since if the trade dispute intensifies we would also expect to see China starting to reduce the duration of its holdings,” McAlevey says.

Beware German automakers’ debt

James Vokins, senior credit portfolio manager at Aviva Investors, says basic economic theory suggests the industries that stand to lose most under protectionist policies are those that export much of their output, have globally-integrated supply chains (i.e. import a lot, too), and have little pricing power.

The threat of a trade war adds to his conviction it is sensible to be underweight bonds issued by European industrial companies in general, and German automakers in particular.

“If you look at what Trump’s been saying, he has clearly got the car industry in his sights. As the US is a big export market for German carmakers, it makes sense to be cautious of this sector,” he says.

He is also on alert for any damage Trump’s actions could inflict on those US companies which have become increasingly reliant on global supply networks in recent years.

“There may be increasing pressure on companies which have benefitted from production overseas to bring it back onshore. That’s either going to be inflationary or companies will have to absorb higher costs themselves, which will hurt their bottom line,” Vokins says.

By contrast, Richard Saldanha, global equity portfolio manager at Aviva Investors, has increased the size of his portfolio’s stake in several companies where he believes the shares have sold off excessively in response to the threat of a trade war.

“Some of these share price falls have been pretty large. Since we think ultimately the US and China will come to some kind of deal, this is a decent opportunity to add to positions in companies that are fundamentally sound and delivering strong earnings,” he says.

Looking further ahead, Grady says the neo-liberal, globalist argument is, at least for now, in retreat. The forces that created Trump and demands for protectionism are not going to go away in a hurry and could well intensify as and when the next recession arrives.

“Does that mean we’re going all the way back to where we were in the 1970s or 1980s? I doubt it. But the risk is that globally we are moving to reverse the free trade gains that have been made since the establishment of the World Trade Organisation in 1995. That would clearly be detrimental to global growth,” he concludes.


 Trump tariffs: US President imposes levy on steel and aluminium, BBC, 08 March 2018

2  Trump reveals $60bn of fresh tariffs on China as EU wins reprieve, The Guardian, 23 March 2018

3 China ‘not afraid’ of trade war with Trump, Financial Times,  06 April 2018 

4 China outlines tariffs on $3bn of US imports in response to Trump move, Financial Times, 22 March 2018

5 Beijing strikes back in trade war with US as Trump accuses China of 'theft', Sky News, 04 April 2018

6Trump proposes $100 billion in additional tariffs on Chinese products, CNBC, 05 April 2018


8 Donald Trump faces farmers’ wrath as China’s tariffs put US soybean exports at risk, South China Morning Post, 05 April 2018

9Trump is desperately looking for ways to save farmers from his trade war with China, Vox, 12 April 2018

10US midterm elections 2018: polls

11 Brewing US-China trade war spooks asset managers, Financial Times, 07 April 2018


Related views

Important information


Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1 Raffles Quay, #27-13 South Tower, Singapore 048583.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.