There Will Be No Going Back: Wall Street's Confounding Optimism Over An Elusive Trade Deal With China - Emerging Market Views

There Will Be No Going Back: Wall Street’s Confounding Optimism Over An Elusive Trade Deal With China

A sharp disconnect is emerging between America’s economic reality and Wall Street’s curiously blind optimism about the future, reflected in another record-setting streak for US stock prices despite a weakening economic outlook.

US President Donald Trump’s multi-front trade war has raised recession fears and contributed to a renewed contraction in US manufacturing activity, forcing the Federal Reserve to react by reversing course on interest rates and cutting them again three times this year. The Atlanta Federal Reserve is now forecasting an alarmingly weak 0.4 percent annualized rate of growth in the fourth quarter.

Yet stocks are happy to keep on trucking to new heights on even the tiniest rumor suggesting some progress on the trade conflict between the United States and China, the world’s two largest economies.

Long-term investors should be reticent, however.

For one thing, Trump has shown a distinct inability to stick to even any modest deals he does manage to strike. After pulling out of the long-standing North America Free Trade Agreement (NAFTA) with Mexico and Canada and following a painstaking renegotiation, Trump nearly torpedoed the entire process with a surprise threat, later recanted to introduce tariffs on Mexico based on immigration quotas.

Perhaps, and more importantly for those concerned about the long-term stability of the global economy, Trump’s erratic and roughshod behavior has likely damaged the world’s trading system irreparably.

That is not to say existing trade deals were perfect. Far from it. Most failed to address crucial issues around workers’ rights, the environment and even the democratic autonomy of nation-states. Hopefully, the next US president can and will begin to take on some of those concerns in earnest.

However, wrecking the system without any plans for what comes next as Trump is doing is even more destructive.

“By flouting international trade rules, the administration has diminished the country’s standing in the world and led other governments to consider using the same tools to limit trade arbitrarily,” wrote economists Douglas Irwin and Chad Bown, of Dartmouth College and the Peterson Institute respectively, in a recent Foreign Affairs essay.

“In some respects,” they added ominously, “there will be no going back.”

If Trump shares one thing with Wall Street, it’s short-termism and a focus that often leads to undue volatility and severe uncertainty. As the two instincts meld, it’s as if investors had become suckers for Trump’s age-old trick of touting ‘deals’ with superlatives before watching them fall apart in one way or another.

In other words, investors are happy to bid up share prices on mere talk or even glimmers of a deal with China, however flimsy the details.

Witness the market’s reaction to the widely touted Trump administration news that it had reached a tentative first agreement with China on several of the outstanding disputes between the world’s two largest economies. They even called it “Phase 1” to make it sound official and locked in. Surely “Phase 2” is around the corner.

But the news flows out of China are quite distinct from the optimism coming out of the administration. Many officials there believe, quite sensibly, that Trump is too volatile to be trusted, and that any real progress toward a truce will have to wait for another administration.

Moreover, the market’s faith in the possibility that the Trump administration can actually achieve a firm, lasting trade peace with China and other key partners is belied daily by political headlines that show the president is in increasingly tenuous territory as Congress’ impeachment inquiry gathers steam.

How can a foreign country strike a deal with an American leader whose authority and legitimacy are actively, constantly—and rightly, being questioned?

In other words: Trump lit the match on a global trade war that will probably outlast his increasingly challenged time in office.