This article first appeared in Forum, The Edge Malaysia Weekly on April 2, 2018 - April 8, 2018

Financial markets were rattled by fears that a trade war might break out between the US and China. A trade war may or may not happen, but it is probably not the biggest risk we face. No, the real concern is that when we peer under the surface of global politics, it looks likely that recent developments in the US, China and the Middle East could create lots of turbulence in the coming months. Trade tensions will probably be just one of many potential flash points.

The US: A harder edge to its foreign and trade policy

President Donald Trump has recently replaced several senior members of his administration with people known for their more combative approach to foreign and trade policy. Secretary of State Rex Tillerson has left, replaced by Mike Pompeo, while National Security Advisor Lieutenant General ­H R McMaster gave way to John Bolton. Both Pompeo and Bolton are known for their hawkish views on important foreign policy issues such as North Korea and Iran. Both have advocated the use of force, with Bolton best known as the blunt-speaking and controversial US representative to the United Nations during President George W Bush’s time. It is rumoured that White House Chief of Staff John Kelly, who has tried to bring order and structure to Trump’s presidency, might also be forced out soon.

In the realm of economic policy, director of the National Economic Council Gary Cohn resigned in disagreement over Trump’s protectionist moves, with Larry Kudlow taking over. Although Kudlow is known to be an advocate of free trade like Cohn, he is said to have moved closer to Trump’s more nationalistic approach. The rest of the Trump economic team is dominated by officials who are sceptical about the virtues of free trade — Commerce Secretary Wilbur Ross, Trade Representative Robert Lighthizer and chief trade adviser to Trump, Peter Navarro, have long histories as opponents of free trade.

After a year in office, it looks like Trump feels less need to include in his team moderates who helped to tone down some of his more extreme inclinations. Instead, Trump now wants a White House staff comprising mainly of hawks who agree with his radical views, people who, far from restraining him, might actually egg him on. Well before these latest personnel changes, US foreign policy was already turning more hard line. This was clear in the defence and national security documents, released earlier

in the year, which sketched out a view of the world that was more militaristic and uncompromising.

A key departure from previous policies in these reports was the willingness to openly identify China as a strategic rival. This was followed by a series of recent trade measures that clearly targeted China. The US Congress has also passed a law allowing high-level US officials to visit Taiwan, reversing a long-standing policy of not annoying China by having a close relationship at senior official level with Taiwan. Thus, even if there is no trade war between the US and China (see ahead), relations are likely to get more troubled, as the US is determined to take a more robust approach to China in many areas.

A more troubled US relationship with China would be awkward for the rest of Asia, most of whom do not want to take either the US or China’s side, preferring to be friends to both. But if strategic competition between the two powers intensifies, East and Southeast Asia will be the arena for that competition, given the immense strategic value of this region to both. Big power machinations in the region would increase tensions, while Asian nations would have to worry constantly over whether the US might actually clash with China.

Get ready for another Middle East crisis

Another area where the recharged Trump administration is likely to change policy is Iran. Trump has consistently derided the international agreement that persuaded Iran to halt its nuclear weapons programme, believing that the US made too many concessions to Iran. Now, there are signs that he may pull the US out of this agreement and impose new sanctions on Iran — something that could derail that agreement and possibly cause Iran to reactivate its nuclear programme. Saudi Arabia recently warned that such a move by its rival in the Persian Gulf would prompt it to also develop nuclear weapons, unleashing a regional nuclear arms race in an area that is already simmering with tensions.

Moreover, Trump is a strong supporter of Israel, which has been laying the ground work for possible military action against Iran’s proxies in Syria and Lebanon — and maybe even against Iran itself. In recent years, Iran has become a major force in Lebanon and Syria, both of which border Israel. It supports the Hezbollah movement in Lebanon, which is the most powerful armed group there and which has intervened to great effect in Syria’s civil war. All this is anathema to Israel, which may feel it has to take military action to cut Iran and Hezbollah down to size.

A new conflict in the Middle East will almost certainly cause a spike in oil prices, which would slow the global economy and raise inflationary pressures. Such a conflict would also undermine global business confidence, reducing investment spending as well. Countries such as South Korea, India, Thailand and Singapore are vulnerable to an oil shock.

But China could also turn out to be riskier

Chinese President Xi Jinping has completed the consolidation of power he has sought. With term limits on the presidency abolished, he is set to remain China’s leader beyond 2022, when he had been originally scheduled to retire. Xi has ousted or marginalised all of his rivals and now dominates Chinese politics in a way that his two immediate predecessors could not. Under Xi, China has become much more assertive in matters of national security, as seen in its unilateral takeover of reefs in the South China Sea, turning them into larger islands that are likely to soon host Chinese military facilities. Xi’s actions since taking over as China’s leader show him to be a risk taker. Now that he is less worried that any policy misjudgement could allow his rivals to oust him, he is set to push foreign policy assertiveness and tough domestic policies even harder.

Xi has centralised more economic policymaking in his hands so that he can drive reforms more energetically than before. But he is no free market liberaliser. In particular, he is likely to more vigorously pursue policies to reduce credit growth in China, to get rid of the many financial imbalances that could undermine China’s economy. But, he also wants to see state enterprises play a key role in the economy. While he is happy to see private companies flourish, he seems to want them to remain subordinate to the state. All this marks a departure from the policies pursued by his predecessors, with unpredictable consequences. For example, weaning the Chinese economy off its addiction to debt is positive and important, but it will be a difficult project with many potential pitfalls.

The immediate issue: How will US-China relations play out?

We do not see an all-out trade war happening. China has responded to Trump’s aggressive trade actions in a judicious manner, which tells us that China believes that a bargain can be made with Trump. China is prepared to make some concessions to the US, as seen in the proposals that Xi’s close advisers, State Councillor Yang Jiechi and Vice-Premier Liu He, brought to the US early in March.

Similarly, the US has other priorities than a trade war with China. Trump is preparing for his forthcoming summit meeting with North Korean leader Kim Jong-un — he will need China’s help if he is to secure an acceptable deal with North Korea. As discussed earlier, Trump is also getting ready to move on Iran — the last thing he should want is to be engaging in multiple confrontations at the same time. One suspects that Trump will be happy with some concessions from China, so long as they are enough to demonstrate to those who voted for him that he has delivered on his electoral promises. Indeed, comments by US Treasury Secretary Steven Mnuchin and trade adviser Peter Navarro in recent days suggest that some form of deal is being negotiated between the US and China.

However, while a trade war is not likely, other forms of US pressure on China could still grow. Trump has indicated more restrictions on Chinese investments in the US, and his administration will certainly act tough on China’s alleged theft of US intellectual property. A good part of the big military build-up that Trump is planning will go into a huge increase in the number of US naval and air force assets deployed in Asia, with China as their primary target.

Conclusion: It is going to be tough for the region

For several reasons, Asia will be a major loser from these developments.

First, most of Asia is dependent on trade, so more trade tensions will hurt a key growth engine.

Second, a more troubled and competitive US-China relationship is the last thing that Asians want since the big powers’ tensions will play out in the Asian neighbourhood, undermining their own security.

And, finally, a likely spike in oil prices if Middle East tensions boil over could slow global demand for Asian exports while also reducing foreign direct investment in Asia.

It is going to be a very rough period for Asian economies.

Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy

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