The US is reaching important — and potentially disturbing — turning points, in politics as well as in the economy. First, the results of the midterm elections have changed the political dynamic, which will reorientate US President Donald Trump’s domestic and foreign policy directions. Second, the economy, while still growing strongly, is beginning to show signs of trouble ahead. Emerging Asian economies will have to prepare for even more turbulence ahead: They will have to step up domestic efforts to support demand while also overcoming differences so as to work together on trade and related issues.
Why the political shifts in the US matter to Asia
The midterm elections were highly consequential for the country’s direction. Having lost control of the House of Representatives, the lower house of Congress, Trump’s Republican Party can no longer offer him the relatively smooth endorsement of policy changes he has enjoyed in his almost two years in office. The Republicans did strengthen their position in the Senate, the upper house. But, while that will give Trump the leeway to make key appointments, such as judicial ones, he will struggle to get major legislation through Congress.
The elections will make politics in the US turn even messier, with consequences for Asia.
• With the midterms over, the campaign for the 2020 presidential election will begin, with aspiring candidates emerging and mobilising support. The country is going to be in permanent election mode for the next 24 months — government strategies and policies will be subordinate to that.
• Trump will feel that his political strategy of divisiveness appeals domestically and aggressive posturing abroad has been vindicated. After all, it does look like his late-stage barnstorming probably helped the Republicans do better than expected in the Senate vote. The election shows a divided nation, with a solid core of voters who are easily swayed by Trump’s hardline nativist appeals.
• Trump’s dismissal of Attorney-General Jeff Sessions immediately after the election provides a foretaste of the political turbulence that we should expect. Sessions’ firing is almost certain to set the stage for other provocative actions by the president — such as an effort to shut down the special prosecutor’s investigation into the Trump campaign’s dealings with Russia in 2016.
• The divided control of Congress spells policy gridlock, with the Republicans and Democrats unlikely to agree on the country’s pressing needs. The fiscal situation is parlous, healthcare is in a mess, immigration policies are crying for reform and public sector infrastructure spending is badly needed, but it is unlikely the current political atmosphere will allow the consensus that is needed to be crafted.
• Once the Democrats formally take over the House of Representatives in January, they are likely to embark on a series of investigations into Trump’s financial and other activities. They can use their powers of investigation to put Trump on the defensive. Much of the president’s bandwidth will be taken up defending his position.
• For Trump, his inability to push forward a domestic legislative agenda means that he will tend to focus on the areas in which he has less need for Congressional support: trade and foreign policy. It is unlikely that he will turn more accommodating — the greater chance is that he will try to replicate the “victories” he has won. For instance, as he tries to renegotiate existing trade agreements or develop new ones, he will probably insist on the clause he had successfully pressured the Canadians and Mexicans to agree to in the revised North American Free Trade Agreement treaty, one that gives the US a virtual veto over its trade partners’ concluding trade deals with countries it considers to be “non-market” — clearly targeting China.
This will make for a more dangerous world
With a presidency that is likely to be distracted by domestic controversies and less able to deliver on clear-minded strategies, rivals such as China and Russia will probably push the envelope in areas important to them, calculating that Trump will not be able to respond effectively if, say, Russia created a provocation in eastern Europe. China could press forward with its militarisation of the South China Sea. Other rivals such as Iran could also take advantage by stepping up operations against US allies in the Middle East.
Trump will almost certainly double up on his aggressive trade agenda, which proved to be popular with important voting blocs in the country. Trade-oriented Asian nations will have to expect the US administration to ramp up tariff and non-tariff measures as well as efforts to pressure Asian countries into making trade concessions.
On China, we would not be surprised if there were to be a temporary improvement in relations. Trump will be meeting Chinese President Xi Jinping at the end of November and there are signs that some kind of trade agreement is being negotiated. However, we do not see such an improvement going very far. The tussle between the two big powers has now gone well beyond trade to a more strategic one, with the US determined to push back against China’s efforts to assert itself in a range of areas.
What about the economy?
On the surface, the US economy looks in the pink of health. The labour market is tight, with employment growing at an average rate above 200,000 a month in recent months, well above what is needed to absorb the new entrants into the workforce. Not surprisingly, wages are accelerating. Activity indicators such as purchasing manager surveys suggest an economy still growing above its long-term potential growth rate of around 2%. Lead indicators point to continued growth in the next six months.
But the rapid growth is clearly the product of the tax cuts and raised spending that was announced earlier this year. These stimulants will fade as we get into the latter half of 2019, which is why the absence of new growth drivers is a worry: In particular, capital spending continues to lose momentum despite a strong economy and the tax cuts that had been expected to boost companies’ plans to expand capacity. Recent data on orders for capital equipment was surprisingly weak. On current trends, economic growth will cool rapidly by the third and fourth quarters of 2019, perhaps to less than 1%.
Still, the US Federal Reserve is, at least for now, set on its tightening path despite nascent concerns about the likely slowdown in growth in a year’s time. Rising wage inflation and fears of financial excesses point to a few more rate hikes in the coming months.
Slowing growth is not the only economic challenge the country faces. Its fiscal position is weakening rapidly while external deficits are also expanding.
• The trade deficit widened to US$54 billion in September, the largest deficit since the financial crisis (except for a brief spike in February this year). On a 12-month moving average basis, the underlying US trade deficit is at pre-crisis levels and the trend is clearly worsening.
• The budget deficit for the fiscal year that ended in September was US$779 billion, the highest since 2012 when the economy was just shaking off the effects of the global financial crisis. Adding in off-budget items, the true deficit is estimated at just below US$1 trillion: This is an extraordinarily large deficit for an economy which, being at a cyclical peak, should be generating huge revenue growth and a declining deficit. If more stimulus is added to the economy, say through an infrastructure spending programme that the Democrats may well support, then the deficit will grow even larger.
One result of these developments is that 10-year Treasury bond yields have surged to the highest levels since mid-2011. Further signs of fiscal laxity could cause a more destabilising surge in bond yields that will exert further pressure on the US economy.
Asian economies must build resilience against potential US-led risks
In short, the US could turn from protecting the existing international order and supporting the global economy to being a source of stresses as its imbalances grow.
Consequently, the region has to prepare for a period of stresses and turbulence.
First, regional countries need to organise defences against a US that will be pressing for more trade concessions. They have to act in concert to be able to withstand such pressures. That means quickly implementing regional trade agreements. It is good to see the Comprehensive and Progressive Agreement for Trans-Pacific Partnership now coming into force now that six of the signatories have ratified it. However, while the CPTPP is a high-quality trade agreement that will be good for the 11 participating countries, more needs to be done. The much larger Regional Comprehensive Economic Partnership is being negotiated currently — but is struggling to reach a conclusion because of an inability to agree on some important parts of the RCEP such as trade in services. The RCEP will offer Asian nations much more protection since it encompasses 16 countries and includes heavyweights such as China, India, Japan and Indonesia, which will vastly strengthen the unified group’s bargaining position.
Second, it must prepare for the boost the US gave to global demand for Asian exports to taper off by the second half of 2019, which would presage a downturn for trade-dependent Asian economies. Since the continued risk of emerging market turbulence limits the use of monetary policy, such as interest rate cuts, the emphasis must be on higher government spending to support demand. Another course of action would be to accelerate efforts to woo foreign investment and tourism.
Third, Asian countries should do more to leverage off some positive trends. One example is the accelerated pace of production relocation out of China. Such relocation has been evident for some years because of rising Chinese costs, but is now gathering stronger momentum because of the fears that the US will expand protectionist measures against exports from China. So far, the evidence suggests that it is Vietnam, Thailand and Malaysia that will benefit most from this relocation.
In conclusion, managing the consequences of political and economic changes in the US will be a key pre-occupation for Asian policymakers.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy