This article first appeared in Forum, The Edge Malaysia Weekly on September 10, 2018 - September 16, 2018

The US economy looks fabulous at the moment. Its job market remains solid with unemployment at the lowest level in almost two decades. Before the year 2000, one has to go back to the Nixon administration to see a jobless rate of less than 4%. The improvement is also broad-based — by gender, race and so on. This has helped fuel consumer confidence, spurring robust spending growth of almost 4% in the second quarter of the year.

The US equity market is soaring. Corporate profits are rising, earnings are surging and the overall market sentiment is positive. The benchmark S&P 500 Index is hitting record highs by the day. And all this is happening when a slew of negative macro news on global trade is unfolding.

Whether we like it or not, US President Donald Trump is taking most of the credit for the good news. His tax cuts are spurring the country’s gross domestic product (GDP) growth, which this year could possibly average 3%. His trade barbs with China — his main strategy to push the trade balance back into America’s favour — keep coming and are seen by hardcore supporters as proof of the strength of the Trump administration.

The US dollar has also rebounded since April. The hunt for safe-haven financial assets has caused investors to once again fall in love with the greenback amid increasing global uncertainties. Again, Trump will hail this development as a glowing testimony of his policy success.

Take a trip to other continents, however, and we will see the opposite. In Asia and other emerging markets, things do not look as fabulous. Their currencies are reeling — the Indian rupee is at an all-time low while the Indonesian rupiah has slumped to its lowest level since the 1997/98 Asian financial crisis. And despite multiple interest rate hikes in the past few months, the rupiah is languishing. The Turkish lira has also succumbed to pressure following the imposition of steep tariffs by the US while the Argentine peso is on a downward spiral.

Meanwhile, China’s economy is feeling the heat despite its continued retaliation against the tariffs imposed by the Trump administration. The country’s headline GDP growth will probably hit a multi-year low this year as inflation rises and business sentiment erodes. Unfortunately, this comes when growth is already slowing from the impact of the government’s measures to deleverage the economy. A 6% to 6.5% growth does not look too bad from the global perspective but for China, that level calls for more fiscal and monetary measures to defend its economy.

Many Asian economies are dependent on China, and the linkages are not just trade but also investment. If China sneezes, Asia’s export-dependent economies will likely start to sniffle, if not catch a cold.

Is it likely that these two regions will converge in terms of economic performance in the near term? The intensity of the trade friction between the US and China is an important determinant to watch. Judging by the steely personalities of the presidents of the world’s two largest economies, it is hard to be optimistic at this juncture.

Still, we cannot rule out the possibility that the trade hawks will eventually realise the long-term repercussions of a long-drawn-out dispute. For instance, a short-term “victory” may mean long-term pains for the agricultural players of the US and the manufacturers of China. Prices will also face upward pressure in both the countries.

Secondly, the US Federal Reserve is caught between a rock and a hard place. Not continuing its rate-hike plan will risk imbalances that could lead to an overheating economy. And if the economy is too hot to handle, the downturn could be severe. Although the US inflation rate remains relatively low by historical standards, surging asset prices are making policymakers uncomfortable. This can be seen from the Fed’s rhetoric in recent times.

However, driving rates up too strongly could risk a sharp downturn. Indeed, shrinking yield gaps (to below 20 basis points in recent days) are already signalling the growing possibility of a recession in the next one to two years.

At the risk of sounding too pessimistic, there are indeed numerous speed bumps ahead. For the US, a more balanced bilateral trade may not equate to an overall improvement in its trade deficit. One reason is that the fiscal stimulus that comes into effect following Trump’s massive tax cuts will lead to a yawning fiscal deficit in the near term. This will eventually be reflected in the country’s current account deficit. And, yes, you guessed it — Trump will likely not see any improvement in America’s overall trade picture. This leads us to another question: Will this situation morph into a currency war, especially if countries wish to keep their exports competitive?

A currency war, if it does materialise, could be more disruptive to the global economy. Businesses will suffer as investments are scaled down due to uncertainties. Swings in capital flows will disrupt global equity and bond markets, leading to further deterioration in business performance. Banks will adopt their standard playbook — cut financing channels to minimise their risk exposure. We can already guess what will happen if such a scenario unfolds.

The recent depreciation of the renminbi is a concern. Many think the Chinese authorities may not have weakened the currency on purpose. Instead, the weakness could be attributed to the market pricing in the prospects of a weaker near-term macro backdrop due to the trade war. But the Trump administration is already eyeing the renminbi’s path with caution. Any possible hint of currency manipulation will spur another round of disputes between the two countries and spark more volatility in the financial markets.

At the moment, the consolation is that China is still pledging to stabilise its currency, which has depreciated markedly against the greenback since mid-April. This is indeed a relief for many regional economies. Indeed, export-dependent Asian economies are banking on the continued stability of the renminbi. Without it, their economies will fumble as well.

There is no doubt that this is again a challenging period for the global economy. World trade is at a crossroads. And while the US is enjoying a healthy economy, others are scrambling to avert an economic disaster. Remember the punchline we read in the news recently, that “Trade wars are good, and easy to win”? Let us hope that the next one does not start with the word “currency”.

Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. The views expressed here are his own.

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