A Trade Truce Won't End the Economic War
The United States and China will reach a deal on trade issues, likely at a summit between Presidents Donald Trump and Xi Jinping. As part of the agreement, China will promise to purchase more U.S. goods, such as agricultural products and energy, and alter its stance on certain structural economic issues like technology transfers, intellectual property rights and service sector liberalization. But as always, the devil is in the details: China will try to bend the terms of any deals it signs, while Washington will not trust Beijing to abide by any agreement. Enforcement mechanisms will also spark heated debate. The United States retains the ability to immediately reimpose tariffs on China if the latter fails to attain specific milestones, or the United States could choose to lift certain tariffs only if Beijing fulfills certain promises. Ultimately, though, China and the United States are likely to disagree on the interpretation of any deal almost as soon as the ink is dry — for this reason, at least some tariffs will likely remain in place throughout the quarter.
Irrespective of any deal struck between the United States and China this quarter, Washington will craft other measures beyond tariffs to influence Beijing's behavior.
In the end, the United States' overall squeeze on China will endure as it fashions other tools beyond mere tariffs. As the United States and China enter a technological cold war, the United States will continue to scrutinize China's tech sector with quick-fire Justice Department investigations into alleged technology theft by Chinese companies and intelligence officers, while also targeting Chinese tech firms such as Huawei. Washington is unlikely to impose a wide-ranging export ban on the tech giant, although it is slowly developing export controls on emerging U.S. technologies. At the same time, the United States will closely screen Chinese researchers and companies working with American universities and research institutes. The White House, meanwhile, will also move to directly support increased U.S. research and development in the tech sector.
A World Divided Over China
Because the fallout from the Sino-American competition will be global, the rest of the world will endeavor to chart a course between the world's two largest economies. The United States will try to convince its allies to take active measures to counter China, but that strategy's effectiveness will be hit-or-miss as China attempts to drive a wedge between the United States and its alliance network. The United States will lean on its global partners to prevent the integration of equipment produced by Huawei Technologies into their 5G networks as the emerging technology sets a new mobile telecommunications standard. Although Washington will lobby hard to portray the company as a cybersecurity risk — threatening, in the process, to cease sharing intelligence with countries that use Huawei equipment — the United States will encounter difficulties in persuading allies to reject Huawei entirely, as evidenced by the United Kingdom's recent conclusion that the company does not pose a major risk.
While the United Kingdom, Germany and other European countries may not totally accede to the United States' wishes, European powers do recognize that China's economic and technological rise represents a threat, particularly as Beijing's ascendence has started to erode their own international competitiveness. With China and the United States locked in their own race to develop and field new technologies, Europe must provide a better foundation for its companies to compete.
To compete with China and the U.S. in the tech sector, European countries will galvanize domestic research and development efforts and initiatives.
France and Germany have proposed new antitrust rules to facilitate the creation of "European champions" that can compete with global American and Chinese conglomerates. Progress will be stalled, though, until the conclusion of European elections this quarter. The debate will continue, regardless, as France and Germany struggle to convince other EU member states, especially in Eastern Europe. (Some countries are less amenable to changes in EU competition laws and/or are willing to do business with China thanks to Beijing's trade and investment overtures.) In the meantime, France, Germany and other European countries will back domestic programs to boost competitiveness in strategic sectors, amping up research and development initiatives and related incentive programs.
Europe and the United States will implement mechanisms to counter China for their own reasons, but two key U.S. allies — Japan and South Korea — have remained on the sidelines. Because the two countries have deep economic ties with China, both harbor concerns about Chinese retaliation in the event they follow Washington's lead on opposing Beijing. Accordingly, Tokyo and Seoul find themselves in an uncomfortable position: They must appease the United States on security yet avoid alienating China when it comes to economics. Given that quandary, Japan and South Korea are likely to remain on the fence in the second quarter of 2019.
Decision Point for Auto Tariffs
At long last, it's decision time for the United States on whether to apply tariffs on auto imports. U.S. President Donald Trump has until May 18 to decide, and though he is likely to move forward on some tariffs, he won't apply them on all imports. Instead, the United States is likely to hand out initial exemptions to Japan and the European Union — including the United Kingdom — as the U.S. seeks to negotiate trade deals with both. Canada, Mexico and South Korea are also likely to receive exemptions. Whatever the case, the European Union and Japan will ultimately need to offer the United States significant concessions because any exemptions might only be temporary.
Japan has an easier path to avoiding auto tariffs than the European Union. When it comes to talks, the United States will demand increased access to Japan's agricultural markets, as well as certain quotas on its auto exports. The pair, however, already did most of the legwork on many issues as part of the Trans-Pacific Partnership negotiations. For the European Union, it's a different story. As we noted in our 2019 Annual Forecast, Brussels and Washington are clearly not on the same page regarding the purview of their trade talks. At present, the biggest bone of contention is agricultural goods — Washington wants to include them in an agreement despite the bloc's objections. Though Brussels and Washington will not resolve their core disagreement, their differences will not necessarily be enough to scuttle talks this quarter. The United States and Europe could very well reach an accord on less contentious issues related to nontariff barriers.
Clouds Loom On the Global Economic Horizon
As a whole, the global economy is in store for some turbulence this quarter, particularly in two places: Europe and China. On the Continent, Germany and Italy — two of the eurozone's three largest economies — have slashed growth estimates in recent months. This is particularly concerning for Rome, where slow growth will compound the problems of a weak banking sector and high public debt burden. A hard Brexit, meanwhile, could foment other troubles for the European Union, though it appears that Prime Minister Theresa May will ask Brussels for an extension to negotiate a new Brexit deal, thereby preventing another crisis in the bloc — at least in the quarter ahead.
In the Asia-Pacific, China's economic slowdown will continue to cast a pall over its major trading partners. For now, Beijing is taking sufficient steps to prevent the United States from imposing more tariffs on exports, but the country's own raft of domestic challenges, such as a fragile banking sector and high levels of corporate debt, will put the brakes on growth.
The U.S. Reconsiders Its Military Posture
Over the past year, the United States has shifted its security focus away from counterterrorism efforts in the Middle East and elsewhere and onto emerging threats, particularly from Russia and China. Washington's announcement of imminent troop withdrawals in Afghanistan and Syria fit into this pattern. In our Annual Forecast, we did not anticipate the extent of Trump's desire to reduce his country's presence in both theaters. Although the United States will maintain a presence in both countries, Trump has served notice that he will deliver on his campaign promises by withdrawing troops from Afghanistan and Syria in some form or fashion.
And as we laid out in our 2019 Annual Forecast, the intensification of the great power competition has accelerated the collapse of arms control pacts, as evidenced by the United States' withdrawal from the Intermediate-Range Nuclear Forces (INF) Treaty. The updated U.S. Missile Defense Review has directed the Pentagon's efforts toward missile defense systems that could also counter China and Russia's arsenals. The new arms race among the three will center not only on strategic weapons, including hypersonics, but also artificial intelligence, automation and cyberspace. These are all long-term issues, but the rest of the world will continue to demand that the trio establish global cybersecurity norms this quarter. None of the three, however, are likely to heed the calls, choosing instead to continue developing cyber tools for offensive purposes.
Washington Changes Middle Eastern Priorities
Another major priority for the United States is its global and regional campaign against Iran. Although European powers have not backed the White House's aggressive strategy, they have begun taking a harder line on Iran, demanding that Tehran make concessions on its regional strategy and ballistic missile program in exchange for Brussels' resistance to Washington's sanctions. That trend will continue this quarter as the United States turns the economic screws on Iran by granting the Islamic republic's oil customers fewer waivers from sanctions in May. For this quarter, however, Iran is unlikely to become more assertive in its nuclear program.
The decline of the Islamic State militant group in Iraq and Syria has also pushed the center of global jihadist activity toward Africa, ensuring that regional battles against al Shabaab, Islamic State-West Africa Province (ISWAP), Jamaat Nusrat al-Islam wal-Muslimin (JNIM) and other jihadist groups in Africa will be the primary focus of global counterterrorism operations. While the United States will play a significant role in facilitating regional counterterrorism operations in places like Somalia, its gradual shift away from a counterterrorism focus means that other countries, namely France, will be front and center in the fight against Islamist militants. Paris will continue its operations in Mali, Chad and Niger.
A New Reality for Oil Producers
For oil producers like Russia and Saudi Arabia, the new reality is continued cooperation. North American oil production is relentlessly rising, and the United States will continue to export crude oil at record levels. Such a shift in the oil market could finally force Moscow and Riyadh to form an alliance on oil production, formalizing a de facto affiliation that has overseen oil supplies since the start of 2017. While this bloc will be able to manage oil prices to a degree, the United States will make a convincing argument to keep production high to prevent any price hikes. The oil price issue will dog Saudi-U.S. relations, which are plummeting amid efforts by the U.S. Congress to reduce cooperation with Riyadh. As a result, the kingdom is looking to improve economic ties with the United States' rivals — China and Russia.
- With less than two years until the 2020 presidential elections, Trump has made it a priority to fulfill his campaign promises, but he has unfinished business on trade, Iran and North Korea.
- A ratification process fraught with difficulties awaits the United States-Mexico-Canada Agreement. Given the demands by the Democrat-led House, the United States is unlikely to approve the deal in the second quarter.
- Rifts at the World Trade Organization could widen this quarter over two critical rulings, including one on whether countries can invoke national security to defend their trade actions. If the ruling states that members cannot engage in such activity, the U.S. reaction could create trouble for the WTO.
- As the global economy slows, Trump will work to prevent the United States from entering a recession by 2020 — limiting his threats to impose more tariffs globally.
- The standoff between Venezuela's two self-declared presidents is likely to result in Nicolas Maduro's eventual exit, and the United States is hoping that increased sanctions will be enough to help oust the long-time leader.
Key Dates to Watch
- Spring: Presidents Xi Jinping and Donald Trump are expected to hold a summit regarding a deal on certain China-U.S. trade issues.
- March 29: Brexit deadline for the United Kingdom.
- April 17-18: Meetings between OPEC and non-OPEC members in Vienna.
- April: Semiannual U.S. Treasury report on currency manipulation due.
- April: Possible timeframe for a partial U.S. withdrawal from Syria.
- May 4: Expiration date for waivers for Iran's oil customers.
- May 18: Deadline for Trump to make a decision on auto tariffs.
- June 28-29: G-20 Summit in Osaka, Japan.