As 2018 comes to an end, it is becoming clear that President Trump’s policies have shaped not only the acceleration of growth in the United States but many policy reactions and therefore growth trajectories outside the US. The decisive fiscal stimulus and financial deregulation in America have created significant momentum: wages, investment, and financial markets all show positive developments. What looked like a possible recession in 2019 is much less likely today than a year ago. In the meantime, Europe, China and the emerging world are plateauing at best, after a too short pickup between early 2017 and mid-2018.
The reasons for this growing divergence are: the uncertainty shock related to the so-called trade war, and the tightening monetary and financial conditions in dollars because of a high-pressure US economy. As of September 2018, the average US import tariffs entered the grey area at 5.2%, from 3.5% last year. The scarring effect on imported inflation and trade diversion is visible yet under control, including through the successful renegotiation of the US-Mexico-Canada trade deal (USMCA). On the contrary, China has started feeling the heat, both in terms of export growth and financial stress. The problem is that the US-China feud is not de-escalating. Some call it the “Thucydides’ trap”, others the new “Cold War”. For economists, the biggest risk is policy bullying, whereby countries are cornered and pushed to make policy mistakes as a coping mechanisms when affected by the double-whammy of protectionism and drying up liquidity. China has immediately reacted to the drop of confidence over the past months with more subsidies, more credit, and more economic diplomacy. The risk of a Minsky moment in China is increasing, but more importantly the hostility towards China has put on hold the natural opening of the country at a critical time for companies.
China is complex and certainly has many assets to withstand a cold war. Just like Europe or Japan, President Trump’s policy-making is a concern, but buffers and agility will help them weather the storm and hopefully benefit from a stronger America. This is not the case for fragile emerging markets. Argentina and Turkey are cases in point: both countries have become more vulnerable (twin deficits) and more politically unstable in the past years. The resoluteness of American policies has precipitated their fate with important financial stress. Policy mistakes explain their contractionary situation today. On the edge, Russia, because of possible new sanctions, and Brazil and South Africa, with potentially unorthodox policy-makers, must be watched. To a lesser extent, Indonesia, India, Hungary and Romania must continue to proactively curb overheating. Interestingly enough, most emerging markets are doing the right things, but it is the ones that are not that hit the front page of the news.