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What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
This update will not appear during the holiday season in late December and will return on January 7, 2020. Happy holidays to all our friends around the world!
The British election last week yielded a historic result. The Conservatives won a 78-seat majority in the 650-member Parliament, obtaining the highest number of seats since Margaret Thatcher led the party in the 1987 election. Moreover, Labour suffered a crushing defeat, obtaining the smallest number of seats since the 1930s. Jeremy Corbyn quickly said that he would not lead the party into the next election, but did not immediately resign, instead calling for a period of reflection. Boris Johnson gambled by calling an election and has won. He moved the Conservative Party strongly in a pro-Brexit direction, expelling party members who disagreed with him. In the process, he left little space between the Conservatives and Nigel Farage’s Brexit party, which did not secure any Members of Parliament. Farage, however, claims credit for Johnson’s win. In any event, the Conservatives obtained most pro-Brexit votes while Labour, by moving sharply to the left, failed to attract centrist-minded voters. Thus, the result is just as much Corbyn’s defeat as it is Johnson’s victory. The other big winner of the election was Nicola Sturgeon, leader of the Scottish National Party. Her party obtained 48 of the 59 Parliamentary seats in Scotland, setting the stage to make a strong claim on holding another independence referendum. Johnson, however, has said he opposes such a referendum. Scottish voters oppose Brexit and now they will reluctantly experience it. They will likely clamor for the ability to remain in the EU, separate from the United Kingdom. Meanwhile, investors were clearly pleased with the result as it offers a greater degree of certainty about the near term than the alternative. Hence, the pound and the UK stock exchanges surging in early trading.
So, what happens next? It is a near certainty that Brexit will take place at the end of January. Besides that, there remains some uncertainty. Johnson ran on a promise to “get Brexit done.” Yet the agreement that the United Kingdom signed with the EU calls for a permanent resolution of the relationship by December 31, 2020. Almost no one believes that this is possible. Thus, there are three possibilities: an extension, ending the transition without a free trade agreement, and an off-the-shelf trade agreement without any of the bespoke concessions that British businesses crave. And, if there is no—or a limited—trade agreement, the frustration in Scotland could intensify and the possibility that the United Kingdom will break up will increase. Moreover, Northern Ireland will be an issue in the event of a no-deal Brexit, potentially putting the Good Friday peace agreement at risk. Thus, the situation remains fluid.
After much confusion, the United States and China announced a limited preliminary phaseone trade deal. Last week, US President Trump tweeted that a deal was “very close,” leading to a sharp rise in US equity prices. Then the press reported that Trump had approved a deal in which the United States would cut tariffs in exchange for China boosting purchases of US farm products and making other changes. Trump tweeted that the press reports were wrong and that tariffs will not be cut, leading equity prices to fall. Then, later, the United States and China announced that there will, in fact, be a deal that will involve modest tariff reductions.1 The deal mainly has the United States cancelling plans to raise tariffs on December 15, and cutting tariffs on roughly US$120 billion in imports from 15 percent to 7.5 percent. The tariff reductions will take place in stages. However, existing 25 percent tariffs on US$250 billion in imports will remain in place. According to a statement from the US administration, the deal will require that China make “structural reforms and other changes to China’s economic and trade regime in the areas of intellectual property, technology transfer, agriculture, financial services, and currency and foreign exchange.” In addition, China pledged to boost imports of US farm products by an unspecified amount. In fact, neither side released the text of the agreement. Although US trade negotiator Robert Lighthizer said that the deal is enforceable, it is not clear what enforcement mechanism, if any, is part of the deal. Rather, it seems likely that the principal means of enforcement is the threat of renewed tariff increases on the part of the United States. Nor is it yet clear what specific structural changes China agreed to make. It is unlikely that it agreed to anything that will fundamentally challenge its existing economic model.
With respect to the Chinese pledge to boost purchases of US farm products, a Chinese official said, “China will increase its purchase of quality American agricultural products that are competitive in the market.”2 This is a significant statement in that China failed to meet the US demand to import a specific quantity of imports. Chinese officials complained that this would violate the rules of the World Trade Organization (WTO) and would go against the goal of having trade driven by market considerations rather than government fiat. In any event, the US administration is keen to help farmers, an important political constituency, especially given the price they have paid during the trade war. US farmers have faced significant Chinese tariffs, which have led trade to be diverted from the United States to South America. As a consequence, farm bankruptcies in the United States are up 24 percent from a year ago and farm debt is expected to reach a record high very soon.3
Many business groups in the United States welcomed the deal. Trump said that negotiations on a phase-two deal will begin immediately. By cutting some tariffs, the deal provides some relief to US importers. Moreover, if perceived as stable, the deal might have a positive impact on business investment in the United States and China. That said, uncertainty remains about when or if a phase-two deal will be reached, if the United States will resort to tariffs again in order to compel China to meet future demands, and if the United States will impose new tariffs on other countries or specific products, such as automobiles. Continuing uncertainty is likely to have a negative impact on investment.
Last week, the WTO became comatose—that is, it no longer has the power to do anything. This is because the WTO’s Appellate Body lost two more members and, with only one member, it no longer has a quorum.4 This results from the US refusal to allow the appointment of new members to the Appellate Body. The United States is protesting what it sees as judicial overreach on the part of the Body and wants substantial changes.
This is an important time in trade history. Recall that, in 1999, world leaders met in Seattle to celebrate the launch of the WTO and were faced with 50,000 protestors who claimed that further trade liberalization would benefit big corporations and the rich and impoverish the poor. They were wrong—trade liberalization disproportionately benefits lower-income households and creates more competition for big companies.
What will be the impact? Initially, there will not be much impact. There are disputes currently set to be adjudicated by the Appellate Body. Those disputes will continue, and the parties involved will likely take unilateral action to punish their counterparts. In the longer term, however, the lack of a method to enforce global trade rules may lead individual countries to act with impunity, knowing that the WTO cannot impose sanctions. This means that the WTO will be a paper tiger.
Meanwhile, the major countries of the WTO are discussing ways to resolve the dispute. In addition, the EU plans to establish alternative methods of resolving trade disputes outside the WTO architecture. It has also proposed changes to the Appellate Body that have been rejected by the United States. The countries that are most eager to resolve the dispute are China and Russia that often use the WTO architecture to resolve disputes. Contrary to what the US administration says, the United States has mostly won its cases at the Appellate Body.5 Still, other countries see the WTO as the only way to assure a fair hearing and are worried about the world fragmenting into a complex and costly series of bilateral agreements among countries.
The US Federal Reserve, as expected, left interest rates unchanged last week.6 The decision was unanimous. Moreover, the Fed indicated that this was not a temporary pause, but rather a new strategy. It intends to keep rates unchanged in 2020, or at least until inflation shows signs of accelerating. Thus, going forward, the risk for interest rates is on the upside. Why? After all, inflation has remained tame, below the Fed’s target, and expectations of inflation have lately declined. The reason is that the Fed believes that, as long as the economy keeps growing, and the labor market remains tight, eventually this will lead to accelerating wages that will be inflationary. Fed Chairman Powell said that there used to be a strong connection between a tight labor market and inflation, but that “as the Fed got control of inflation, the connection got weaker and weaker and weaker to the point where there is still a connection, but it is a very faint one.” Thus, the Fed now wants to keep rates unchanged until the connection grows stronger. Still, this may take time.
Powell said that, because there continues to be slack in the labor market, there remains room for formerly discouraged workers to rejoin the labor force and, in the process of boosting supply, hold down wages. He said, “The fact that low- and moderate-income communities have such high levels of unemployment and low levels of labor force participation tells you that there is slack out there.” Yet he also indicated that, once the slack goes away, wages are likely to accelerate, thereby boosting the risk of higher inflation. When that happens, the Fed will likely have to increase interest rates. However, Powell said, “As you can see, inflation is barely moving, notwithstanding that employment is at 50-year lows—and expected to remain there. And so the need for rate increases is less.”7 Moreover, Powell warned about the dangers of inflation remaining too low. He noted, “Inflation that runs persistently below our objective can lead to an unhealthy dynamic resulting in worse economic outcomes for American families and businesses.” Finally, despite the Fed’s evident determination to leave rates unchanged in 2020, investors are pricing in one interest rate cut in 2020. They apparently believe that inflation will remain below the Fed’s target and that, as a consequence, the Fed will become concerned and will cut rates accordingly.
There is much talk about the degree to which the political crisis in Hong Kong will undermine that territory’s economy and financial system. Clearly, the economy has been hurt, with real GDP declining as a consequence of reduced tourist inflows and retail sales.8 The financial system, however, has been more resilient than many people expected. Activity in Hong Kong’s markets has been strong as evidenced by the recent successful listing of Alibaba shares on the Hong Kong market.
One of the fundamental components of Hong Kong’s stability is its fixed exchange rate versus the US dollar. This has been in place since a currency crisis in 1983 led the British government under Margaret Thatcher to end the floatation of the Hong Kong dollar and peg it permanently to the US dollar. The peg has held for a generation. It means that Hong Kong’s central bank lacks control of monetary policy. Rather, it is subservient to US monetary policy. If US interest rates rise, leading to outflows of capital from Hong Kong, the central bank meets the demand for US dollars by selling reserves and vice versa. Some observers have expressed concern that the political crisis might undermine the peg, leading to a sharp depreciation of the currency. Yet, so far, the evidence suggests that this worry is not warranted. The reserves of the central bank, at roughly US$433 billion, have barely moved in recent months.9 In addition, reserves have consistently increased in recent years. This means that there has not been excessive selling of Hong Kong dollars that would require a depletion of reserves. Investors have, therefore, not lost confidence in the peg. This is notable in that the history of international finance is littered with the remains of failed currency pegs. Hong Kong’s successful 36-year peg is an anomaly and demonstrates that the territory still has significant positive attributes despite political upheaval.
So, what could possibly undermine the peg? One possibility is the US government—the US Congress recently passed, and the president signed, a bill that gives the US government the power to suspend Hong Kong’s special trading status if the territory’s autonomy is undermined by the Chinese government.10 Currently, Hong Kong is exempt from the tariffs the United States has imposed on China. Nor are there any restrictions on exports of sensitive technology to Hong Kong. That could change if the United States implements the new legislation. Such a change could undermine investor confidence, potentially leading to a run on the Hong Kong dollar. While this seems unlikely, it clearly gives the United States leverage with China. After all, China’s government hardly wants to see the global centrality of Hong Kong’s financial system undermined. That would hurt China. That said, the United States would probably not want to do this given the potential cost to US financial institutions and the potential for disrupting global financial markets. One analyst said that the possibility that the United States would impose sanctions under the new law is a “nuclear option.”
The trade war is heating up again, largely reflecting statements made by the US administration.11 What follows is a discussion of the latest events.
One of the principal elements of US trade policy in the recent era has been the element of surprise—and it happened again last week. President Trump tweeted that he will reimpose tariffs on Brazilian and Argentine steel and aluminum.12 He said that this was in retaliation for substantial currency depreciation in these countries that had hurt US farmers. Brazil and Argentina are major agricultural producers and have lately increased their trade with China, in part due to Chinese retaliatory tariffs on US farm products. The United States had previously imposed tariffs on Brazil and Argentina on national security, only to later provide them with exemptions.13 Those exemptions are now being rescinded. There will be a 25 percent tariff on steel and a 10 percent tariff on aluminum.
The US complaint about currency depreciation is interesting as depreciation is not a policy of either country’s government. Rather, the Brazilian real and the Argentine peso have both fallen because of political uncertainty, economic weakness, and the strength of the US dollar.14 In fact, both countries would likely prefer that their currencies stabilize. That is because currency depreciation can lead to higher inflation and it hurts businesses and banks that have foreign-currency debts. Yet to facilitate a resurgence of their currencies, these countries’ central banks would have to tighten monetary policy, and that could exacerbate their economic weakness.
While there was speculation that the US administration would like the two Latin American countries to impose voluntary restraints on farm exports to China,15 it is not likely that either would agree to this. Moreover, such action would fly in the face of the rules of the World Trade Organization, which is meant to promote a market-based rather than a managed system of international trade. Meanwhile, Brazil especially will be hurt by the steel tariffs. Both Brazil and Argentina are in the midst of economic difficulties, with Brazil emerging slowly from a recession and Argentina deep in recession.
As retaliation for France’s digital services tax, President Trump last week said that he will impose a 100 percent tariff on US$2.4 billion in goods imported from France including champagne, cheese, yogurt, and handbags.16 He threatened to impose tariffs on traded services too. Additionally, he said that the US might impose new duties on products from other European countries as retaliation for EU subsidies for Airbus. France’s finance minister said that France is prepared to retaliate against US tariffs. He noted that the two countries had previously agreed that the digital services tax would remain in place for two years while OECD negotiations take place, and that companies would receive tax rebates in the interim. Thus, he indicated surprise at the latest US threat and said it was not warranted.
Meanwhile, the United States hoped to deter other countries from imposing similar taxes—taxes meant to collect revenue mainly from US-based technology companies. Yet the US effort is, evidently, not a success. Other countries still have plans to impose similar taxes. These are Canada, the United Kingdom, Austria, and Indonesia, among others. In the case of the United Kingdom, the plan is to impose a 2 percent tax on revenues of search engines, social networks, and online retailers.17 The taxes are even higher for other countries. For example, the digital services tax on revenue will be 3 percent in France and Italy, 5 percent in Austria, and 7.5 percent in Turkey. Canada also has proposed a 3 percent tax. Indonesia plans a 25 percent tax on profits while many other countries intend to extend existing taxes on online marketplaces to social networks and search engines. In any event, governments are keen to boost their revenues by tapping into new widely used technologies. A senior Austrian official said, “The goal of this is a same level of taxation for digital and traditional media in order to create a level playing field for all companies. Europe and the United States should—due to the current economic situation—work on a sustainable relief of the trade dispute, instead of compromising the relations with mutual threats of punishment.”
There have been efforts at the OECD and the European Union to find a common formula for this initiative—so far without success.18 For the United States, which is keen to protect the interests of US-based technology companies, the decision to impose retaliatory tariffs suggests one of two possibilities. Either the United States has given up hope that the OECD process will be successful or it is using tariffs to try to force a solution. After all, countries are not eager to face major US tariffs. Several Nordic countries rejected an EU proposal for an EU-wide 3 percent tax on digital services revenues because they were worried about potential US retaliation. How this issue will be resolved remains uncertain.
It is interesting that the current US administration is going to considerable lengths to protect an industry that is not a natural constituency for President Trump. Indeed, he said, “The tech companies you’re talking about are not my favorite people because they aren’t exactly for me, but that’s OK. They’re American companies.”19 Moreover, the US administration likely recognizes that these companies are the crown jewels of the US economy, that they will play the leading role in the burgeoning technology conflict between the United States and China meant to determine who will dominate technology in the 21st century. Also, it is worth noting that the CEOs of two leading US technology companies have lately made efforts to build a personal relationship with Trump.20
Late last week, President Trump said that he will be happy to wait until after the US election to conclude a first-phase trade deal with China.21 Specifically, he said, “In some ways I like the idea of waiting until after the election. The China trade deal is dependent on one thing: Do I want to make it? We’re doing very well with China right now and we can do even better.” This statement, combined with recent protectionist activity, has led many investors to downgrade their expectations regarding trade liberalization and to revise their expectations regarding the possibility of greater certainty. The result has been a decline in equity prices in the United States, Asia, and Europe. This comes at a time when many investors had become more confident that trade disputes would recede and that the global economy was bottoming. The latest action will likely boost the uncertainty that has hurt business investment.
One of the factors that have contributed to the slowdown in the global economy has been a sharp decline in global automotive sales. This is not likely to reverse soon. The problem from an analytic perspective is to understand why this has happened. After all, the decline has come about due to policy reasons (trade war), structural reasons (shift to electric vehicles, ridesharing apps, etc.), and cyclical reasons (global economic deceleration). While it is difficult to extract the impact of each factor, they are all creating challenges for the global economy. Interestingly, although the global deceleration of manufacturing has largely been attributed to trade tensions and uncertainty, a significant share of that downturn is due to problems in the automotive sector, and not all of those problems are trade-related.
First, a few facts. Global car sales grew steadily and strongly after the 2008–2009 recession, but fell for the first time—by about 1.5 percent— in 2018.22 In 2019, sales are expected to decline by around 4 percent, an even bigger decline than took place at the height of the global financial crisis a decade ago.23 The bulk of the decline is due to China that is, by far, the largest automotive market in the world. In China, sales fell 11 percent in the first 10 months of the year versus a year earlier. This was attributed to weaker credit market conditions, rising popularity of used vehicles, new emissions standards, and a general slowdown in the economy.24 Given that China is the largest market for Western automotive producers,25 the slowdown in China has reverberated around the world. In the United States, sales are expected to decline by about 2 percent in 2019 and even further in 2020, driven by weaker employment growth, rising popularity of ridesharing apps, and restrictions on trade. Sales are down in Europe due to slower economic growth and disruption from changes in environmental regulations. Other major markets around the world have seen a sales plunge. Thus, there appears to be a perfect storm hurting the industry. The decline in global demand has already led to a sizable reduction in employment in the industry that is likely to reverberate across many sectors that supply the industry. Many automotive producers have scaled back investment spending, both due to weaker demand expectations and uncertainty about how trading relations are likely to evolve.
Going forward, several factors that could influence the direction of sales. Many factors are likely highly disruptive. Let’s consider a few.
Trade relations are likely to have a big impact. First, the US-China trade dispute has involved tariffs on automotive trade, especially a sizable increase in China’s tariff on imported vehicles from the United States. How the trade dispute evolves in the coming year could have a significant impact on the industry. Moreover, US tariffs on steel and aluminum, which have already affected automotive producers, remain a source of uncertainty. Second, the USMCA, which is meant to be the successor to NAFTA, has yet to be approved by the US or Mexican Congresses. If implemented, it could lead to higher costs of automotive production and, consequently, higher prices and weaker demand. That is because the USMCA requires higher wages and higher domestic content than was the case with NAFTA. If ratification is further delayed, however, it will likely create uncertainty for automotive companies that could stymie investment spending. Third, the United States has still not indicated if it will impose tariffs on automotive imports as has been threatened, especially from Europe. The uncertainty has had a negative impact on investment by German automotive producers. If implemented, tariffs will significantly disrupt the industry on both sides of the Atlantic and could have a negative impact on economic growth and employment as well. Moreover, the United States has not promised that such a tariff will exclude Japan, although Japanese officials appear to believe they are likely to be exempted.
There are two main structural changes taking place in the industry. One is the move toward electrification, which is disrupting production processes in multiple markets. The other is a change in how people move around. The popularity of ridesharing apps implies a need for fewer vehicles. In the United States, fewer young people are obtaining driver’s licenses and more are choosing to live in urban environments where car ownership is less important.
The slowdown in the global economy implies weaker demand. There is clearly a risk of recession in Japan, Western Europe, and the United States. Even without a recession, weaker growth of employment and income will likely contribute to weaker demand for automobiles. Higher levels of consumer debt in the United States, China, and Korea could restrain automotive spending as well. Yet causality works in both directions. The automotive industry is so big that anything that disrupts or hurts the industry also hurts the global economy. The problem is that the trade situation and the disruptive structural changes in the industry are not likely to be reversed any time soon. Thus, the automotive industry is likely, at the least, to have a restraining impact on global economic growth in the coming year.
The US government’s employment reports indicate that the US job market remains surprisingly robust. The government reported that 266,000 new jobs were created in November, the highest since January. Thus, this number is an aberration compared to most of 2019, although it is similar to employment growth in 2018. One observation does not make a trend, so it would not be correct to say that the job market is suddenly accelerating. Still, the November report is impressive. Actually, there are two reports: one based on a survey of establishments, the other on a survey of households. What follows are the details.
First, as noted, the establishment survey indicated job growth of 266,000, the best since January.26 Notably, this included a 54,000 increase in the number of workers in manufacturing, including 44,000 new jobs in the automotive sector. This large number largely reflects the return of striking General Motors employees to their jobs. It means that, without the returning striking workers, there was not much growth in manufacturing employment. Also, there had been a similarly large decline in manufacturing employment in October. If the impact of the strike is excluded from the October and November numbers, then overall employment growth in each of those months was actually similar rather than the big gain seen in November. Even so, total job growth for the two months was quite strong, indeed much stronger than was needed to absorb new entrants into the labor force. In addition, most of the remaining job growth took place in three industries: professional and business services, health care, and leisure and hospitality. The increase in health care was especially large. Also, the government reported that real (inflation-adjusted) average hourly earnings of workers were up 3.1 percent in November versus a year earlier. This was a bit slower than the 3.2 percent increase clocked in October. As such, it does not appear that wages are accelerating, although they are rising faster than inflation. The failure of wages to accelerate further given the tightness of the job market is one of the puzzles that is perplexing economists.
Second, the separate survey of households paints a somewhat different picture.27 It found only modest job growth, but faster than the very modest increase in the labor force. The result was that the unemployment rate fell to a 50-year low of 3.5 percent. In addition, the rate of labor-force participation fell slightly as the growth in labor force was slower than the growth of the working age population.
What can we infer from the latest reports? First, it is clear that the US job market remains resilient. Yet the strong job growth is not consistent with the evidently slower growth of the economy. This inconsistently can only last so long. Moreover, strong job growth in the midst of a tight labor market cannot endure for very long. In part it is driven by the return of discouraged workers to the labor force. But this has limits given that many discouraged workers lack the skills needed for the jobs being created. Second, a tight labor market ought to generate greater increases in wages than are taking place. Either wages will soon accelerate or job growth will decelerate—both will happen together. From the perspective of the Federal Reserve, this is a very important issue and will play a role in determining the optimal monetary policy. Last week’s report, however, will surely reinforce the Fed’s decision to keep interest rates steady rather than continuing to reduce them.
In the past year, one of the key trends in the Eurozone economy has been bifurcation. That is, while exports and investment have weakened, consumer spending has been reasonably strong. Or, looking at it another way, while the manufacturing sector has been in recession, the services sector has continued to grow. Yet one worry has been that the troubles in the industry will spill over into services, and that the consumer side of the European economy will weaken. Well, it appears that might already be happening. The EU released the latest data on retail sales and the trend is in a negative direction.28 Specifically, real (inflation-adjusted) retail sales in the Eurozone were down 0.6 percent from September to October and were down in three of the last four months and four of the last six months. In October, real sales were up only 1.4 percent from a year earlier, the slowest rate of growth since May. For the month, there was an especially sharp decline in spending on clothing, electrical goods, and medical products. There was also a surprisingly sharp decline in online spending. Nonetheless, spending on automobiles increased. By country, there was a very sharp 1.9 percent decline in spending in Germany from the previous month. In France, however, spending was up 0.1 percent and in Spain, it was down 0.2 percent. Data was not available for Italy.
Meanwhile, the troubles in Germany’s industrial sector continue.29 It is reported that, in October, industrial production in Germany fell 5.3 percent from a year earlier and fell 1.7 percent from the prior month. In fact, German industrial output has fallen in five of the last seven months versus the prior month. Also, October output of capital goods was down especially sharply, falling 4.4 percent from the previous month. Germany is a major exporter of capital goods and this likely reflects weakening overseas demand for these products. Indeed, Germany also published data showing that orders for industrial products fell sharply in October. Moreover, production of intermediate and consumer goods increased in October versus the prior month. Thus, the weakness of German industry has much to do with weak business investment, both at home and abroad. That, in turn, is likely the result of trade uncertainty.
The Hong Kong economy is in recession.30 In the third quarter, real GDP fell sharply for the first time in a decade. The decline is, in part, a reflection of foreigners avoiding Hong Kong because of the unrest that has disrupted the society there for the past six months. The city-state depends heavily on tourist traffic, but in the third quarter, tourist arrivals were down 16 percent from a year earlier. Visits from neighboring China, which accounts for about 70 percent of tourists, fell 29 percent. This led to a 20 percent decline in retail sales in August versus a year earlier, the sharpest decline on record. The hotel occupancy rate in Hong Kong, which had been as high as 95 percent in late 2018, fell to 63 percent in September.
In addition to tourists, Hong Kong also depends on its role as a transit hub for goods leaving or entering China. But trade is also down, mainly because of the impact of the US-China trade dispute. In the three months leading up to October, imports into Hong Kong were down 11 percent and exports were down 8 percent. Besides, exports to the United States were down 24 percent in September versus a year earlier.
The future of the trade situation will depend, in part, on whether the United States and China can reach an interim trade deal before the end of the year. US President Donald Trump said that a deal is near. Specifically, he said, “I have a very good relationship, as you know, with President Xi. We’re in the final throes of a very important deal—I guess you could say one of the most important deals in trade ever. It’s going very well.”31
Meanwhile, Trump signed a bill32 passed nearly unanimously by the US Congress mandating sanctions on China if it interferes with Hong Kong’s autonomy. While the bill is mostly symbolic, it is clearly very important. Otherwise, the government in Beijing would not have been so critical of it. Beijing has complained that the bill represents interference in the internal affairs of China. Some observers were worried that if Trump signed the bill, it would reduce the likelihood of China agreeing to a trade deal. However, following Trump’s decision, Beijing criticized the US Congress regarding the bill but did not criticize Trump. This was seen as evidence that Beijing still wants to find common ground on trade and will not allow the bill to interfere with that goal. Meanwhile, Trump’s decision was greeted by euphoria in Hong Kong. The protestors see the US bill as signaling that the world’s richest country will not stand by idly should China crack down on the protests.
Why did Trump sign the bill? Apart from whether he thought the bill to be good public policy for the United States, there were likely other factors at play. If Trump had vetoed the bill, it would’ve been very likely that his veto would have been overridden by the Congress, thus embarrassing the president and weakening his leverage with China. Signing the bill enabled him to be on the side of a popular issue while, at the same time, signaling to Beijing that he may not make significant concessions in order to achieve a trade deal. Statements from negotiators on both sides suggest there has been progress on trade. However, these statements ought to be taken with a grain of salt. There have been episodes in the past year in which it appeared that the negotiators were close to a deal, only to have either Trump or Xi change their minds about what they were willing to do. That could still happen. So, the uncertainty continues.
In any event, the question remains as to what will happen to Hong Kong. Recently, there were district council elections in Hong Kong that resulted in a strong showing for pro-democracy parties. While the councils don’t have vast power, the polls themselves indicate popular sentiment and could circumscribe the ability of the government to act against the protestors. Here are the facts:33
The importance of this election is that more than two million people voted against Beijing. This fact makes it difficult to imagine Beijing taking violent action to quell the unrest—that could turn Hong Kong into a new Belfast or Beirut. On the other hand, the fact that pro-democracy parties did so well is now expected to quell the protest movement—at least temporarily. In a sense, the election represents a release of pressure. As such, equity prices initially rose on expectations that the polls would lead to a more peaceful situation.
In the longer term, unless the protestors obtain the democratic reforms they desire, it seems likely that the protest movement will continue. This leaves Beijing in a quandary. If it sends in troops to crack down on the protests, it could further undermine Hong Kong’s economy, which would reverberate in China, which, in turn, depends on Hong Kong’s role as a financial intermediary with the rest of the world. Cracking down would also damage China’s reputation in Taiwan where it hopes to convince the people that a one-country two-systems approach can work. On the other hand, China can hardly agree to democratic reforms in Hong Kong if it is not willing to do that on the mainland. So, what can it do? One option is to simply do nothing. That is, it can let the protestors stew in their own juices, thereby undermining Hong Kong’s economy. Meanwhile, it can take steps to develop Shenzhen and/or Shanghai into major financial centers which could effectively replace the central role of Hong Kong as China’s financial intermediary with the world.
In recent months, some indicators have suggested that the global economy may be bottoming out and that the downturn in economic activity is starting to reverse. However, some of the latest data on trade suggests otherwise. Specifically, the CPB World Trade Monitor reported that in September, the global volume of trade fell 1.3 percent from the previous month. In addition, the volume of trade was down 1.1 percent from a year earlier,34 the fourth consecutive month of declining trade. This figure has declined in six of the last 10 months. The decline in global trade volume was, not surprisingly, led by the United States and China. In the United States, imports fell 2.1 percent from August to September. In China, imports fell 6.9 percent. Bilateral trade between the two countries is declining at double digit rates.
Why is this data important? The answer is that trade drives economic activity, especially business investment. Indeed, we have seen declining investment in many economies, especially the United States. The decline in trade reflects rising obstacles to trade, decelerating demand, and changes in the structure of global supply chains. All other things being equal, the decline in trade will reduce the growth of global GDP. This has already happened. Plus, the decline in trade does not appear to be reversing, indicating that the troubles in the global economy are not waning away.
Meanwhile, the European Union (EU) has seen a more pronounced weakening of trade than other developed economies, according to the latest data from the Organisation for Economic Co-operation and Development (OECD).35 The OECD said that global trade declined in the third quarter of 2019 but noted that “the slowdown was particularly pronounced in the European Union, with exports contracting by 1.8 percent and imports by 0.4 percent. Exports and imports fell across all major EU economies, with declines of 3.6 percent and 1.7 percent, respectively, in France, and of 0.4 percent and 1.8 percent, respectively, in Germany.” The OECD also said that exports increased modestly in China and Japan but fell modestly in the United States. Imports for China and Japan declined. Exports declined in major emerging countries including India, Brazil, and Mexico.
What explains the relative weakness in Europe? There are several factors hurting European trade. First, weaker demand overseas, especially in China, has hurt German exports of capital goods. Moreover, there has been a synchronized slowdown in business investment around the world, thereby hurting Germany (especially). Second, trade uncertainty has hurt business investment in Europe and the United States. A survey by the European Investment Bank36 found that 70 percent of businesses in the EU and the United States said that trade uncertainty is a reason to cut back on investment. The uncertainty is mostly driven by the US-China trade dispute. Third, German businesses are uncertain about trade between the EU and the United States, especially given the US threat to impose tariffs on German automobiles and the recent tit-for-tat tariff increases made by both the United States and EU. Fourth, Brexit uncertainty is taking a toll as well, and is not likely to go away even if Britain exits the EU in January.
Finally, one important indicator of the health of the global economy is the health of Singapore. Indeed, a Deloitte leader in Asia Pacific recently said that if you want to see what is happening in the global economy, look at Singapore. So, let’s take a look: The latest data show that Singapore’s manufacturing output increased 4.0 percent in October versus a year earlier, the biggest increase since November 2018.37 There were big increases in pharmaceuticals (up 29.6 percent), consumer electronics, computer peripherals, and data storage. In addition, there was a modest 0.4 percent gain in overall electronics, a big change from sharp declines in the previous two months. And although semiconductor output declined 0.9 percent, it was far better than in the previous month. Singapore is an export-driven economy, so these figures suggest the possibility that global demand, especially from China, is picking up—although export volumes continue to fall. Notably, China’s purchasing manager’s index (PMI) for manufacturing just rebounded. On the other hand, Singapore’s minister of trade and industry warned that “the journey ahead is still long. The world’s many uncertainties remain. Singapore can be easily affected by the many downside risks.”
In China, household debt has been rising, reaching levels normally associated with much more affluent economies. The central bank has indicated concern.38 It said, “The debt risks of the household sector and some low-income households in some regions are relatively prominent and should be paid attention to.” According to the central bank, household debt is now roughly 60 percent of GDP in China. Compare this with 75 percent in the United States and 50 percent in Western Europe.
Besides, Chinese household debt is now roughly 100 percent of Chinese household income. Debt as a share of GDP has roughly doubled since 2012. This increase has fueled consumer spending, which, in turn, has helped offset the negative consequences of the trade war. However, the lion’s share of household debt in China is mortgage related and reflects the fact that the government has periodically encouraged property investment in order to stabilize economic growth. Plus, roughly two-third of the mortgage debt is held by households that own more than one property. That is, a lot of the increase in debt can be attributed to households engaging in property speculation. This is reflective of the fact that many households see property as a good vehicle for generating nonwage income.
Consequently, the central bank has said there should be restrictions on bank loans used for property speculation. It also called for greater scrutiny of borrower income and credit worthiness and said more should be done to educate lower income households about the risks of borrowing. For China, the sharp rise in household debt poses a risk to financial stability should there be a further economic slowdown.
In October, personal income in the United States barely grew while consumer spending grew modestly.39 However, spending on durable goods declined, indicating consumer caution. Let’s look at the details of the latest income and expenditures report from the US government: