Straits Financial Chief Economist Commentary - December 2024

Several reasons not to overly worry about Trump’s threat of US raising tariffs

Summary:

• There is no cause for significant concern regarding the impact of the US raising tariffs on China's exports next year. Since 2018, China's dependence on the US market for exports has been continuously decreasing, while the export market share of other developing economies has been increasing. As long as the overall trade deficit of the UN does not decrease, it means that even if China's trade surplus directly against US decreases, China's overall trade surplus may still remain.

• The real policy move that Trump can have a significant impact on China's overall exports is to cut fiscal spending. The cycle of US fiscal spending is highly positively correlated with the overall trade deficit cycle. Only a significant reduction in US fiscal spending can lead to a substantial decrease in the overall US trade deficit. However, a significant reduction in fiscal spending would also shake the foundation of the US economy and stock market. Thus, implementing this policy would be a significant challenge for Trump.

• The US is heavily reliant on the current economic development model, which Trump is unlikely to change. The current US economy is currently being dominated by high-tech and service industries, making it almost impossible to return to the manufacturing dominated economic model of 50 years ago, leading to more dissatisfaction of the middle and low-income American working class population.

• From Trump’s advocated policies, including corporate tax cuts and deregulation, the monopoly of large capital and giant corporates in the US will only be stronger, and the gap between the rich and the poor will also be wider. Cutting fiscal spending will lead to a further decline in the living standards of low-income groups, while rising tariffs and mass immigrant deportation will result in an increase in inflation. Therefore, these policies are unlikely to solve the problem.

• On 8th November, China’s Ministry of Finance launched a plan to swap 10 trillion RMB LG shadow debts over the next 5 years, of which RMB2 trillion will be done this year. The net issuance of refinancing bonds by LGs in November has exceeded RMB2 trillion, which will not only alleviate LG funding problem at year end but will also  positively  impact the domestic economic fundamental and financial market liquidity.

• With the increase in government fiscal stimulus and the scale of LG bond refinancing, we expect that the domestic economy and market liquidity will improve in the future. Therefore, A-shares are expected to steadily rise up.

• For commodities, we believe that the overall price upside is still not big. After taking office, Trump may immediately repeal Biden government's clean energy plan and related subsidies, and at the same time, lifting the restrictions on domestic oil digs in the US. Therefore, we believe that Trump's coming to power puts certain pressure on the prices of clean energy related metals and oil commodities.

Previous Views:

Since September, with the introduction of various stimulus policies, China's fiscal expenditure and broad-based deficit increased rapidly. We expect this will improve domestic economic fundamentals, with Q4 2024 GDP recovering to 5% YoY growth. Overall, A-shares may rise again, but it will focus on small and medium-size cap thematic stocks.

Views in December:

I.                 No need to overly worry about the impact of Trump tariffs on China's exports next year

As the US general election ended with a resounding victory for GOP and Trump, the market became increasingly worried about the US raising tariffs on Chinese exports. At the same time, due to concerns about a significant decline in China's overall exports next year, the RMB exchange rate has also weakened significantly, and the domestic stock market's expectations for the Chinese government to introduce a new round of domestic stimulus policies to hedge against the risk of weakened external demand continue to rise.

However, we believe that there is no need to worry too much about the impact of the Trump 2.0 government's tariff increase on China's exports. Although in the short term, raising tariffs may have an impact on some Chinese direct exports to the US, we believe that this impact will be  short-term. Since 2018, China's dependence on the US market for exports has been decreasing, and the proportion of direct exports to the US in China's exports has decreased from 20% to around 15% (see Figure 1).

Over the past few years, the regions where China's exports have grown rapidly have mainly been developing economies such as ASEAN, Russia, Africa, and Latin America. The Chinese government will continue to increase China's export share to these developing economies through diplomatic and trade negotiations, foreign aid, and “One Belt and  Road Policy”.

Source：Bloomberg，CEIC，Wind

Secondly, from a perspective of global trade, as long as the overall trade deficit of the US remains unchanged, it means that a decrease in China's trade surplus with the U.S. will not impact the overall size of China's trade surplus. . In fact, we can see that this is the case during the 8 years from Trump 1.0 to today (Figure 2). Within the 8 years, the average monthly trade deficit of the US expanded from US$40 billion to US$80 billion, but its direct trade deficit with China has actually decreased. The expansion of the US trade deficit in the past 8 years mainly came from Mexico, Vietnam, South Korea, Taiwan, China, Canada, and India.

Source：Bloomberg，CEIC，Wind

As long as the overall cost-effectiveness advantage of Chinese goods remains, regardless of whether the US will increase tariffs, the majority of the US trade deficit will still transfer into China's trade surplus. The most direct approach is for the US to purchase goods directly from China. To conclude, under the premise of a globalized trade system, regardless of whether the US raises tariffs or not, the overall balance between the US trade deficit and China's trade surplus is unlikely to change  in the future.

Source：Bloomberg，CEIC，Wind

We believe that this scenario fundamentally lies in the US fiscal policies. We have discussed several times before that the US fiscal spending and deficit have significantly expanded in the past 5 years, leading to a significant increase in the overall import growth. This is the main factor that has caused the US monthly trade deficit to expand from US$40 billion before the pandemic to US$80 billion. The rolling 12-month total fiscal outlays by the US government is shown in Figure 4 below.

Source：Bloomberg，CEIC，Wind

Based on Figure 4 that compared to pre-COVID19, annual fiscal outlays have increased by approximately US$2.5 trillion. At the same time, the US trade deficit has expanded from US$500 billion per year to US$1 trillion. From this perspective, the significant expansion of US fiscal spending over the past 5 years has not only been the biggest driving force behind US economic growth and stock market record highs, but also the main reason for the US exporting excess liquidity to the world, leading to asset price growth in various countries around the world.

However, in China, although the trade surplus has increased significantly, foreign exchange reserves have not risen. This means that the capital brought by the large surplus has not really flowed into the country, but has been retained overseas or invested in various assets overseas. Therefore, A-shares and Hong Kong stocks have not benefited from this.

Therefore, the real question is, if Trump truly wants to reduce the trade deficit, there is only one effective way to do so—significantly reduce US government fiscal spending. Although we have seen Elon Musk talking about cutting US fiscal spending during the establishment of DOGE and the new nomination of US Treasury Secretary Bessent, it simply cannot change the fact that the expansion of US fiscal spending has been the most fundamental supporting factor for US economic growth and global stock market gains in the past 5 years.

From this perspective, no trader in the market currently believes that the US government is likely to reduce its total fiscal spending in the next two years. Therefore, for China's exports, Trump's coming to power does not imply that there is no risk.

II.                Growing path dependence and political divergent risks in the US will remain unsolvable

The US has a huge growing path dependence on the current global economic model, which, in our view, Trump can hardly change. For example, Trump repeatedly advocates "manufacturing back to the US" and "MAGA" starting his first term of office. However, from a data perspective, during his first term, the proportion of manufacturing in the US GDP continued to decline. When he won the 2016 election, the manufacturing industry accounted for 10.8% of US GDP, but when he left office in 2020, this number decreased to 10.1% (see Figure 5). On the contrary, during the past 4 years of Biden's presidency, due to the impact of the pandemic on global supply chain, the demand for domestic output has increased, manufacturing has slightly rebounded to 10.2% of GDP. However, looking at the long-term cycle of the past 70 years, there is still no sign of a reversal in the overall decline in the proportion of manufacturing in the US economy.

Source：Bloomberg，CEIC，Wind

Also, from the perspective of capital expenditure, the same pattern applies. The US economy is currently being dominated by high-tech R&D and service industries, making it almost impossible to return to the manufacturing dominated economic model of 50 years ago. Looking at the capex of US companies, the proportion of R&D investment is also increasing (see Figure 6), hence traditional manufacturing industries which are labor-intensive and capital intensive are unlikely to become the dominant core of the US economy again.

Source：Bloomberg，CEIC，Wind

However, from a sociological perspective, the past economic structure shift in the US has inevitably led to a reduction in income and job opportunities for a large number of traditional manufacturing industry workers., The rise of American right-wing populism represented by Trump in the political arena is the result of this social dissatisfaction. The Democratic Party's response to this is a large-scale fiscal expenditure expansion which we had mentioned earlier, attempting to alleviate this contradiction through various welfare programs or even directly giving money to low-income groups. However, judging from the results of this year's US election, the Democratic Party's policy path choice is clearly a political failure. The Democratic Party not only lost all the swing states, as well as the majority of both houses of Congress, but also lost the popular vote to Trump in the general election for the first time.

But does this mean that Trump can really change the current economic development path of the US? We believe that the possibility is very low. Firstly, the current path of economic development in the US is highly favorable to large capital and the ultra-rich class, especially those who possess a significant amount of equity capital wealth. At the same time, this model is also very favorable to the monopolized companies in the US. In the past few years, the Democratic Party's large-scale fiscal expansion has further strengthened the advantages of these large capital and giant corporates. The policy proposals of the Trump government such as deregulation and corporate tax cuts will only further strengthen the advantages of these monopolized giants and large capital, so that they can gain a larger proportion in the economic growth benefits.

Similarly, if the Trump government significantly increases the overall import tariffs on the major trading partners, ordinary consumers in the US will also pay the price, especially for low-income groups.

III.                LG shadow debt swap plan helps to improve fundamentals and market liquidity

Since September, with the introduction of various stimulus policies, China's policymakers made significant efforts, and the growth rate of broad fiscal expenditure and deficit has significantly accelerated. On 8th November,  the Chinese Ministry of Finance announced a 5-year debt swap plan for local government’s shadow debts, with a total amount of RMB10 trillion. Among that, the newly added amount of bonds scheduled before the end of 2024 is RMB2.8 trillion, of which RMB800 billion will come from the already issued RMB3.9 trillion LG special project bond this year, and the remaining RMB2 trillion will be financed through the issuance of new LG refinancing bonds. In 2025 and 2026, the Ministry of Finance will provide an annual debt swap to LG shadow debts of RMB2.8 trillion per year. In 2027 and 2028, that number will be RMB800 billion  per year. The total debt refinancing plan in 5 years at RMB10 is shown in Figure 7 below.

Source：Bloomberg，CEIC，Wind

With the announcement of the Ministry of Finance's LG shadow debt refinancing plan, we have seen that since November, the speed of LG bond issuance has once again accelerated. According to our statistics, the net issuance of the two types of bonds mentioned above has exceeded RMB2 trillion in November, which means that the fundings available for 2024’s LG shadow debt swap plan have been basically in place (see Figure 8).

Source：Bloomberg，CEIC，Wind

The newly added RMB2 trillion in LG debt swap fundings will have a significant easing effect on the tight financial situation of local governments at the end of this year and the beginning of next year.

In addition, the increase in bond funds has increased the amount of social financing and  increased the total amount of funds in society.

IV.                Market strategy

The US stock market is currently in the atmosphere of “Trump trading”. We believe that the overall US stock market will remain strong. The market will focus more on Trump’s favorable factors of the stock market, such as tax cuts and deregulation, while overlooking factors that could have a negative economic impact, such as raising tariffs and cutting fiscal spending. We expect that this situation may continue until Trump officially takes office in January.

We believe that there is very limited room for a decline in the A-shares market. . With the increase in government fiscal stimulus and the scale of LG bond refinancing, we expect that the domestic economy and market liquidity will improve in the future. Therefore, A-shares are expected to rise slowly but steadily, with overall index may not move up too much, and the market will still focus more on investing in small cap and thematic stocks.

As for commodities, we believe that the overall price upside remains limited. After taking office, Trump may immediately repeal the Biden government's clean energy plan and related subsidies, and at the same time, lifting the restrictions on domestic oil digs in the US. Therefore, we believe that Trump's coming to power puts certain pressure on the prices of clean energy related metals and oil commodities.