The big concern is not tariffs but the scrambling of a world order that protects small nations
To appreciate the true nature of the emerging risks, we need to assess the net effect of all the changes being wrought by the new US administration — its approach to other nations, including its protectionism as well as domestic policies on tax and spending cuts, the shake-up of government departments, radical deregulation and divisive social policies.
Nothing in Trump’s first term compares with the more extreme version of American First that he is pursuing — even though there have been occasions in the past when previous American administrations bullied their way around the world.
A basic question is whether the new administration has the capacity to make the right judgement calls on global issues. Unlike his first term, President Trump is now surrounded by officials loyal to his stark views of the world and who are likely to pursue his vision zealously. However, it is unclear if these officials have the depth of knowledge and nuanced understanding of global issues required in a more turbulent world. With few restraining voices in the administration, its early actions are already producing waves.
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Some of these early actions and statements threaten to undermine the norms that kept small nations secure — and could encourage other regional powers to act aggressively against smaller neighbours. One example is Trump’s casual announcement that the US is thinking of taking over Gaza, shipping its 2 million people off to neighbouring countries and building it into the “Riviera of the Middle East”. Aside from the disregard for the Palestinians’ rights, Trump’s statement casually consigned decades of American diplomacy to the wayside. At the same time, the US Secretary of State was in Panama demanding that it give in to America’s demands for greater control of the Panama Canal on the questionable premise that China controlled the Canal. This was after Colombia was pressured to accept illegal immigrants deported from the US in a manner that it objected to. Trump has also threatened to cancel all future assistance to South Africa simply because he disapproved of its domestic laws governing land issues.
The new president has also withdrawn the US from international agreements on global issues, which took years of delicate compromises to negotiate — the Paris Accords on climate change and the OECD agreements on global taxation are examples. The US is also walking out of the World Health Organization.
Trump’s officials have abruptly cancelled US foreign aid programmes. As America supplies 40% of global humanitarian aid, crucial funding has dried up overnight for initiatives to help many of those in extreme misery around the world. The soft power that the US gained through decades of good work is at risk.
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So, welcome to the new world of greater instability and insecurity.
From now on, forget about negotiating all-country solutions to critical challenges such as climate change, the contentious issue of taxation of multinational companies, and future pandemics. Other countries will also seize on America’s actions to pull out of international agreements. For example, Argentina is moving closer to leaving the Paris Accords as is Indonesia.
Of greater concern is how Rwanda has brazenly invaded the Democratic Republic of Congo — just as Trump was being inaugurated. Rwanda calculated that the US under Trump would not push back. In the many global flashpoints worldwide, we will now see regional powers tempted to commit aggression they would not have contemplated before: watch the Balkans, where tensions have been rising and the disputes in the Horn of Africa involving Ethiopia, Egypt, Somalia and Sudan.
Huge uncertainty over the protectionist threat
Trump’s protectionist threats have also significantly raised trade war risks. He threatened a 25% tariff on most imports from Canada and Mexico and then deferred these for a month after the leaders of the latter two countries offered modest concessions on illegal immigration and drug smuggling. He warned Europe that he would soon hit it with tariffs as well. Europe has promised a vigorous response against the US if that threat is carried out.
Trump has proceeded with a 10% tariff hike on China and suspended the postal deliveries of small parcels from China and Hong Kong, which helped China’s highly successful e-commerce firms export to the US. China has made it clear that it will be no pushover. It plans to impose higher tariffs on selected American exports to China, place export controls on a range of minerals and launch an anti-monopoly investigation into US tech giants Google and Nvidia — and perhaps Intel shortly.
For all we know, these actions could be reversed once Trump has the planned conversation with Chinese President Xi Jinping. It could be that the American and Chinese actions against each other represent the pushing and shoving involved as the two big powers negotiate a deal. After all, Trump’s dominating priority is domestic and he does not want to be distracted by an early clash with China. Xi is also aware that the Chinese economy needs time to recover from its current malaise and that now is not the time to risk the export engine, which is helping to keep the Chinese economy afloat.
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A deal would not be surprising, but it is doubtful that it will prevent a rise in protectionism or a grand bargain with China that makes the world a more peaceful place. Remember that Trump is obsessed with trade deficits and has been a lifelong supporter of tariffs. Not only does China have the largest surplus with America, but Trump and his allies need much higher tariff revenues to cut taxes without enlarging the budget deficit or slashing popular social programmes. Trump also believes that tariffs give him leverage over weaker countries. The bottom line is that the average tariff rate will rise in the US, and there will be retaliation by other countries, leaving world trade in a worse position.
Remember also that there is a fundamental clash of interests between China and the US. China’s security needs demand that the US withdraw from the western Pacific. However, that would require Trump to surrender 170 years of American strategy, tracing back to when a fledgling US forced the opening up of Tokugawa Japan in 1853. Even if he is personally willing to walk away from longstanding American commitments to Taiwan, Japan or South Korea, Trump will struggle to get away with that, especially given the number of hardcore anti-China hawks in his administration. Finally, note that Trump’s promise to build a shield against hyper-sonic missiles is aimed at China, so he is keen to check China.
The economic consequences cannot be benign
To assess the economic impact, let us start with the US economy. The good news is that a higher average tariff rate could see global manufacturers diverting investment in new factory capacity to the US. Supply chains will be re-ordered to some extent so that more is produced within the US than elsewhere. In addition, Trump’s promise of major deregulation and tax cuts has already sent small business confidence soaring to multi-year highs, which could mean more investment and hiring.
However, we suspect that an initial spike in growth will then be followed by downside risks for several reasons:
The first is that, despite businesses loving Trump’s agenda, much uncertainty will be created by his radical and disruptive approach: the wholesale slashing of government spending in selected areas, the sacking of senior bureaucrats in important departments, and the rolling back of President Biden’s incentives for the green transition are just some recent actions that are unsettling the business environment. No one can tell whether high tariffs will still be imposed on Canada and Mexico after the month’s pause. Neither can we say the extent of retaliation and counter-retaliation in the trade arena. The growing anger at the controversial policy approaches taken by Elon Musk, Trump’s czar for downsizing government — this backlash will grow as other newly appointed cabinet secretaries begin implementing even more unsettling measures as is likely. There will be much social and political dissension as the half of the country that voted against Trump mobilises and finds its voice.
The next concern is that with the US economy growing above its potential since the pandemic, there are limited labour and capital resources to meet the additional demand for domestically produced cars, oil and building materials that higher tariffs will create. Furthermore, firms are likely to pass at least some of the higher costs from tariffs to US consumers. Given that tariffs are likely to cover a broader range of imported goods this time, even stronger inflationary pressures than in Trump’s first term can be expected.
And that means further delays in rate cuts from the Federal Reserve, several of whose officials have been speaking recently of the need for caution in pursuing rate cuts.
Furthermore, as Trump’s allies in Congress are keen on tax cuts but are not eager to follow through on spending cuts, the fiscal position will likely worsen. As we have argued before, this will lead to bond yields and, therefore, the cost of capital rising further. That will also slow investment spending.
Conclusion – what does this mean for Asia?
First, it is only a matter of time before the Asian economies with persistent trade surpluses with the US are hit with tariffs. For example, Vietnam has the fourth largest surplus with the US. Others, such as Malaysia and Thailand, have acted as conduits for Chinese goods to bypass previous US tariffs, so they are also at risk.
Furthermore, while China’s 10% tariffs might seem benign, remember that they come on top of the average 25% rate already covering much of US-China trade. That could mean redirecting Chinese exports to Southeast Asia, adding competitive pressures on domestic producers.
In addition, tighter financial conditions will be expected as the US dollar strengthens further, increasing pressure on emerging Asian currencies. Ultimately, this means less room for Asian central banks to ease monetary policy even as trade uncertainties undermine economic growth.
Finally, the big question is whether the reconfiguration of supply chains, which has helped boost foreign investment in Southeast Asia, will continue as protectionism grows. The continuing inflows of foreign investment in recent months, when fears for greater protectionism were already evident, suggest that this positive for the region could persist. After all, protectionism will hit China harder than Southeast Asia. Moreover, the region has improved its fundamentals through better infrastructure, deregulation, easing restrictions on foreign investors, improved trade integration through major trade agreements such as RCEP and CPTPP and labour market reforms.
Overall, however, we should expect a period of turbulence and damaging political, financial and economic pressures. The region’s policymakers must devise monetary and fiscal policies to protect from the downside risks while finding creative diplomatic ways to contain American protectionism by leveraging the region’s geo-political importance.
Manu Bhaskaran is CEO of Centennial Asia Advisors
