Stephanie Kelly

Hi, and welcome to Macro Bytes. My name is Stephanie Kelly and together with my co host, Paul Diggle, we guide you through this complex world of politics, economics and markets. And this week in the wake of the G7 and the NATO summit, we're going to be delving into US China relations and asking how has the Biden administration impacted this relationship? And then going on to talk about what a more protectionist world might mean for the hot topic among investors at the moment - inflation. To help me dig into all of this. I'm delighted to be joined once again by Jeremy Lawson, Director and Chief Economist of the abrdn Research Institute, and a regular on this show. Welcome back, Jeremy.

Jeremy

Thanks, Steph. It's great to be here.

Stephanie

How are things?

Jeremy

Hi, yeah, not too bad.

Stephanie

So let's maybe kick off and talk about the geopolitics of the US China relationship, which is something we've talked about a ton on this podcast before. The nature of the US China relationship, the tensions, particularly under the Trump administration, maybe a good place to start is to talk about, you know, the G7 was seen as this sort of welcome waggon, for Biden to join the political multilateral sphere and set the US out as a new active participant in global democratic multilateralism. What do you think about, I guess, how the entire event went, and particularly the US role in it, and the role also, of China while not actively at the event had to play in the whole weekend?

Jeremy

Yeah, it's interesting. So I always have low expectations for these set piece events. I think, in large part, because the history is that a lot of the time, there are very few concrete binding actions that emanate from the discussions. And so the communique sort of represent, in a sense, shared views where they exist, and often actually, it's what's not said, or looking, looking between the lines where the real information is here. So from my side, what was probably more interesting was the way that on the one hand, the Biden administration is looking to repair relationships with allies. And so this is a friendlier G7 meeting than many of the meetings between Trump and other G7 leaders had been, clearly though the Biden administration is still very focused on the China conundrum, as I'll call it. Right. So what to do about China, from an international perspective through the prism of domestic US politics, but then also, then the ongoing struggles the US is still having, getting its allies to sing from the same hymn sheet.

Stephanie

Yeah.

Jeremy

If that makes sense. I mean, you know, Steph, this is something that you've written and talked about a lot. So I don't know whether you got the same impression. But that was my takeaway, that although there is common ground, there are clearly still some very important differences. And then that was reflected in the pretty lukewarm language that related to China within the communiques and the press conferences.

Stephanie

Yeah, absolutely. I have to say, I think that's that's spot on. I can always think, I always think of politicians watch what they do, not what they say. And these events are opportunities to say things. But insofar as they even said very much at this event, I think you're right. There's a clear divergence in the way that for example, Boris Johnson wanted to talk about China, or the way that Angela Merkel wants to talk about China. You know, she's actively saying she wants China to be a part of solutions, particularly as it pertains to climate. But then you've got Biden who, you know, I think it was pretty clear going into this that he is actively rallying countries together. I think he tried to put it under the auspices of the autocratic regimes right? So explicitly this isn't about China, this is about autocratic regimes. But then if you follow that up with and we're going to launch our own democratic alternative to the Belt and Road strategy, it's hard not to read that as being a China focused approach to the way that you build a global, you know, multilateral approach.

Jeremy

Yes, I think that's right. This, this phrase 'autocratic regiemes', it's meant to depersonalised right, to focus the sense in which we've got a broader geopolitical strategy, which is attempting to pin autocratic regimes back. And I think also, my guess is that within his within sort of Biden's sort of a advisory group, they probably settled on this in part as a way of distinguishing themselves from the Trump administration, because Trump was often not unreasonably seen as being closer to some autocratic regimes. And so this is a way of differentiating while still maintaining what is clearly again, as you say, look at what we're doing, not just at what we're saying. A very sort of pointed, multi focus sort of strategy to pin China back in a range of ways.

Stephanie

Yeah, exactly. And I think that you've kind of pinpointed there some of the differences between the Trump approach and the Biden approach when it comes to the China relationship. And what struck me at the G7 and since Biden has taken office, is that if you have a US ally, who is much more politically multilateralist, and much more keen to work with other allies, but who continues to have, you know, very cautious and very explicit views around the role of China in the global economy, and in particular, you know, Biden's focused on issues like human rights and transparency. But what he's also been able to do is because he's part of that group, now, it puts them under, to my mind, more pressure to almost pick a side, or at least to speak out against areas. Do you think that's fair?

Jeremy

Yeah. Look, I think that that's certainly one of the objectives of the US administration to put those allies in a position where at least, if not outright, picking a side, certainly leaning in the direction of the US. But let's take climate as an example of why I think this is so difficult. Europe recognises like we all do that there is no long-term climate solution without China's full participation, right? China is the world's largest emitter. At the moment, it's sort of pledged to a netzero 2060 sort of target, but without actually reducing the absolute level of emissions till 2030. There can be noconstructive Glasgow meetings without seeing China's full participation and working towards a common solution. But also, it there are other angles to it. There's the fact that Europe and many other countries are very dependent on the supply of renewable related technology, which is itself then dependent on other countries achieving their emission objectives. And then, even if we're sort of thinking about, well, who are the players we can constructively negotiate with? So on the one hand, you might say, well, the US is a natural ally. But actually, you could argue that the US's higher level emissions objectives are even less credible than China's because of the domestic political considerations in the US, and the fact that the two parties have completely different visions for what the future should look like. And so from that perspective, Europe has to be quite clever. It's got this natural alliance structure through NATO, and other types of relationship, but its objectives are broader. And actually, in some of those areas, China may be a more constructive partner than the US. So they have to tread this really careful line between them.

Stephanie

Yeah, yeah, absolutely. I think that that's, it's sort of on the one hand, ideology, you know, beliefs around the role of democracy and free speech, and therein in human rights on the one hand, and on the other hand, there's the real economic ties, and as you rightly pointed out the role that China has to play when it comes to climate. So we think it's hard to feel like this is something that's going to get resolved really quickly. And one of the things we often get asked. We always talk about US-China, decoupling, you know, over time. When people say to us, but 'when will that happen?' - that's harder to pinpoint. Right? It feels like the relations continue to become more challenging. But at what point does that tension between the incentives for Europe and other allies to align with the US and the incentives for them to not align with the US when it comes to China? At what point does that pinch point come through? And it feels really hard to say when that will happen?

Jeremy

So the when is a difficult question and maybe actually, it's the wrong question, in the sense of in the same way, as soon as the Brexit referendum took place, and the result was clear, we spent a lot of time talking about Brexit being a process, not an event. So, the US decoupling or the fragmentation, as I prefer to call it, of the US-China relationship will be a multi decadal process. Right? This is something that, these tensions were becoming clear towards the end of the Obama administration and the Trump administration codified it or symbolised that with a dose of rhetoric that made it sound like it was all unravelling incredibly quickly. The reality though, is that you can't decouple rapidly. And that relationship is intertwined in many ways I think. So what we can be confident about is the direction of travel. What we can be less confident about is the speed of change. And then I think that is sort of challenging for markets, you know, to sort of bring it back to that question. What markets struggled to digest at times under the Trump administration is, well, what was the true signal? What's the information content? And what is he saying? And so you swung through the tweeting process between, oh my gosh, we're entering an enormous disruptive trade war to actually no, this is just a slightly more volatile vision of the status quo. And so the market pricing is constantly adjusting or having to reprice on that basis. Whereas under the Biden administration, it feels more predictable. That I think helps explain why amongst many investors, they're now saying, well, geopolitics is not a particularly important sort of risk for us that we take into account, at least on a cyclical horizon. But underneath the surface, this same structural trend is in place, and I think will continue to be very important for thinking about the structure of the global economy, and the nature of returns and what you can be confident about and less confident about over time. So actually, I think in some ways, it's become harder to invest around geopolitics.

Stephanie

Yeah. Because you don't have those kind of specific ..

Jeremy

Yeah, exactly. Because the mood music makes it I think, in some ways harder because Biden is trying to give the impression of incrementalism but actually things are happening more significantly underneath the surface.

Stephanie

Yeah, yeah, totally. And to be honest, it is one of the great frustrations, I think about trying to speak to ambassadors about politics, because there's often a perception that if there isn't an impending announcement, or an announcement that's just come, or an election, then political risk is off the table, when actually, as you rightly pointed out, particularly with Biden, things are going through and things are happening, you know, within the congressional side, that have really meaningful impact on the way that US and Chinese investors can interact, and the way technology and firms can interact with the US economy, right? It's huge.

Jeremy

Exactly, or maybe another way to put it is this question of the future of globalisation, and I think we're probably going to lead on to this soon anyway. It comes up regularly. But it comes up often in this context, that weakening globalisation is brand new, right? This is just something that's happened in the last one to two or three years. That's just fundamentally untrue. Right? So, if you look at the growth rate of global trade relative to the growth rate of global GDP, there was the rule of thumb before the financial crisis was the global trade was growing at about twice the rate of global GDP. And then, after the financial crisis, and particularly after 2010, we sort of settled into a much weaker sort of structural environment. So this was present in trade flows, it was present in cross-border capital flows, you see it in momentum behind global trade agreements with liberalisation, whether it be regional, or global. So the momentum behind globalisation, at least the trading capital components of globalisation, were weakening well, before Trump became president, right. So again the incentive structures were already shifting. And so again, it's very important to have that background and take that into account. So when you widen your lens in that way, and you realise, well, this is already 11 years in the making, right? The shift, the breakpoint, isn't the pandemic, the breakpoint, wasn't the Trump administration, actually, the break point if anything was the global financial crisis, well, then you start to see things in quite a different way.

Stephanie

And I think that leads us really well onto the second part of this episode, which is around talking about the inflationary consequences. And you've made a good point there, which is all of a sudden, I think when you when you talk about this idea that globalisation has been slowing for some time, obviously investors have only started paying attention, particularly to US-China tensions since the Trump administration thereafter. And I think one natural question we get a lot is how significant are the inflationary implications of a US-China trade war? And maybe let's start with Jeremy, if you could just for those listeners, who aren't economists maybe just give a bit of a sense of how a trade war could in theory even affect inflation?

Jeremy

Well, I mean, I think the simplest way to think about it is that trade has a major effect on the nature of competition and price pressures within industry. So for example, as nearly everybody, I presume, listening knows that over the course of the last 40 years, there's been a pretty steady reduction in the manufacturing share of economic activity across the advanced economies. And where this is partly because of strong productivity growth, or you don't need as many people to undertake a particular activity, but that also because the supply chains have been sort of broken up and large amounts of activity shifted to emerging economies, and China is arguably the largest sort of relative winner from that particular exercise. So that process of effectively locating production in places where it can be done most efficiently, taking into account the wages that prevailed in those locations, is something that's put downward pressure on the prices where that globalisation has taken place - i.e. if, for example, the majority of the world's toy manufacturing hadn't shifted to China and other emerging economies over the last 40 years, we'd all pay a lot more for toys today. So that's a pretty straightforward thing. So why didn't a trade war matter? Well, a trade war can be thought about as placing additional new barriers on those interlinkages. Where can production take place? What is the even where it can? Are we going to effectively impose sort of new tariffs on that production or the imports. And the way to think about a tariff is it's a tax on consumption. It's a tax on the consumption of an important good. Now, some of that tax can be absorbed into the profit margin of the producer. But then, chunks of it get passed on. In fact, there's plenty of evidence to suggest that the tariffs that were imposed under the under the Trump administration were passed on through supply chains. And so it can have quite important effects on inflation through that channel. I mean, it can simply, just by making markets less contestable, can sort of weaken productivity growth in the global trading goods sector as well. And you know, that in itself, think of it as weakening the supply side of economies. If it weakens the supply side of the economies, you might get into a position of excess demand. So, there's a relationship between spare capacity and underlying inflation, at least in the longer term sense. So there are a variety of ways that it can influence price developments, both in short-term periods, if you get like a sudden imposition of new barriers to trade, but also more slowly and structurally over time.

Stephanie

So maybe, given what you've just said, there is one question that comes to my mind straight away. You said, for example, it is evident that the tariffs between the US and China fell on consumers, i.e. firms did not just completely absorb them. But that didn't show up in inflation. So I guess a natural question is, how much is this relevant to the ongoing debate or fears about inflation? Or is this just a much different beast?

Jeremy

I think this is where, again, you have to recognise that there are certain things that we purchase that I think have more symbolic importance. Then if you to go through your entire household budget and work out how you allocate your money in a particular month, or actually, it can turn out that, well let's take something like white goods, people can have a pretty clear sense of has the washing machine gone up in price? Has it gone down in price? This is one area where tariffs were imposed. But if you look at the average proportion of the household budget in the year that's devoted to white goods, it's actually tiny. So one answer to your question is, well actually the proportion of consumer items that are affected by those tariffs is pretty small, not just in terms of their breadth across all consumer categories, but then obviously, then, in terms of the things that China has the heaviest influence on. And so in some ways, that just means that the impact, it's not that it wasn't there. It's influencing the relative price of some goods in particular, but that gets sort of swamped by other factors that are influencing inflation and can matter just as much, if not more. So for example, the ongoing sort of pace of technological change is arguably or you know, likely to have a much larger effect on generalised sort of goods, price inflation and services inflation over time. You have central banks that because they're targeting inflation, right, they can be reacting to the shocks in real time, or with a lag, but the point being that they're the last mover here, right? And so. So if you're sort of trying to think about persistent effects, you have to take that into account. You have to be taking into account the state of the economy at a given time, and what's happening to the exchange rates. So there's so many different moving parts, and things that influence inflation in the aggregate, that again, you sort of stand back from all of this, and you can say, well, weakening globalisation, you can think of that as a headwind or a tailwind to inflation in the sense that it puts upward pressure on some prices, but is not large enough and deterministic enough that it will determine the overall evolution of inflation in an economy again. So think of the post crisis period. I think it highlights this really well. You have weakening globalisation, but an environment where most central banks found it very difficult to meet their inflation targets. That might seem like it's hard to reconcile, but I think is less so when you take into account is just the fact that the globalisation wasn't pushing prices down as much as it did before, and the all these other factors were doing even more work than they were in the earlier period. And it's the sum of these things that matters.

Stephanie

I think that's a super helpful way to frame it. And to put it into context as sort of a tailwind but not deterministic of the overall inflation picture, which has so many different components in it. I'm afraid that is actually all the time we have but thank you very much Jeremy for joining.

Jeremy

No, no, it was it was it was great to be on as usual. And, and thanks for having me.

Stephanie

Thank you so much. And as always to our listeners. If you do have any comments on the discussion today, or questions or ideas for future episodes, you can email us at macrobytes@abrdn.com. We are also moving to a fortnightly schedule. So please join us in two weeks time when Paul is going to be talking about the US labour market.

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