Will the trade war work as a buffer for financial folly?

Since the first US move towards diminishing its bilateral trade deficits with key partners such as China, the negative consequences for countries involved have been on the spotlight. The world witnessed that before. It isn’t pretty. This time is not going to be different. But, besides the long-term havoc, could it at least give for some leveraged countries time to prepare? Or it will actually be worse if we consider macro-financial implications as well, not only the trade dimension of lost economic growth?

The trade tensions escalated during the period in which China is changing its economic growth model, culminating into lower (even though still high) growth rates. Without the so-called trade war, China could calmly achieve its economic goals: move from the investment-plus-exports-oriented growth model, following technological progress of other countries by just adapting its factories – very rapidly – to produce what was developed in other countries, to an internal-consumption-plus-research-oriented growth model, actually leading the innovation process. 

Changing the economic growth model alone is complicated and it comes with growing pains. Amid this endeavor, the last thing a policymaker wants is a threat exactly on the main pillar of the growth model it is trying to abandon. It has to jump before it is too late, and that is precisely why the trade war imposes additional hurdles beyond the economic sphere.

China’s economic (and political) influence over other countries are not only due to trade relations, even though it is an important global player. Its high savings rate made possible for the Asian giant to send capital overseas. Not only it has financed trade deficit and high consumption rates in the US, but the country has also been financing more projects than we thought we already knew. These are the finds of Horn, Trebesch e Reinhart in a recent NBER working paper.

The authors dig into public loans and found out that the government has financed low- and middle-income countries around the globe, becoming their largest official creditor (surpassing even the IMF and the World Bank). In the past, this meant overcoming credit rationing, but now might be an additional source of international concern.

Short-maturity Chinese lending, probably designed to increase the frequency of having to rollover credit, creating a lock in dynamics between governments, increasing and solidifying Chinese political influence, had not only being made in market terms (that means, charging a risk premium), but also using commodities exports as collateral. Some prices may fall with lower growth rates in China, what might create a procyclical problem (very common in financial crises): exports decrease, so does the value of collateral, which implies less income and less credit, amplifying the problem.

If the trade war decreases the velocity of Chinese growth model change, it might have an unintended consequence. Since the Asian giant might have to sustain economic growth in order to not having questioned (or in order to defend) its geopolitical influence, this might actually provide some additional time for deleveraging (the IMF should be summoned here to coordinate the problem, since it would be an additional recessive pressure on the global economy).

We already know the capabilities (that means, the political macroeconomics behind those decisions) to solve these vulnerabilities in low- and middle-income countries. This probably will not happen. In that scenario, they actually may leverage even more (since China may double the bet to augment economic ties with those countries). In that case, the trade war would not work as a buffer, but rather as an amplifier.