The Finance 202: Even a limited trade war with China could really cost the U.S. economy

The firm concludes such a move would shave only .1 percent from GDP this year and next — barely a bee sting. But S&P Global Ratings Chief U.S. Economist Beth Ann Bovino writes that “the potential hit to business confidence, increased financial-market volatility, and collateral damage to global supply chains could prove more damaging.”

Manufacturers that rely on imports to build airplanes, communications tech and other machinery would face disruptions. The potential damages to U.S. exporters of soybeans, cars, chemicals, planes and other products targeted by China’s proposed retaliatory tariffs have been well documented.

And if Trump imposes the full $150 billion in tariffs he's laid out and it's met with an equivalent response from China, the firm projects a .6 percent hit to economic growth. That's no longer a bee sting. 

What's more, the outfit projects the tariffs would add to the upward pressure on inflation. Rising prices on consumer goods would take a bite out of household buying power, diminishing the economic boost that the tax cuts are expected to deliver. "What we're worried about is the trade spat drags on … consumers stop spending so much, firms stop investing, confidence goes down, and we go to a less good growth path," S&P Global Ratings economist Paul Gruenwald said Friday at a conference in Manila. 

It could also encourage the Federal Reserve to raise short-term interest rates faster. And if that happens as investors pile in to U.S. Treasurys over concern about the specter of a trade war — a development that would lower long-term borrowing costs — the yield curve could finally invert. Then, “with the gap between short- and long-term rates already holding near its narrowest in more than a decade, market watchers may worry whether this augurs a recession in the near term, as has been the case in the past many times. This is certainly something the Fed would like to avoid.”

The report, released Friday, comes as the dust is still settling on the Trump team’s two-day talks with their Chinese counterparts. Negotiators are set to brief the president and solicit his call on next steps. The U.S. team “entered the talks with a sweeping set of demands that called for China to drop its tariffs to match lower U.S. levels; eliminate limits on U.S. investment in key industries; end state-sponsored cyberattacks on U.S. targets; strengthen intellectual-property safeguards and halt subsidies for several advanced technology industries,” The Washington Post’s Simon Denyer and David Lynch report. 

The presentation of that list solved one long-standing mystery heading into the talks: What, precisely, an internally-divided American team is demanding of the Chinese. And the Chinese answered with their own requirements, including that the U.S. “drop a complaint over China’s licensing terms for foreign patent holders and immediately designate China a market economy, which would give it easier treatment under routine U.S. trade enforcement actions,” per Simon and David.

With maximalist demands on the table from both sides, the trouble now may be that “they understand each other all too well,” said Scott Kennedy, a Chinese expert at the Center for Strategic and International Studies. The Post’s Heather Long finds a silver lining in the Trump team naming its priorities. “Now that the list is released, there's at least a starting point,” she writes. 

— Stocks and bonds going nowhere fast. WSJ's Akane Otani and Michael Wursthorn: "U.S. stocks and bonds appear deadlocked despite a positive response to April’s 'Goldilocks' jobs report, reflecting the conflicting impulses of a strong economy against rising interest rates and creeping fears about inflation. Lingering concerns over the durability of the global growth story and the likelihood of tightening monetary policy have left many investors in a rut, neither inspired to pour money into the market nor convinced they should bail out just yet. Markets’ inability to get a meaningful boost from the glut of strong corporate earnings over the past few weeks has sapped confidence further... Some investors [are] saying they expect to see more volatility and weakness in the weeks ahead."

— Wage growth stays lousy. The Post's Matt O'Brien: "The unemployment rate has dropped below 4 percent for the first time in 18 years, and the truth of the matter is we have no idea how much further it can go. That's the silver lining for what is, if not a dark cloud, at least a surprisingly off-color one: Even though unemployment is a mere 3.9 percent, wages don't seem to be rising much faster than they have for the last couple years, and at nowhere near the rate they were before the crash. That's not what's supposed to happen when unemployment gets as low as it can ... which tells us that unemployment must not have bottomed out yet... It might be that 4 percent unemployment is the new 5 percent unemployment: good, but not good enough."

— Dudley: Inflation target not met yet. Bloomberg: "Federal Reserve Bank of New York President William Dudley said he is optimistic about U.S. growth, while adding it’s too early to judge that the economy had overcome persistently low inflation. 'I wouldn’t quite declare victory yet' on consistently achieving the Fed’s 2 percent inflation target, Dudley said Friday... 'The inflation data goes up and down month to month, but we have made some progress and I am certainly happy where we are today.'"

San Francisco Fed President John Williams, Dudley's replacement-in-waiting, told CNBC on Friday he sees inflation modestly overshooting the Fed's target. "I am personally comfortable with the fact that inflation may overshoot that 2 percent for a while," he said.

TRADE FLY-AROUND: 

— NAFTA crunch time. Reuters's Veronica Gomez and Anthony Esposito: "Talks to update the NAFTA trade deal enter a make-or-break week on Monday, as ministers from Canada, the United States and Mexico seek to resolve an impasse in key areas before elections in Mexico and the United States complicate the process. Discussions in Washington will center on rules of origin that govern what percentage of a car needs to be built in the North American Free Trade Agreement region to avoid tariffs, the dispute-resolution mechanism and U.S. demands for a sunset clause that could automatically kill the trade deal after five years... Sources close to the talks have suggested there is a creeping feeling of uncertainty and pessimism going into the new round because of gridlock on the most critical issues."

The U.S. is pushing Mexico to boost auto worker wages. WSJ's William Maudlin: "The administration is seeking to complete its overhaul of the North American Free Trade Agreement with new rules that would penalize the Mexican auto industry unless it boosts wages—to roughly $16 an hour... Under Nafta, U.S. manufacturers have produced in Mexico where wages are cheaper, but the Trump administration now is seeking to force Mexican factories to pay more for labor—or send auto jobs back to the U.S. or Canada."

— China to open financial industry. Bloomberg's Malcolm Scott and Hannah Dormido: "China’s $42 trillion financial sector is set to open up to the world like never before. To deliver on longstanding pledges and help stave off the threat of tariffs from... Trump, Chinese officials have set a June 30 deadline to ease ownership and business restrictions for banks, securities firms, asset managers and life insurers. Securities firms like Goldman Sachs Group Inc. and UBS Group AG have an opportunity to boost their share five fold as they take more direct control of joint ventures, projections by Bloomberg Intelligence show. Insurers including AIA Group Ltd. are set to cash in on their already healthy presence, while banks like HSBC Holdings Plc and Citigroup Inc. face a steeper road ahead to build market share, but will reap juicy profits as they do so. Much as World Trade Organization entry in 2001 revolutionized the manufacturing industry, opening the financial sector could transform how capital is allocated and wealth managed across China."

— China pumps up its semiconductor industry. WSJ's Yoko Kubota: "In a move that could further heighten tensions with the U.S., China is poised to announce a new fund of about 300 billion yuan—$47.4 billion—to spur development of its semiconductor industry as it seeks to close the technology gap with the U.S. and other rivals. The new war chest by the government-backed China Integrated Circuit Industry Investment Fund Co. follows a similar fund launched in 2014... Among other efforts, the fund would be used to improve China’s ability to design and manufacture advanced microprocessors and graphic-processing units... The 2014 chip-development fund has been at the heart of U.S. complaints about China’s technology policy in recent years."

As ZTE asks Commerce to suspend ban. Reuters: "China’s ZTE Corp has submitted an application to the U.S. Commerce Department’s Bureau of Industry and Security for the suspension of a business ban, it said in a filing to the Shenzhen stock exchange on Sunday. Washington imposed a seven-year ban on U.S. companies selling components and software to ZTE last month after finding the Chinese telecoms company breached U.S. sanctions on Iran."

MELTDOWN WATCH: 

— Giuliani says Trump wouldn't have to comply with a Mueller subpoena. The Post's Mark Berman: "Trump would not have to comply with a subpoena issued by the special counsel investigating Russian interference in the 2016 presidential election and could invoke the Fifth Amendment if he does sit down with him, one of his lawyers said Sunday. 'We don’t have to' comply with a subpoena, Rudolph W. Giuliani, the former New York mayor who recently joined Trump’s legal team, said in an interview on ABC News’s 'This Week.' 'He’s the president of the United States. We can assert the same privileges other presidents have.' Giuliani’s claims comes less than a week after The Washington Post reported that special counsel Robert S. Mueller III, who is seeking to interview Trump, had raised the possibility of subpoenaing the president during a meeting this year."

Giuliani also said it's possible that Trump fixer Michael Cohen paid off other women, besides adult film star Stormy Daniels. 

— Trump, the "King of Debt," went on a cash spending spree. The Post's Jonathan O'Connell, David Fahrenthold and Jack Gillum: "In the nine years before he ran for president, Donald Trump’s company spent more than $400 million in cash on new properties — including 14 transactions paid for in full, without borrowing from banks — during a buying binge that defied real estate industry practices and Trump’s own history... Trump had access to far more cash than previously known, despite his string of commercial bankruptcies and the Great Recession’s hammering of the real estate industry... Trump’s lavish spending came at a time when his business was leaning largely on one major financial institution for its new loans — Deutsche Bank, which provided $295 million in financing for big projects in Miami and Washington."

— WH trims request for spending cuts. The Post's Erica Werner and Damian Paletta: "The White House will ask Congress as early as Monday to cut a relatively modest amount of spending from a few unused prior-year accounts, retreating from an earlier plan to whack tens of billions from the recent $1.3 trillion government spending bill. Instead, the omnibus spending bill will be spared after congressional leaders urged the White House to take a more limited approach, according to multiple Republicans familiar with the plan. The exact figure that the White House will ask Congress to cut remained in flux Friday... The White House will avoid cuts to the omnibus bill in its rescission request to Congress on Monday, Republicans said. The savings are expected to come instead from a number of unused accounts."

— Up next: The farm bill. WSJ's Kristina Peterson, Jesse Newman and Heather Haddon: "House Republicans return to Washington this week facing an intraparty fight over a sweeping agricultural and food-stamp bill, one of the last major policy battles before November’s midterm elections. House GOP leaders will begin this week corralling support for the next five-year farm bill, a task complicated by opposition from conservative Republicans and Democrats. The proposed legislation, estimated to cost $867 billion over a decade, is a priority for many lawmakers in agricultural states. It couples federal support for farmers with food-stamp benefits for the poor, elderly and disabled... In recent years its passage has been made treacherous by partisan fights over the size and restrictions of the food-stamp program."

— Can a proud "policy nerd" economist win a Republican primary? NYT's Ben Casselman profiles Tim Kane, who's seeking to replace Rep. Pat Tiberi (R-Ohio): "Mr. Kane, 50, has a résumé that sounds as if he answered a casting call for a Republican congressional candidate: An Ohio native, he served in the Air Force, then earned a Ph.D. in economics and worked at conservative think tanks such as the Heritage Foundation and the Hoover Institution. Along the way, he helped start two companies, wrote four books and became a familiar commentator on economic issues in newspapers and on television. Yet, in part because of that same résumé, Mr. Kane can seem almost uniquely out of step with the Republican Party in 2018... There has been no independent polling, and local political experts say that with turnout expected to be low, Tuesday’s outcome is anyone’s guess. 

— Buffett previews Berkshire future without him. WSJ's Nicole Friedman: "Warren Buffett tried to reassure shareholders at the Berkshire Hathaway Inc. annual meeting Saturday that the company’s success would continue once he is no longer at the helm. Berkshire promoted Mr. Buffett’s two potential successors, Greg Abel and Ajit Jain, to vice chairmen in January and gave them bigger responsibilities overseeing the company’s business units. The managers of Berkshire’s 60-plus business units now report to either Mr. Abel or Mr. Jain, rather than to Mr. Buffett... 'The reputation belongs to Berkshire now,' Mr. Buffett said. 'For somebody that cares about a business. we absolutely are the first call and will continue to be the first call.'"

Meantime, he wants more Apple. Reuters's Jonathan Stempel: "Warren Buffett said he would be happy if his conglomerate Berkshire Hathaway Inc owned more than 5 percent of Apple Inc’s stock, including if the iPhone maker bought back more of its shares... It came two days after Buffett revealed having bought 75 million additional Apple shares, and four days after Apple said it may buy back $100 billion of stock... 'I love the idea of having our 5 percent, or whatever it is, maybe grow to 6 or 7 percent without our laying out a dime. But you have to have a very, very special product, which has an enormously widespread ecosystem, and the product is extremely sticky.'"

— Wells Fargo agrees to $480 million settlement with shareholders. NYT's Stacy Cowley: "Wells Fargo’s tab for its sham accounts scandal shot up again on Friday, when the bank agreed to pay $480 million to settle a class-action claim from shareholders who said they were harmed by the bank’s false statements about its misdeeds. The deal, which still needs approval from a federal court in San Francisco, would compensate investors who bought Wells Fargo stock from February 2014 to September 2016 — the month that regulators and law enforcement officials brought the bank’s illegal actions to light and fined it $185 million. The bank said it denied the shareholders’ accusations but chose to settle the case to avoid the cost and distraction of fighting the claims."

— Tesla's finances are deteriorating. WSJ's Charley Grant: "CEO Elon Musk’s ongoing feud with Wall Street analysts captured the most attention last week after a memorably contentious conference call on Wednesday. Mr. Musk promised an imminent 'burn of the century' for investors betting against his stock in a post to Twitter on Friday. Investors shouldn’t be distracted: Dismal first-quarter results and falling bond prices call into question Tesla’s $50 billion market capitalization and its overall financial health."

— Deutsche Bank heads uptown. Bloomberg: "Deutsche Bank AG is literally leaving Wall Street, moving its New York headquarters to midtown Manhattan as the German investment bank embarks on a broad shakeup of its U.S. operations. The company will lease 1.1 million square feet of office space at Columbus Circle, slashing its footprint in the city by 30 percent, the head of Deutsche Bank’s Americas business, Tom Patrick, wrote in a memo to staff on Friday. The firm, which has been leasing offices at 60 Wall Street, will begin the move in the third quarter of 2021."

Companies Trying to Deal With Discrimination Face Backlash (WSJ)

Now hiring, for a one-day job: the gig economy hits retail (Abha Bhattarai)

— Quarles: Capital proposals a win-win. American Banker's John Heltman: "Federal Reserve Vice Chairman for Supervision Randal Quarles said Friday that proposed changes to the agency’s supplemental leverage ratio rules and stress testing regime would make the financial system safer without a material reduction in overall capital retention. In a speech delivered at the Hoover Institution in Stanford, Calif., Friday afternoon, Quarles said that recent criticisms of the Fed’s proposals to revise the enhanced supplementary leverage ratio have centered on the assertion that the proposal would lead to heightened risk in the financial system by reducing the system’s ability to weather shocks."

​​​​​​Today

• The Federal Reserve Bank of Atlanta’s 23rd Annual Financial Markets Conference continues.
• The SIFMA’s Operations Conference and Exhibition begins.
• The Economic Policy Institute holds an event on the Tax Cuts and Jobs Act.

Coming Up

• The House Science, Space and Technology Subcommittee on Oversight and on Research and Technology holds a hearing on blockchain technology on Tuesday.
• The Center for Strategic and International Studies holds an event on financial inclusion in the digital age on Tuesday.
• The Brookings Institution holds an event on the future of the middle class on Tuesday.
• The Insured Retirement Institute’s Action18 conference begins on Tuesday.
• The American Enterprise Institute holds an event on community banking on Wednesday.
• The Atlantic Council holds an event on US-China trade tension’s implications for Latin America on Wednesday.
• The Securities and Exchange Commission’s fifth annual conference on financial market regulation begins Thursday.
• The Peter G. Peterson Foundation’s Fiscal Summit is on Thursday.

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