Stratfor’s 2018 Fourth-Quarter Forecast
- The United States will pile more tariffs on China, targeting $200 billion worth of imports, and may ramp up the pressure further after midterm elections in November as trade negotiations stall.
- While the successful renegotiation of the North American Free Trade Agreement will mitigate the U.S. administration's threat to impose tariffs on automobiles and auto parts in North America, the European Union will probably fail to avoid the measures.
- A steep decline in Iranian oil exports, along with looming production disruptions in countries such as Libya, Nigeria, Venezuela and Iraq, will constrict global oil supplies, prompting the White House to try to coerce Saudi Arabia to dig dangerously deep into its spare capacity.
- S. unilateralism in tariff and sanctions policy will push regional powers such as Turkey to pursue ties with non-Western states and drive world powers such as Europe to reclaim their economic sovereignty.
China Braces for More Tariffs
As U.S. President Donald Trump approaches the midpoint of his presidency, he will take his controversial trade policy into more extreme territory. China is already bracing for more U.S. economic pressure as trade talks between the two giants stall. Beijing will still keep the door to dialogue open, sticking to its offer to buy more U.S. goods and to liberalize select sectors, but it will not cave to U.S. demands for deeper structural reform. That means more tariffs ahead.
Having completed the first phase of its tariff assault, targeting Beijing's Made in China 2025 industrial campaign, the White House will follow through with a threat to impose 25 percent tariffs on $200 billion worth of Chinese goods. Though the U.S. administration could modify the tariffs list to try to soften the blow to U.S. consumers, it has demonstrated a tolerance for incurring industrial and consumer costs in pursuit of its tariff policy. Beijing so far has responded in kind to the tariffs, but in the next phase of the trade war, it will have to resort to more indirect retaliatory measures as well, including passing prohibitive regulations targeting U.S. goods and companies. Frustrated that a stronger dollar and weaker yuan are blunting the tariffs -- and that the strategy overall has yet to compel China into a deal on Washington's terms -- the White House could even step up its threat to cover all Chinese goods. (Mindful of consumer impact, however, the White House will probably wait until after the midterms and deploy the threat toward the end of the year, when it's likely to hit another impasse in negotiations with Beijing.)
A Selective Subduing of the White House's Auto Tariff Threat
The United States' risk of a trade war is highest with China for two reasons. First, the trade assaults -- as well as the investment reviews and export control discussions that Congress will debate this quarter -- fit into the White House's broader strategy to weaken an emerging great power adversary. Second, Washington has considerable latitude to use investigations of trade abuses under Section 301 of the Trade Act of 1974 -- a particularly powerful legal tool -- to hammer Beijing with multiple rounds of tariffs. But outside China, the White House's hard-line devotion to reducing its global trade deficit by slapping tariffs on its trade partners, and threatening indefinite rounds of retaliation, will run into serious constraints. The White House's threat to apply tariffs of up to 25 percent on finished vehicles and automotive parts for national security reasons under an investigation under Section 232 of the Trade Expansion Act of 1962 will take the spotlight this quarter, putting Mexico, Canada, Germany, Japan and South Korea on edge -- and for good reason.
Relative to the tariffs on steel and aluminum imports, which the Trump administration justified on national security grounds under Section 232, the prospective auto tariffs would have a much greater impact, affecting more than $200 billion in imports. The Center for Automotive Research estimates that they would put at least 750,000 jobs at risk and cost the United States as much as $42.2 billion in lost gross domestic product -- and that's without considering the effects of likely retaliation.
Given the economic hit the United States will take from expanding tariffs on China, the White House will probably have to dial back (though not entirely rescind) its threats of auto tariffs this quarter. To that end, the U.S. Commerce Department may recommend lowering the auto tariffs or excluding parts from them when it issues its review on the national security threat from auto imports. The prospect of auto tariffs could also motivate Congress to check the president's authority on Section 232 cases and give the secretary of defense more authority over trade-related matters of national security.
The White House will get mixed results from wielding auto tariffs in its ongoing free trade negotiations. Mexico and Canada stand the best chance of tempering the threat through their revision of NAFTA, which will tighten up rules of origin for the continent as a whole. The United States, after all, would deal itself a massive political and economic blow if it were to destroy the deeply integrated automotive supply chains that stretch across North America. By contrast, proposals among non-NAFTA countries to eliminate auto tariffs altogether through a limited trade deal with the United States would contradict the White House's drive to reduce trade deficits. The White House, then, will push for more comprehensive agreements to balance out foreign auto imports by favoring other U.S. exports, namely agriculture. That's when negotiations could hit a wall.
Outside North America, the U.S. trade discussions will be a mixed bag. South Korea will try to lean on its existing negotiation over the U.S.-Korea Free Trade Agreement to escape the threat of auto tariffs. Japan will try to piggyback on Seoul's talks with Washington and will try to draw the Trump administration's attention to its auto investments in the United States. Eventually, though, it could give in to the White House's demands for a more comprehensive free trade negotiation. The outlook for the European Union's trade talks with the United States, meanwhile, is the bleakest. U.S. demands to include agriculture in the talks to help balance the trade deficit will prevent consensus in the Continental bloc, dragging the negotiations into next year and hampering Germany's ability to shield its automotive sector from tariffs.
To try to ease the inevitable trade clash with the United States, the European Union will work to promote its proposal to reform the World Trade Organization (WTO) this quarter. The Continental bloc is focusing on addressing mutual concerns about Chinese trade abuses and U.S. complaints about the organization's Appellate Body since the United States has already moved to reduce the number of judges on the court to three, the bare minimum. Though the proposal may take the edge off EU negotiations with the White House, it won't be enough to defuse the threat of auto tariffs.
Iran and Potential Supply Disruptions Will Drive a Tight Oil Market
Crude oil markets will remain tight in the fourth quarter, primarily because of the sharp reduction in Iranian oil exports due to the return of U.S. sanctions. Iran's crude exports have already declined by more than 1 million barrels per day from their high of about 2.7 million bpd in May, and once sanctions take effect Nov. 4, they could drop below 1 million bpd. As the United States prepares for midterm elections, scheduled for the same month, anxiety over high oil prices will rise in Washington. Trump will lean heavily on Saudi Arabia to keep oil markets well supplied and oil prices under control.
The kingdom has about 2 million bpd in spare capacity -- enough to make up for Iran's production drop. Doing so, however, would prevent Riyadh from responding to supply disruptions elsewhere, for instance in Libya, Iraq, Nigeria or Venezuela, where production is also at risk this quarter. (Venezuela's economic crisis will keep steadily depressing production regardless, and if a coup were to take place there, a more abrupt disruption could follow.) Furthermore, a lack of pipeline capacity is likely to limit U.S. production growth in the fourth quarter. So even though Saudi Arabia supports the White House's efforts to weaken Iran through sanctions on the country's oil exports, the initiative will put its own domestic production capacity, and the international oil market as a whole, at great risk.
Looming Risks for the Global Economy
Clouds will gather over the global economy in the fourth quarter, but the storm will not hit just yet. While the White House is taking a more aggressive approach to its trade policy, the economic headwinds of more extreme tariffs on China and of the auto tariffs, if enacted, will take more time to build. NAFTA will survive the quarter as a trilateral pact, despite the White House's threats, even if it takes on a new name. And though trade risk will certainly factor into the U.S. Federal Reserve's deliberations, the Fed lacks a complete picture of the effect that many of the trade moves underway will have. Economic modeling of the consequences of tariffs is imperfect at best, considering that most don't account for retaliation, the rising cost of inputs in integrated supply chains and consumer sentiment. Recession concerns will likely become more pronounced next year, but for now, the Fed will stay on course with its tightening cycle and is due to enact at least one more interest rate hike before the end of the year.
Meanwhile, the European Central Bank will weigh the rising risk from Brexit, Italy and Turkey against the Continent's modest economic growth and the return of inflation to the eurozone as it prepares to end its quantitative easing program late this year. And as China braces for a more direct economic hit from the United States, Beijing will carefully manage the yuan to prevent the currency's steep decline, while injecting fiscal and monetary stimulus as needed.
For countries already struggling with weak currencies, expanding current account deficits and financial outflows, U.S. monetary tightening, rising energy prices and a growing trade risk will make for a particularly stressful quarter. Argentine President Mauricio Macri will stick to the reforms and liberalization required by the International Monetary Fund (IMF), effectively ending his political career in the process. A populist push in India ahead of the country's next general elections in 2019 will limit fiscal prudence, even in the face of a rapidly rising oil import bill. But Turkey, faced with dwindling reserves, a ballooning current account deficit and maturing corporate debt, takes the cake when it comes to emerging market risk. Escalating strife with the United States, coupled with Turkish President Recep Tayyip Erdogan's reluctance to shift away from loose monetary policy and fiscal expansion, will weigh heavily on the Turkish lira.
Pushing Back on U.S. Unilateralism
In fact, Turkey will be a compelling case study this quarter in the broader trend of pushback against U.S. unilateralism in trade and sanctions policy. Caught in the great power competition between the United States and the Eurasian axis of China and Russia, Turkey will keep one foot in NATO while also building up its strategic ties with the east. But Ankara will gravitate more toward non-Western powers in its time of need, since the United States is only making its economic straits worse. Pakistan, likewise, may turn to China rather than the IMF for a $10 billion loan to ease its financial distress.
At the same time, France and Germany will lead the push to reclaim European sovereignty from the United States. European powers will have limited options in the short term for insulating their banks and companies from the U.S. secondary sanctions on Iran. In the long term, however, discussions over an autonomous payment and settlements system -- a reaction to the U.S. threat to sanction SWIFT, the worldwide communications network that underpins international financial transactions -- could change the global financial system. If Europe joined forces with China and Russia to build a blockchain-based financial payment and settlements system, for example, it could erode U.S. financial clout.
This excerpt is republished with permission from Stratfor, a geopolitical intelligence firm. The complete 2018 Fourth-Quarter Forecast with detailed regional forecasts is available at Stratfor Worldview.