Beyond Now: How Europe Wins the U.S.-China Trade War

'The big legacy will be that Europe becomes more powerful'

Jul 10, 2019
Finance

SMITH BRAIN TRUST  The typical economics refrain about trade wars is that there are no winners. But that’s not altogether true in the case of U.S.-China posturing.

Albert “Pete” Kyle, a finance professor at the University of Maryland’s Robert H. Smith School of Business, sees an unexpected winner emerging from the conflict. The United States and China might suffer losses, but Europe could come out ahead.

“I think the big legacy will be that Europe becomes more powerful than it used to be,” Kyle says in a recent interview with China’s Shenzhen Media Group. “It used to be that Europe followed the U.S., but I think in the future the rest of the world will tend to follow Europe.”

He sees a bipolar world forming, with the United States on one end and a China-led Asia on the other side. And he sees Europe in the middle as “the most powerful.”

The reasons why come down to that trade war. Amid the trade hostilities with China, the United States, he says, will continue trading with Europe. Beijing, meanwhile, still punishing U.S. companies, will refuse to import their products, opting to import products from their European rivals instead.

“So, the European companies will be the winners,” says Kyle, the Charles E. Smith Chair in Finance at Maryland Smith.

Recent volatility in the U.S. stock market suggests that Kyle isn’t alone in his theory.

“You’ve seen some fluctuation in American companies because the trade war could punish them,” Kyle says. “But the bigger reason you see the fluctuation – or stock market sensitivity – is that if the trade war gets out of hand and becomes really bad, both China and the U.S. could suffer a lot. So, there are huge gains to be had in stopping the trade war.”

The U.S.-China decoupling is casting ripple effects across capital markets, as well. China already imposes capital controls that keep capital from leaving the country. And the country has a high savings rate, which tends to keep interest rates and the cost of capital low. “So if China isolates itself from the U.S.,” Kyle says, then “returns to investors in China will be quite low.”

However, he adds, borrowers in the U.S. would also have to pay higher interest rates for financing that they need.

In the long run, China is likely to emerge as a major supplier of capital to countries all over the world. The United States might well be one of them, but it won’t likely be the main one, as China further extends its reach into other developed and emerging economies.

“China at some point in the future – unless it makes some really bad decisions – will be the world’s largest economy,” Kyle says.

The big question, Kyle says, is whether China, in its near-term policies, will look inward or outward. “I see signs China is looking in a more regional way,” he says, for example with the Belt and Road Initiative, and supplying more capital to its neighbors. It’s a sort of insurance policy against Trump-style protectionist policies and tariffs.

In the United States, the trade war is already dividing U.S. companies into those getting hurt by the trade war, and those benefiting from it.

Companies that rely on Chinese manufacturing or Chinese consumers are on the injured end.

U.S. companies that used to compete with Chinese rivals, meanwhile, are finding their products suddenly are more competitive at home. “Those firms keep quiet and quietly sell their products at really high prices and make a lot of money in the U.S.,” Kyle says. “Those firms getting hurt ask for an exemption or some kind of special treatment.”

When they get special treatment, they grow quiet, he adds. The complaints tend to stop.

That’s why you shouldn’t expect a sudden end to the trade war.

“Looking around the world at the history of protectionism, you’ll find that once a tariff regime gets put into place you’ll find there are companies that benefit from it and because of that, it’s hard to get rid of the tariffs,” Kyle says.

“So currently in the U.S., the tariffs on China are brand new, so it should be easy to get rid of them. But if they stay in place for, say, five years, there’ll be companies that adapted effectively and would fight getting rid of them. They would fight quietly.”

Conversely, he adds, if China were to slap tariffs on agricultural products, it would make food more expensive for Chinese consumers. Nonetheless, there would be millions of Chinese farmers who would be able to charge higher prices for their products, and they’d probably enjoy those benefits.

“But eventually,” Kyle says, “there’ll be losers – consumers – who’ll lose a lot more than the winners gain. Adam Smith wrote about this in the 1700s.”

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About the Expert(s)

KylePete

Albert S. (Pete) Kyle has been the Charles E. Smith Chair Professor of Finance at the University of Maryland's Robert H. Smith School of Business since 2006. He earned is B.S. degree in mathematics from Davidson College (summa cum laude, 1974), studied philosophy and economics at Oxford University as a Rhodes Scholar from Texas (Merton College, 1974-1976, and Nuffiled College, 1976-1977), and completed his Ph.D. in economics at the University of Chicago in 1981. He has been a professor at Princeton University (1981-1987), the University of California Berkeley (1987-1992), and Duke University (1992-2006).

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