So much attention is focused on the trade conflict between the US and China that it is all too easy to miss the bigger picture. Anyone wanting to comment on the trade battle between the world’s two largest economies can draw on a raft of forthright tweets from US President Donald Trump. There is also no shortage of scenarios on the damages the trade row could mean for US and Chinese companies.

Key points

  • Too great a focus on the trade war between the US and China tends to obscure the conflicts between America and Europe
  • The US and Germany in particular are often at loggerheads
  • Some of US-European tensions could be the result of the Trump administration’s idiosyncrasies but these are far from the whole storyStructural shifts in the relations between the main economic blocs are likely to have important practical implications

US-Chinese trade tensions are of course all too real but they are arguably only part of a larger story. The system of international relations that was constructed after the carnage of the second world war seems to be breaking down.

Take the following statement from one of Europe’s leading politicians. Giving the commencement address to Harvard students in May, she described how she was brought up in what was then called the German Democratic Republic. She described how the East German regime separated itself from the West by building a wall of concrete and steel. Those who tried to cross it without permission were either arrested or shot. 

The speaker went on to talk about different kinds of walls – walls in the mind, walls of ignorance and walls of narrow-mindedness. In conclusion, she called for such walls to be torn down.

Most readers will have realised early on in the description that the speaker was Angela Merkel. Her unmistakable target, although she was diplomatic enough not to identify him by name, was Donald Trump. The German chancellor had launched a direct attack on the US president from inside his home country.

Merkel’s attack on Trump was remarkable for several reasons. For a start, it went against the convention, widely honoured in the decades following 1945, that nation states should not interfere in the internal affairs of others. Merkel was, for better or worse, clearly expressing vehement views on a domestic US political debate. The fact that her onslaught came from one of Europe’s most guarded politicians made it even more notable.

Perhaps most strikingly it was far from a one-off in spats between the US and Europe. On the contrary, there are conflicts between the two regions on a wide range of issues. Germany is a particular target for Trump’s attacks – perhaps because of the Exportmeister’s huge trade surplus – but it is far from being the only target.

● Trump has attacked Europe for what he regards as insufficient defence spending. In particular, he has criticised Germany for failing to immediately raise its spending to the agreed level of 2% of GDP. Germany is increasing its spending but not to a level the Trump administration deems sufficient.
● Trump has angered Europeans with his withdrawal from the Iran nuclear deal. Under the terms of the agreement the Iranian regime would limit its nuclear programme in exchange for reduced sanctions. But Trump withdrew the US from the deal calling it “decaying and rotten”.
● European leaders are highly critical of the Trump administration for its withdrawal from the Paris agreement on climate change. Trump’s charge against the agreement was that it would undermine the US economy. His move was almost universally condemned by European leaders as well as receiving criticism from inside the US.
● Trump has annoyed many European leaders with his support for many anti-establishment parties and for Brexit in particular.
● Trump has threatened Germany with sanctions for its involvement in Russia’s Nord Stream 2 natural gas pipeline.
● These disputes are on top of those over trade. For example, the US and Europe have had a long-running dispute over subsidies and tax breaks for their respective airline manufacturers, Boeing and Airbus. The Trump administration has also threatened tariffs against European cars on the grounds in response to tariffs and trade barriers imposed by the EU on US vehicles.

Perhaps the intensity of these disputes has not reached that of those between the US and China but they are far from trivial. They encompass a wide range of topics and two out of three of the world’s largest economic blocs. Under these circumstances, it is perhaps peculiar that US-European tensions have not received more attention.

One possible explanation is that in the US there is a much broader hostility to China than there is to Europe. President Trump has widespread support in US political and business circles for his assaults on China’s trade policies. In contrast, there is far less of a US drive to penalise Europe.

Dani Rodrik, an expert in international trade at Harvard university, points to the broadness of hostility towards China in the US. “There is a very broad coalition that, for a variety of reasons, is directed against China, so Trump acts as a vehicle for the outlet of all this anti-China sentiment.”

another side of the triangle

This coalition includes business and political interests. High-tech firms are worried that Chinese companies will steal their secrets. Multi-national corporations are concerned about technology transfer to China. And America’s national security establishment is concerned about China’s rising geopolitical influence.

In contrast, neither the US business community nor the national security establishment generally want to raise tensions with Europe. “The protectionists in his administration are much more isolated when it comes to Europe,” says Rodrik.

Indeed, there is a lot of common ground between the US and Europe on economic matters. Nathan Sheets, the head of global macroeconomic research at PGIM Fixed Income and a US undersecretary of the Treasury for international affairs in the Obama administration, takes this view: “The complaints that the US has about Chinese trade, investment and business practices are ones that Europeans very much share,” he says. “It’s not a level playing field for foreign firms in China. There are intellectual property rights issues, there are technology issues, there are investment issues.”

Another possible explanation is that a large part of the current tension between the US and Europe is to do with the peculiarities of the Trump administration. Whereas Trump favours a bilateral trade policy – where he reaches what he regards as the best possible deal for the US with other nations – the EU pursues a multilateral approach. While Trump often supports populist movements, most European politicians regard this as anathema.

There is certainly some truth to this charge but it is not an absolute. If Hillary Clinton had been elected as president in 2016 there can be little doubt that she would have kept the US in the Paris climate change agreement and criticised Brexit. On the other hand, Barack Obama criticised European levels of defence spending and involvement in the Nord Stream 2 gas pipeline before Trump.

Matt Gertken, a specialist in geopolitical strategy at BCA, an independent provider of global investment research, is one of those who puts the emphasis on the policies of the Trump administration when it comes to tensions with Europe. “I think it’s largely driven by the administration’s focal points as opposed to a structural conflict between the US and Europe,” he says. He points in particular to the disputes between the Trump administration and the German government. 

However, there is a more fundamental explanation for the tensions between the US and China taking on a particularly virulent character. This does not rule out the significance of Trump’s idiosyncrasies or the importance of the broad range of US forces ranged against China. But it does suggest more fundamental forces are at work.

This is the idea that an emergent China is threatening to replace the US as the world’s most powerful nation. Since the Asian nation started opening itself up to the world market in the late 1970s, it has grown from a rural backwater to global player. By one key measure it is already the world’s largest economy (see figure). It is also shifting to more sophisticated industrial production, developing a formidable military and even starting to exert ‘soft power’ by promoting Chinese culture abroad.

It arguably provides a textbook example of what Graham Allison, a political scientist at Harvard University, describes as the “Thucydides trap”. This is named after the ancient Greek historian who wrote about how the rising power of Athens instilled so much fear in Sparta that war was inevitable. Allison estimates that comparable conflicts between emergent powers and established players have emerged 16 times in the past 500 years. In 12 cases they have led to war.

Sigmar Gabriel, a former vice-chancellor of Germany, sees changing international relations in similarly sweeping terms. For him, the rise of China as a global power has in turn had a knock-on effect on US relations with Europe.

“The biggest mistake you can make is to always look to the current American administration when it comes to the trans-Atlantic relationship and the future,” he says. “The tectonic shifts we see today started many years ago. And it has nothing to do with the current president.”

For Gabriel, the rise of China means that “600 years of Eurocentric policy in the world has ended now. We are in a new age.”

This development has meant, in Gabriel’s view, that the US has shifted its focus to Asia. “The first American leader to make this shift was Obama, rather than Trump. Obama was the first president who said America was a Pacific nation.”

Gabriel’s conclusion is that Europe has to train itself to be a global actor. For example, he favours French President Emmanuel Macron’s proposal for a European Security Council. He also says Europe needs to put more emphasis on cultivating good relations with the US.

Indeed, it is striking that, in relative terms, the EU has declined far more relative to China than the US. Back in 1980, at the start of China’s economic expansion, the EU economy was about 13 times the size of that of China. In contrast, by next year the Chinese economy is forecast to be about a third larger than the EU’s (see figure). Of course, average incomes in the EU are still much greater, since it has a much smaller population than China and started from a far higher base, but the relative shift is dramatic.

Didier Borowski, head of macroeconomics at Amundi , talks in terms of a “multi-polar world”. The world economy is not driven by one dominant power, with the US playing the key role after 1945, but divided into three different economic blocs.

From a practical investment perspective he sees advantages and disadvantages to this shift. The problems have been widely rehearsed. “From a political standpoint it seems more uncertain and more fragmented,” he says. But from an economic viewpoint there is an upside. “You will see increasingly divergent trends. You will not see one single economic cycle.”

For Borowski, the upside is that there are new sources of diversification. Different emerging markets, for instance, are more likely to move in different directions. In Amundi’s view, they should no longer be treated as a unified category.

shares of global output

“From a strategy perspective there are windows of opportunity in this environment, despite the fact that the uncertainty is high,” says Borowski.

For Sheets of PGIM Fixed Income, there is a distinct downside to tensions between the world’s competing economic powers. However, the impact is likely to be indirect rather than directly on the financial markets. “I think where it registers is business investment. Business investment has been soft relative to what might be expected, given where economic activity is.” This includes in Europe where business investment has been lower than might be expected otherwise.

Of course, in the longer term this is likely to affect investment returns. Lower business investment means that there is less room for companies to grow over time. But the impact will not necessarily be a direct hit on asset prices.

The changing balance between the world’s largest economic blocs looks set to have a profound impact. Focusing too much on US-China tensions is likely to lead to one-sided conclusions.