Any US-Japan deal will have implications for the Asia Pacific region, and beyond

The proposed trade deal between the US and Japan will increase pressure on wider global relationships as new loyalties emerge and established alliances shift.

Even as investors continue to worry about the trade war between the US and China – the two largest economies in the world – other trade disputes have been simmering:

• In the West, the UK and European Union are grappling with how trade will look in a post-Brexit world. The US has imposed tariffs on EU steel and aluminium, and threatened agriculture and cars. Moreover US President Trump’s new US-Mexico-Canada trade pact is still waiting for legislative approval.
• In Asia, Japan and South Korea are engaged in a dispute over supply chains and security, exacerbated by old wounds that go back millennia. The US is also attempting to renegotiate terms of trade and security agreements with these two key regional allies, with the US and Japan recently announcing plans to sign a trade deal, albeit excluding autos.
• Importantly, over the past few years, the US administration has also been using the US dollar (USD) and access to USD financing as a weapon of trade. A full 88% of all foreign exchange transactions occur in the US dollar and there has been systematic targeting of Russia, Iran and Venezuela, with possibly China to come.

What are the political implications of the US-Japan deal?

Things could get tricky if Japan and the US strengthen their relationship while Japan and South Korea grow more distant – particularly since Japan, South Korea and the US have traditionally been allied against North Korea, China and Russia. For its part, Japan has tried to be more assertive on the regional and global stage, which has helped Prime Minister Shinzo Abe’s political standing, but Japan’s inability to heal historical regional wounds has affected its relationship with many of its neighbours, as well as the defence constraints embedded within the Japanese constitution.

Will the US-Japan deal, if ratified, affect President Trump’s re-election chances? Not likely. 

Arguably President Trump’s need to pass a trade deal with Japan became more important once the tariff war with China heated up. Yet domestically, the Japan deal is not on the public radar in the US, meaning President Trump is under very little political pressure to punish the Japanese. A bilateral trade deal between the US and Japan is subject to Japanese parliamentary approval so this lack of public scrutiny bodes well for the Trump administration, which may be running out of time before the 2020 presidential election.

Further, the current levels of negotiation will enable President Trump to remain magnanimous when discussing Japanese/European trade, while focusing public attention on his own trade achievements, like the renegotiation of NAFTA.

Japan has successfully removed a currency clause from the trade deal, which President Trump initially wanted to implement. Years of ultra-loose monetary policy has resulted in Japan facing negative interest rates and it needs to intervene in the currency markets by keeping the yen at low levels in order to feed their export-led economy. President Trump is keen to weaken the dollar in a bid to strengthen US exports, lower the consumption of foreign goods and lessen the trade deficit.

Domestically, were President Trump to successfully depreciate the USD it could potentially bolster his chances for re-election in 2020. However, engineering a weaker currency has proven more difficult than anticipated. In June the European Central Bank decided to restart quantitative easing which pushed down the value of the euro. Meanwhile China has permitted the renminbi to depreciate against the USD, undermining the impact of US tariffs. Around Asia, it seems highly likely that regional currencies will not wish to appreciate against either the USD or renminbi, in order not to lose export competitiveness. Accordingly, with Japan, Europe and China all suppressing currency appreciation, the USD has nothing to depreciate against, except possibly sterling after Brexit uncertainty ends – and obviously the ultimate currency, gold.

Together, the US and Japanese economies represent approximately 30% of Global GDP so, were this deal to collapse, there would be potential for global economic ramifications. The market reads trade uncertainties negatively and Japan itself has suffered from the US-China tariff fights as the yen appreciated, resulting in lower Japanese exports and negatively affecting their economic outlook.

What are the investment implications of a US-Japan deal ?

Although a US-Japan agreement would likely benefit Japanese industrials (excluding autos) and US agriculture, there is also a focus on e-commerce and digital trade. Both countries have agreed to address “unfair trading practices including intellectual property theft, forced technology transfer, trade-distorting industrial subsidies, distortions created by state-owned enterprises, and overcapacity”. The Trump administration looks to be leveraging its relationships in the region in an attempt to restrict China from working with other nations in the fields of space, defence, nanotechnology, biotech and other areas.

Such co-ordination should boost companies domiciled in both domestic markets. However, some of that positivity might be offset if Japan and South Korea continue to withhold key technology components from one another, with the key losers being multi-national tech supply chains.

Incidentally, some of this co-ordination has already been hampered by the US’s withdrawal from the Trans-Pacific Partnership (TPP), although the agreement is still being pursued by the remaining participants, despite China regarding it as a regional policy ploy to hinder its own economic growth and influence.

Although US-China trade tensions negatively affect global demand, many companies are already moving supply chains away from China and into Asean* countries, creating opportunities in other parts of the region. However, ultimately an ongoing trade war between the US and China will create further industry fragmentation globally.

It’s fair to say that most countries throughout Asia would prefer to have access to the markets in both the US and China. Being forced to choose sides is not a decision anyone wants to take – though the looming threat of recession in the US and EU may be one of many reasons why Asia may choose to promote trade within the region:

• In the short-term, Japan may side with the US, as illustrated by the current deal, But longer-term, it’s not that simple:
• Japan owns USD 1 trillion worth of Treasuries, but also has USD 1 trillion invested in China.
• 50% of Japanese corporate revenue is derived overseas, with China as one of Japan’s largest markets accounting for 20% of sales and profits. Although revenue derived in the US is currently larger, its margin is lower.
•  A similar dynamic is at work in South Korea – which relies on US defence technology but exports nearly three times more to China than the US.
• It’s unclear what Hong Kong’s future holds given the uncertain future of the current status quo.
•  For Taiwan, it may be prudent to take advantage of its position between two superpowers.
• The vibrant, youthful economies of India and Indonesia will likely require greater partnerships with China, particularly given the ageing demographics in the West, which will become a systemic decelerator of growth.

It seems Mr Trump’s main priority is to “win” the battle with China, and secondarily to find a resolution to a nuclear North Korea. We can’t say for sure when, how or if the economic hostilities between the US and China will end, but investors need to keep an eye on growing trade tensions and their likely impacts as old alliances are frayed and new ones form. In the short term, investors may see the US as the better and more attractive economic opportunity, but China could be the longer-term victor.

*Association of Southeast Asian Nations )

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