Emerging markets confront a trade dilemma

The lifeblood of emerging markets has always been their exports within a framework of robust global trade. The advent of U.S. tariffs worldwide has placed these countries between a rock and a hard place.

  The rock is clearly the size and extent of U.S. tariffs. These new tariffs have dwarfed the imposition of levies during the first Trump presidency. Back then, the U.S.-China trade war benefited some EM countries by attracting increased foreign direct investment and manufacturing as alternatives to Chinese trade.

It also meant increased exports in some cases, especially in agricultural products. In response to the U.S. tariffs on their goods, China hit back by raising their own barriers to U.S. imports. China reduced agricultural imports from the U.S. and increased its purchases of soybeans from Latin America.

In addition, since the last trade war, foreign direct investment into key emerging markets such as Mexico, Vietnam, and Indonesia have steadily increased. A large part of this new investment came from China and Hong Kong. Faced with a continued rise in U.S. tariffs and restrictions under the Biden presidency, China relocated some of its manufacturing to regions that had avoided U.S. tariffs. This allowed Chinese exporters to end run tariffs and continue selling to the U.S. market through other countries. Trump 2.0 is closing that loophole.

However, China has upped its trade game in response. As tariffs bite and domestic demand remains subdued, China pivots away from U.S. trade. Chinese imports into the U.S. have declined from 21% in 2018 to 14% in 2023. That total has dropped further since then. Economists estimate that total trade with the U.S. today only accounts for 2% of China's Gross Domestic Product. To compensate for the American market shortfall, China has turned its attention to exporting its excess capacity to other developed markets in direct competition with other EM exporters.

At the same time, imports from China have exploded higher throughout emerging markets. And it is not just intermediate goods that make up more of the advanced products they routinely re-exported to America. Final goods from China are now flooding into EM countries, which are displacing local industries and jobs.

This surge of 'Made in China' imports has forced several countries to raise tariffs (with the urging of the U.S.) on Chinese imports. Their domestic companies simply could not compete against this flood of cheaper-than-cheap imports.

 In desperation, Mexico has raised tariffs on textile and apparel imports from China to 35%. Thailand and Malaysia have levied a 7% and 10% value-added tax. Even Russia, which relies on China's trade, recently imposed restrictions on Chinese auto imports for the same reasons.

Many EM nations acknowledge that China still plays a crucial role in their medium-term growth and development, especially in Asian countries. This places them in a hard place to preserve their domestic industries while maintaining good relations with the world's number two economy.

And yet, Southeast Asia nations were also among the hardest hit on "Liberation Day." On July 4th, when the 90-day temporary reduction expires, that region's tariffs will skyrocket to almost 50%. That will be a devastating blow to EM economies. Many economists predict that the gross domestic product among EM countries could be cut in half if those tariffs are implemented.

The implicit message from both of the world's leading economies is that emerging markets should decide which side to back. The rock and the hard place for many nations will be choosing between the U.S. and China. Retribution for picking the wrong partner could be costly on several fronts.

Chinese President X Jinping calls on his trading partners to "uphold the common interests of developing nations." He argues that the 'Global South,' a term referring to a collection of countries (that now number 134 nations), should pull together. This so-called 'Group of 77', mainly in the southern hemisphere, are considered developing or less developed countries than those in the Global North.

 These nations, mainly in Africa, Asia, Latin America, and Oceania, often have lower income levels or share common political and economic interests. Many of these countries are now developing trade and other strategic alliances, often with the support of China.  

In contrast to China, the U.S., over the last 100 days, has made it clear that "America First" means just that on both the geopolitical and economic front. Relationships between America's traditional allies and trading partners have been upended.

Given the U.S. backpedaling in its support for Ukraine, Canada, Mexico, and others, many nations worldwide, including those in emerging markets, have concluded that while powerful, the U.S. has become an unreliable partner. They walk a fine line between these two powers and have little room for error.

Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires.  Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI).  None of his commentary is or should be considered investment advice.  Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at billiams1948@gmail.com. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.