US tariffs are becoming more like a game of poker than a serious economic strategy as President Donald Trump seeks to bluff his way to a winning hand position while assuming that others have few cards to play. But this is no game where global financial markets are concerned.
Nor is the 90-day truce declared between the US and China in their tit-for-tat trade war – with seemingly significant concessions on the part of both Washington and Beijing – likely to allay fears.
Recent analysis by the Washington-based Institute of International Finance (IIF) underscore concerns about the dramatic effect that Trump’s tariffs and other trade measures are having on international portfolio investment flows and global debt levels.
Government and corporate debt are both surging at the same time that equity flows are in retreat from emerging markets, which many fund managers have long viewed as the most promising source of future economic growth.
Meanwhile, global debt is mounting in emerging as well as mature economies as they step up borrowing in order to counter the impact of Trump’s policies on growth, and to finance structural economic adjustment.
Global debt
The global debt mountain has been growing for years, like a volcano pushing upwards as molten lava accumulates beneath the earth’s surface, ready to erupt with lethal force. Trump’s tariffs and trade wars could be the precipitating factor, as the IIF’s latest Global Debt Monitor shows.
According to the report, global debt rose by US$7.5 trillion to a record of over $324 trillion in the first quarter of the year, with the debt-to-gross domestic product ratio for emerging markets reaching an all-time high of 245%. Much of the increase was accounted for by a surge in Chinese government debt, but the problem goes wider. The main contribution to the first quarter debt surge came from not just China but also France and Germany.
With trade surpluses declining in the face of tariffs and rising US protectionism, export-dependent Asian economies in particular may be forced to resort to greater borrowing in order to finance domestic economic growth if they are to avoid recession.
While debt-to-GDP ratios have declined in some mature economies, that does not apply to the US. “Tough choices lie ahead,” the IIF says. “US government debt levels are projected to soar over the next several years and could trigger increased market volatility unless new revenues can be sourced to offset planned tax cuts and extensions.”
The IIF’s latest Capital Flows Tracker published on May 8, meanwhile, shows the growing discrepancy in buoyant flows of new debt finance to emerging markets compared with equity capital withdrawal.
Debt flows to emerging markets remained positive at $9.7 billion in the first quarter, but this was overwhelmingly concentrated in China, which attracted $10.6 billion. Excluding China, emerging markets suffered a net outflow of $900 million which, according to the IIF, suggests “a marked pullback in broader risk-taking”.
Meanwhile, equity flows recorded a steep decline of $9.9 billion with equities, excluding China, accounting for $9.4 billion of the total, reflecting “a sharp deterioration in risk sentiment and a breakdown of emerging market foreign exchange carry trade strategies”.
The IIF says the current environment differs fundamentally from past episodes. “This is not an exogenous shock but a deliberate policy action with structural objectives. As a result, the scope for rapid normalisation is limited. Capital is adjusting accordingly. Investors are increasingly focused on fundamentals, seeking combinations of yield, liquidity, and macro stability.”
