A trade war between the U.S. and China is brewing and could be the biggest risk for global investors, a prominent asset manager told CNBC.
"We may be brewing up for a trade war because of the mistaken way that many policymakers interpret the trade issues. I don't believe that the U.S. trade deficit is as big a problem as many say," said Jim McCaughan, CEO of Principal Global Investors, to CNBC Tuesday.
President Donald Trump has repeatedly voiced his concerns about his country's trade deficits with several countries including China, and his administration is attempting to open up China's economy to U.S. companies.
Since the president's inauguration there have been fears a trade war may begin between the two countries, which would involve the introduction of tariffs and quotas on imports. Trump's Commerce Secretary Wilbur Ross has previously said the president will take "bold action" to address Chinese steel imports entering the market.
McCaughan says this kind of tough talk appeals to the president's base, but he added that Trump would "blame someone else" in the event of a trade war and any negative consequences.
"That's what politicians always do," he said. "U.S. assets abroad tend to be very high return … Whereas foreign investment into the U.S. is in Treasury bonds. So the income from the American assets is way bigger than from the liabilities - if you look at it that way the capital account is structurally in surplus – you can't have a trade surplus as well," he added.
The world has been teetering on the brink of a trade war for some time and this could be the biggest risk for investors, McCaughan also added. He says tariffs on steel imports would be bad for markets.
"As far as the market's concerned, tariffs on steel would be very bad news, because it would run the risk of setting off a trade war," he says.
"If the administration gets riled up by its base into tariffs, then you have anti-trade agenda winning."
Limited action from US?
China is the focus of trade deficit concerns because it is the U.S.'s largest trading partner and accounts for around half of the U.S. trade deficit. However, the administration may be limited in what it can do to China, according to a report by risk consultants Control Risks.
"Trump's options for inflicting severe and widespread economic pain on China are inhibited by legal, regulatory and legislative practicalities, including U.S. commitments under the World Trade Organization," the consultancy said in a report published in February.
"They are further constrained by the high likelihood of effective retaliation by China, particularly if he pursues more unilateral and unconventional options."
McCaughan's comments come after trade data from China disappointed markets. In July, exports from China grew 7.2 percent in dollar terms from a year ago and imports rose 11.0 percent in dollar terms. Both were much lower than expected.
Despite weaker-than-estimated growth, China maintained its trade surplus with the U.S. of around $25 billion. This trade gap is closely watched due to growing tensions between the two countries.
"Chinese trade data for July disappointed market consensus expectations. Both yearly export and import growth moderated in comparison with the previous month, against expectations for remaining just as strong," said Susan Joho, economist at Julius Baer, in an email to CNBC.
"Export growth to the U.S. almost halved amidst tensions over China's large trade surplus with the U.S."
Debt problems
The reason for the relatively lackluster trade growth indicated that China is failing to switch the focus of its economy from manufacturing to consumption, according to McCaughan.
"The reason growth is where it is in China has a lot to do with continued construction activity and that is not something that is long-term sustainable," he said.
"You run into debt problems very quickly if construction is what's driving the economy."