“As a rich man is likely to be a better customer to the industrious people in his neighbourhood than a poor, so is likewise a rich nation. [Trade restrictions,] by aiming at the impoverishment of all our neighbours, tend to render that very commerce insignificant and contemptible.” -Adam Smith
With the headlines dominated by the Brexit extension and upcoming general elections, much of the UK’s attention has been drawn away from an issue with a significant impact on trade and world economies.
We’re talking about Trump's trade war with China.
It all started fifteen months ago when the United States decided to renegotiate duties paid on imports it receives from China. This holds high relevance as these two countries account for a significant portion of the world’s imports and exports. The Trump administration's protectionist outlook and policies allowed them to conclude that the US was receiving the short end of the stick when it came to its trade dealings with China. With exports dwarfed by their imports, the United States Balance of payments ran into a $621 bn deficit. The deficit mainly comes from US reliance on foreign countries for capital goods like electronics, retail, telecom equipment. A significant amount of these imports come from China. The actual deficit is significantly higher (close to 800 bn), but is offset from US exports of services like tourism, as well as some large scale high-value manufacturing in industries like aircraft manufacturing and medical equipment).
Effect of protectionist policies
The increase of tariffs on Chinese goods entering the US lowers the incentive of Chinese Businesses to supply goods to the United States. The apparent victory that comes in the stimulus to local US industries is in fact offset by the higher cost, lower quality and less quantity, which will ultimately affect the price paid for by the consumer. The US government believes that the sanctions can be effective by creating an incentive for people to start new businesses in the manufacturing sector, thus increasing the self-sustainability of the country.
On the Chinese side of this bargain, this slowdown hurts their business, which in turn hurts the Chinese economy, which is structured to promote the export of goods abroad. This situation is what leads us to the second contention of this dispute- The deliberate and willful depreciation of the Chinese Renminbi.
This concept is crucial, as it directly affects the United States' ability to enforce its self focused protectionist policies. Since the collapse of fixed exchange rates, currency exchange rates are now determined by their demand and supply in the foreign market. The more a currency is demanded, the higher it will trade for in the market. This draws attention to a point of contention one may have seen in the news lately. The size and depth of China's currency reserve. The trillion-plus dollars held in this reserve has the ability to influence the value that the US dollar trades at. The United States argues that Chinas central bank policies are deliberately geared towards holding massive foreign exchange reserves as the reduced supply puts upward pressure on the dollar, making it trade at higher levels. In addition to this, the bank ensures ample availability of Renminbi in the economy, and the high supply and liquid nature put downward pressure on the price compared to the US dollar. This means that measures can be taken by the Chinese government to get around the protectionist measures placed by the US government. As one of the largest holders of US treasuries, China has some kind of a say on what the dollar can trade for. A weaker Renminbi keeps Chinese exports cheap for the US, and consumers will continue to choose Chinese products as their dollars will give them high value.
Foreign effect of trade war
This trade was has led to an extended uncertainty in global markets. Export reliant economies have directly felt the effects of this trade dispute as supply chains between them have now been compromised until the issue is resolved. But the extent of the damage so far cannot be understated.
Germany, a country heavily reliant on exports to the UK and China, is one of the larger economies to suffer directly from this dispute. The uncertainty surrounding Brexit and the trade disputes have hampered its dealings abroad, with the country’s economy contracting for the second consecutive quarter, furthering fears of a recession.
Figure 1: Germany's economy shrinks to -0.1%
Source: Germany National Statistics Office
Germany's auto sector accounts for 47% of its yearly exports. A significant portion of these exports are luxury cars aimed at serving the Chinese market. With Chinese consumers tightening their wallets, Germany's economy is beginning to falter. This fact is further highlighted through reports of declined profits from leading German automakers like VW and BMW. Experts say the new American policies will inevitably hurt imports from Europe as well, further creating fear in export-reliant economies like Germany.
The pain caused by this uncertainty is very evident and apparent, with no clear progress on the issue. What remains certain is the significance this dispute has on world trade. With no clear route on sight, only one thing remains certain:
In a trade war, everyone loses.