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Trade War: a long way to go.

Shokh Makhmudov & Guido Bassi


Global Trade Tensions

The US-China trade war has been grabbing the world’s attention with its high trade barriers since 2018. Nonetheless, these trade pressures might have encompassed some countries which have trade cooperation with the US and China.

Figure 1: Other trade battles since Trump took office

Source: BBC Research

The US not only imposed taxes on China but also Canada, Mexico, and the European Union, encouraging people to purchase more American products. This led to retaliation effects by these countries with tariffs as shown in Figure 1.

Furthermore, the International Monetary Fund (IMF) in its report lowers the global growth outlook to 3% from 3.2%, making up the lowest level since the financial crisis. They particularly downgraded most advanced economies. Likewise, the figure for Japan has not changed since the US is pushing trade cooperation as vividly shown in Figure 2.

Figure 2: GDP change by global region and country

Source: Collected from IMF reports

According to the World Economic Forum’s simulation, they estimate that the US-China tariff war could shrink global growth by 0.7 percentage points (pp) to 2.8% in 2019. And they claim that impact could impact more on China’s economy (-0.9 pp) on account of direct trade impacts, and the US economy would be reduced by (-0.4 pp) due to less direct trade effects and on Europe (-0.8 pp) by virtue of indirect trade effects. Further, the World Economic Outlook reports that the economic repercussions caused by the US-China tariffs, outlining reduced investment, direct costs, market turmoil, and lower productivity could impact the global economy.

Many policymakers around the globe are concerned about trade uncertainty, instability and its impact on the global economy. To exemplify, Christine Lagarde (President of the European Central Bank) in her former role as the managing director of the IMF told that: “ Overall, we estimate that US-China tariffs including those implemented last year could reduce global GDP by 0.5% in 2020… This amounts to a loss of about $455 billion, larger than the size of South Africa’s economy. Similar views are held by Kristalina Georgeva (current managing director of IMF) who said in the conference: “Everyone loses in a trade war. For the global economy, the cumulative effect of trade conflicts could mean a loss of around $700bn by 2020, or about 0.8% of GDP. As a reference, this is approximately the size of Switzerland’s entire economy.”

Trade Uncertainty

A new measure of trade uncertainty has been constructed by the World Trade Uncertainty (WTU) index which utilizes reports from the Economist Intelligence Unit (EIU) to measure trade uncertainty for each of 143 countries on a quarterly scale. Yet, even more striking, a rise in trade uncertainty has been one of the reflective factors of the slowdown in global growth. The index coincided with an increase in trade war tensions between the US and China which constitute direct and indirect effects on the world economy. Since the direct impacts are relatively small, nevertheless, indirect effects are likely to push these tensions significantly. Companies, for example, maybe less likely to invest when there are uncertain trade cooperations between two major countries. Additionally, the measure of global economic policy uncertainty escalated for over 18 years of span, reaching the uttermost point ever in 2018 (Figure 3). The graph suggests that the rise in uncertainty may have already had some impact on the global economy and maybe the cause of slowing global growth. As reported by the World Economic Forum, based on their evaluation, the escalation in trade uncertainty observed could be sufficient to shrink the global growth by up 0.75 percentage points in 2019.

Figure 3: Measures of policy uncertainty

Source: Measuring Economic Policy Uncertainty (Baker, S. et al)

These leading uncertainty indicators can be used to estimate investor confidence about the long-term prospects of global economic measurement. Although these trade uncertainty spikes are mostly associated with US-China trade tensions, trade uncertainty has also increased in US trading partners such as Canada, Mexico, the European Union, and Japan (Figure 4). These figures can also be linked with retaliation effects as shown in Figure 1.

Figure 4: Trade uncertainty by global region and country

Source: World Trade Uncertainty Index

It is noteworthy to mention that, as a result of expectations of better performance in Brazil, Russia, Saudi Arabia, and Turkey, the Fund told that global growth was set to reach 3.4%. But this gauge was vulnerable to downside risks, including deteriorated trade tensions as well as Brexit-related disruptions. Therefore, the removal of trade barriers and with sustainable agreements has positive effects to boost confidence in investment leading to growth in the world economy.


Ad Interim Trade Deal

Recently, a new wave of moderate optimism has increased regarding the global outlook for the financial industry. Several companies are beating expectations (equity market) in the 3rd quarter, while the S&P 500 reached a record high on October 28th (+7% since the end of August).

Figure 5: S&P 500 versus SSE composite index (Shanghai stock exchange)

Source: Bloomberg

One of the reasons for this optimism is an interim trade deal between Washington and Beijing announced on October 11th (before the earning season) and due next month. The leaders of these two countries were expected to meet in Chile on November 17th (Apec summit, now canceled) to sign an agreement that probably wouldn’t have addressed some of the major contentious points like intellectual property theft and subsidies. According to Thompson Reuters, this signature could encounter a further delay.

The plan to raise tariffs on $250bn worth of goods to 30% on October 15th has been suspended; however, a 15% tariff hike is still planned for December 15th. 

Unlike previous rounds of tariffs that hit the US manufacturing sector more, this time American households are expected to bear the brunt: taxed goods include laptops, smartphones, and clothing.

Moves and Countermoves

The latest actions of the Trump administration seem to show a willingness to avoid an escalation of the trade tensions. In fact, the Purchasing Managers ‘Index (PMI) in the US has decreased significantly in the last two quarters and this could imply postponed corporate investments. The S&P 500 also suffered in August (-5.5% between July 29-August 26) and the fears of a possible recession before the election in 2020 could bring the US to seek a partial agreement. For the same reason, a weak deal exposes itself to criticism among American voters, and which doesn’t make “America great again” could be counterproductive.

Figure 6: PMI indices for US (red) and China (green)

Source: Bloomberg

Another strategy implemented by the US is the blacklisting of Chinese companies: sanctions are put in place to ban American corporations from dealing with their Chinese counterparts.

A famous example is Huawei, at the center of attention for possible backdoors installed in its 5G technology, according to the American Intelligence. Although in May US companies were banned from selling their components to the Chinese tech giant, Huawei registered an increase in revenue of 24.4% in the first 3 quarters of 2019. The startup SenseTime (with its $7.5bn valuation, the highest for a startup worldwide) was recently added to the blacklist, while the co-founder Xu Bing was visiting New York.

Other than imposing its tariffs, China has been using its currency to relieve the effect of tariffs on its economy. If Chinese exports are more expensive due to higher tariffs, the depreciation of its currency makes them less expensive.

Figure 7: Benchmarking Renminbi performance

Source: Bloomberg

Due to the nature of their political system, the Chinese have the possibility to wait for the next US election before giving any concession. The downside of this strategy is that the Democratic Party agrees with the Republican administration when it comes to condemning China. In addition, the other four years of Trump will give the US a strategic advantage, as this second mandate would be the last of the presidency in any case. In August, the Chinese government introduced a new benchmark lending rate to lower banks’ cost of capital, followed in September by a lower banks’ reserve requirement ratio. 

A stimulus in public spending focused on infrastructure projects (e.g. roads) has been implemented for instance, with an increase of quotas of special infrastructure bonds that regional governments can sell (+59% from last year, $320 bn).

To reach its target yearly growth rate of 6-6.5% some experts argue that the central government could allow some speculative investments into properties or could loosen the grip of regulations on shadow banking. Nevertheless, this could worsen economies distortions over the medium term.

The soaring pork prices (+69% YoY in September) are pushing inflation to high levels (around 3% in September). This crisis is due to the African swine fever and it’s not related to any tariffs. However, since the 3% mark is the upper limit of the yearly CPI target for 2019, this is certainly an additional concern for the Chinese central government. Finally, the September Producer Price Index (PPI) sunk further to minus 1.2 percent (YoY).

Figure 8: US-Chinese CPI vs US-Chinese trade balance (US Green, China Violet)

Source: Bloomberg

It is probably in everyone’s interest to avoid an escalation of the trade war; however, both parties are still strong enough to bring this contentious further. If there will be an interim agreement before the next round of tariffs, it probably won't address the main issues of this dispute (subsidies and cyber theft). A deal could be made around the bilateral trade balance, which is easy to monitor.

The preconditions and the durability of this agreement will also affect its effectiveness.

The removal of some of the new imposed trade barriers could certainly boost market confidence, stimulate global growth and diminish policy or economic uncertainty.

The Chinese reaction to the WTO ruling, which cleared the Asian country to impose 3.6 bn in new tariffs on the US, could also improve or deteriorate the relationship between the two powers.

Yet, a deal between two major nations always requires concessions on both sides, which are unlikely in the near future due to current internal political situations in both countries.


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