Markets hate uncertainty, and there’s nothing more uncertain at the moment than Donald Trump’s next move in the escalating trade war with China.
Late last week the US President riled markets by asking officials to look at the possibility of tariffs on another $US100 billion worth of Chinese exports to the USA.
The Chinese response was rapid and blunt, warning of a “fierce counter strike” to any new tariff measures — by no means a hollow threat given how quickly the Chinese retaliated to the Trump administration’s previous sanctions announcements.
By Sunday, Mr Trump sent what might be considered a conciliatory tweet … sort of.
“President Xi and I will always be friends, no matter what happens with our dispute on trade,” he tweeted.
“China will take down its Trade Barriers because it is the right thing to do.
“Taxes will become Reciprocal & a deal will be made on Intellectual Property.
“Great future for both countries!”
It is not clear China is on the same page re: trade barriers and intellectual property, and both US and Chinese officials have said there are no negotiations currently underway.
This has left markets vacillating on each statement while investors guess how large and widespread the tariffs between the two countries will become.
It also explains why Wall Street plunged more than 2 per cent on Friday.
The original tariff proposals between the two counties on trade worth about $US50 billion a year each sound massive, but they’re a relatively small proportion of both countries’ trade and economies.
Analysts estimate the US tariffs on China only affect 2.5 per cent of total Chinese exports and about 2 per cent of total US imports.
China’s planned 25 per cent tariff applies to about 38 per cent of America’s exports to China, but would affect just 2.7 per cent of China’s total imports.
What traders had been hoping, though, is that these moderate tariffs would be abandoned or watered down.
Now the opposite has happened and Donald Trump has escalated the scale of the potential trade war.
The fear on markets is that Donald Trump’s one-upmanship just keeps ratcheting these trade barriers higher and higher on more and more goods.
Globalisation spreads the fallout from trade wars
In a trade war between the US and China you might expect that other countries could emerge as winners.
However, in the era of globalisation the fallout from bilateral trade barriers can hurt innocent third parties.
Supply chains now snake across the globe, so tariffs that increase the price of one good in China could end up also raising the prices of hundreds of other products and services that rely on that good.
“Industries now, more than ever, are much more integrated into a supply chain with other industries,” explained Citi’s senior economist Joshua Williamson.
“So, it might be the case that there’s an export opportunity opening up but, given the fact that this could escalate to include more goods and services for both the US and China, the risk is that some of your supply chain is adversely affected by that and your costs may go up.
“So this schadenfreude view that there might be some winners is quite myopic.”
Figures from investment bank Morgan Stanley show around 60 per cent of US imports from the NAFTA zone (Canada and Mexico) are used by US companies as components in final ‘Made in the USA’ products.
Morgan Stanley also found that 43 per cent of Chinese exports go to other businesses overseas, often to be used in local production of goods and services for end consumers.
This means that it is very difficult to predict the downstream effect of tariffs on demand, supply and prices.
For example, Australian wine exports to China aren’t going to be hit with the 15 per cent tax that will be imposed on US rivals.
That should give local producers a price advantage that boosts sales. But if the price of fermentation tanks goes up because of US steel tariffs then that could erode that cost advantage.
Moreover, if the price of many consumer staples in China rises because of tariffs on US imports, then Chinese consumers may cut back on their overall wine spending.
An historical illustration of how everyone ends up losing during trade wars can be found in the Smoot-Hawley Tariff Act passed into US law during the early stages of the Great Depression (i.e. before it had become “great”).
It is widely credited with worsening America’s economic downturn and exacerbating the depression, and was immortalised in the cult film Ferris Bueller’s Day Off.
Australian households would pay for global trade war
If the trade war between the US and China escalates and goes global, then the costs to a mid-sized, open economy like Australia’s are potentially significant.
Citi’s economics team estimates that three years after trade barriers go up, the Australian economy would be $21 billion smaller than it would have been.
That would lead to about 70,000 more people being unemployed, pushing the unemployment rate up by half a percentage point.
The Australian dollar would fall 6 per cent, making imports even more expensive, and prices in shops would go up.
The combined effect of a weaker dollar and rising prices would make the average household $1,500 a year worse off.
Josh Williamson said this could in turn have further flow-on effects that are all but impossible to predict.
“If you’re spending more on product ‘A’ or service ‘A’ you’ll probably therefore need to spend less on product or service ‘B’,” he explained.
“The current period of time makes it interesting because we know that household debt is at a record high in Australia, so I think there are households, if this dispute were to escalate, that would be doing some budget calculations about what they will and won’t purchase.”
Given how financially stretched many households are, and how much many retailers are already struggling to grow or maintain sales, a trade war could be a disastrous outcome for Australia’s economy — especially a tariff battle involving our two biggest trading partners.