The United States and China may be headed towards a full-fledged trade war. While the risks are not imminent (yet), the 60 billion dollar tariffs against imported Chinese goods has resulted in a quick retaliation. A proposed list of 128 US products worth 3 billion dollars may be subject to tariffs (perhaps good for Australian exporters with US agri-food imports such as fruit and wine on the proposed list of products). The US-China trade deficit is equivalent to USD 350 billion in 2017 – needless to say, these discussion of tariffs pose significant risks to global trade.
What risks does this pose?
Worsening bilateral relations, weaker investor sentiment and some outflows
it is hard to imagine how investor sentiment can remain buoyant in the context of worsening relations. Confidence indicators will also likely decline. A manageable but noticeable drag on the economic outlook through investment channels. Capital flows to the region are expected to remain positive. But if Friday’s knee-jerk reaction from global markets is anything to go by – the Hang Seng Index fell by 3%, while the Shanghai Composite fell by almost 4% on Friday – the coming year will be difficult.
Chinese exporters will be impacted
Chinese exporters may experience a decline in orders. Cancellations and amends to long-term contracts are possible. Rather than boosting “jobs in the US”, more expensive Chinese imports will likely be substituted by cheaper equivalents. Bangladesh, Cambodia, India and Vietnam could gain market share in textile and shoes, while Korea, Philippines, Taiwan, Thailand and Vietnam, will probably gain in consumer electronics, and other machinery and equipment. In the longer term, China has more to lose as exports to the US account for 5% of its GDP in 2016 (versus 0.5% for the US).
Beijing’s retaliations will hurt the Chinese economy
US imports (such as soybeans and pork) can be substituted with imports from other markets (Brazil and Uruguay for soybeans; Germany, Spain and Denmark for pork). However, with larger market share comes more bargaining power. Food prices were a major drag on Consumer Price Inflation (CPI) last year (1.5% YOY). Low base effects are already exerting upside pressure on CPI. Higher input prices will amplify these pressures and lead to imported inflation. Indirectly, higher inflation may trigger authorities to tighten monetary policy faster than expected, with repercussions for heavily-indebted enterprises across the board.
More protectionist measures could follow:
Negotiations are likely to commence soon. For example, Brazil and the European Union clashed over steel and aluminium prices in February, but US tariffs were finally exempted on 22nd March. While a full-fledged trade war has not yet manifested, things could take a turn for the worse if no agreement is reached.
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