- Fears of a trade war resurfaced after Donald Trump decided last March to drag age-old protectionism out of the past, imposing tariffs on US imports, and triggering China’s retaliation. A solution may be on its way and a closer look points to mere trade skirmishes.
- Alternative scenarios include a Trade Feud and a Trade War. Both would be (very) disruptive for markets, global trade, business insolvencies, and growth in the US, the EU and China.
- Other forms of protectionism (Financial, Regulatory, Data, Currency, Environmental, Sanitary, Security, and Intellectual Property) could be even more disruptive.
Since the beginning of the year, President Trump has demonstrated a certain chutzpah for protectionism announcements and measures (see Figure 1).
Truth be told, many countries have been exempted since such announcements - from the steel and aluminum tariffs e.g. -, and the second wave of announcements, targeted at China, could end up being negotiated directly between the US and China.
Much ado about nothing?
In the meantime, global trade is actually doing well. Global trade volumes rose by an estimated +4.8% in 2017 while protectionist measures continued to pile up (+489 new measures in 2017 compared to 2016 (see Figure 2).
The acceleration of global growth was strong enough to more than offset the dampening effects of these new protectionist measures and push many countries to open up again to benefit from the synchronized acceleration in growth.
Interestingly, the US was already the most active country in developing new protectionist measures (+90 measures in 2017 from +84 in 2016). Among large economies, it is the only one with an increased number of new measures.
The US has always been a free trade promoter, initiating both the WTO (World Trade Organization) in 1995, and the GATT in 1948 (General Agreement on Tariffs and Trade, WTO’s predecessor) to avoid the devastating impact of protectionist initiatives such as the US Smoot-Hawley tariffs.
Yet, trade liberalization never was a walk in the park: WTO disputes, the rise of non-tariff measures, and periods of protectionist rhetoric are common in the context of elections.
Previous American Presidents did not hesitate to have recourse to protectionist measures for electoral purposes. The upcoming mid-term elections in November 2018 certainly explain the hostile rhetoric.
Figure 1 Protectionism timeline
Indeed, opposing free trade to the well-being of American families is not new in a late economic cycle, marked with volatility and nervousness, rising twin deficits, and the implementation of a fiscal stimulus.
The ongoing aggravation of twin deficits in the US (the current account deficit reached 2.3% of GDP in 2017 and the fiscal deficit amounted 3.4% of GDP in 2017, the highest cumulated twin deficit since 2013) explains the higher aggressiveness in terms of trade policy of the US Government. The use of tariffs though, is from another time. As a result, the average tariff rate of the US has registered a structural decline to reach today 3.5% of duties on all imported products. Indeed, tariffs represent old instruments of trade policy, which were progressively sidelined to the profit of more imaginative or disguised forms of protectionism (technological content, anti-dumping measures, sanitary regulation, and technical constraints). However, they have the advantage to be rapidly advocated and applied in circumstances that the US President judged as representing a threat for national security, without the approval of the Congress traditionally required for trade issues.
Figure 2 New protectionist measures by top 10 countries
Figure A US trade deficit by country and by sector for top 20 import markets, USDbn (*)
Euler Hermes’ Protectionism Tracker
To anticipate protectionist announcements, one can calculate the bilateral trade balances by country and sector with the US. Electronic, Electric, Machinery and Equipment and Automotive are the most at risk.
Imports of Electronic, Electric and Textile from China are the largest contributors to the US trade deficit; they correspond to the list of Chinese products targeted: Industrial and electrical machinery, Optical equipment, Vehicles (railway, aircraft), Chemicals (incl. pharmaceuticals) and Metals (steel and aluminum mainly). Conversely, to track retaliation by China, Agri-food (where import tariffs have been increased on EUR3bn products) ran the largest deficit. The recent Chinese retaliatory measures have targeted Aircraft, Cars, Chemicals and Agri-food products (of which Soybeans, Cereals, Beef). Outside China, Mexico, Germany, Japan and Canada are the largest contributors to US trade deficits with Automotive, Machinery and Equipment, Electrical and Electronic equipment. Mind the deficit!
Why Trade Games only?
To evaluate the economic impacts of trade disruptions, we defined three scenarios based on the average tariff on imports in the US and the number of new protectionist measures (Figure 3).
First, our baseline scenarios called Trade Games, corresponds to a mild increase of the average tariff by +0.5pp from 3.5% today for the US with negligible retaliation. This is the unfolding situation, following the announcements, and our most likely scenario.Our second scenario (Trade feud) - which is unlikely - corresponds to an increase of +2.5pp for import tariffs for the US and the rest of the world bumping them to 6% for the US and 8% globally (lingering retaliation). This scenario could also happen in case of a concentrated bilateral quarrel between the US and China if the US tariff to all imported Chinese product were to rise to 15%.
The last time this level of trade disruption was observed was in the mid-80s with dozens of new protectionist measures per month.Last, our Trade war scenario (very unlikely) corresponds to an increase of tariffs globally by +8.5pp i.e.to 12% in the US and 14% globally.The bilateral version of it would mean a 45% tariff on all Chinese imported products, which echoes what President Trump used to say on the campaign trail.
Note that this situation has not happened since the mid-60s, before the sixth round of the GATT.The results of the three scenarios (and their variants) are summarized in Figure 4.In our baseline, exemptions and risks are taken into consideration in limiting the escalation but even with confirmed measures all being effective, world import tariff increase is less than +0.5pp but above +3pp for US-China bilaterally.
According to our model, this would cut US growth by -0.1pp to +2.9% in 2018 and have a negligible impact on inflation.Domestic demand would remain strong and cause an aggravation of the current account deficit by -0.6pp and of the fiscal deficit by -1.1pp.Europe will not be impacted; China would remain on a soft landing trajectory and emerging markets would continue to benefit from an early phase of recovery through:
(i) a continued rise in commodity prices (for commodity exporters); and (ii) a sizable trade opportunities.The main risks lie in the confidence shock causing volatility on the financial markets:
The VIX index should stay below 20 on average, while US yields increase steadily to 3.2% at year-end.
The US real effective exchange rate should remain broadly stable and the Fed tightening cycle on track.
Figure 3 Protectionism and average tariff on imports in the US across time
Figure 4 Protectionism scenarios
Based on import demand elasticities, combined export losses for US and China would amount to around USD30bn per year (see Figure 5), which represents only 0.1% of global trade of goods and services.
Mexico and Canada would lose close to USD2bn worth of exports, mainly concentrated in Automotive, Electronic and Electric, Machinery and equipment. Japan and Germany would be next in line with -USD0.7bn and -USD0.6bn of potential export losses.
All in all, total losses would remain below USD50bn (0.2% of global trade) which should not be a drag on global trade growth. The latter is expected to increase by above +4% in volume terms on average in 2018-19.
Global economic growth would remain strong with an increase of +3.3% in 2018.
Figure 5 Total export losses by country, USD bn Trade games: +0.5pp increase in tariffs (*)
How disruptive could a US-China Trade Feud or a Trade War be?
In our Trade feud scenario, global trade growth would slow down (-2pp from 4% in volume terms). The US growth would be cut by -0.5pp, Eurozone growth would lose -0.6pp, China growth would be reduced by -0.3pp and recession would be registered in several emerging markets.
The slowdown in global demand would trigger a fall in oil prices to 50 USD/bbl.
The Fed would postpone its interest rate hikes. Looking at a scenario concentrated on US-China only, the targeted products by the US should reach a total of USD230bn (compared to the USD60bn already announced) and USD170bn by China (compared to the USD60bn already announced). The bilateral import tariffs in this scenario would reach 15% and 34% respectively.
In this scenario, Eurozone losses should prove more limited thanks to increasing export market shares to both the US and China.
We would expect a total of EUR3 to 4.5bn additional exports to the US and EUR2 to 4bn to China.
Biggest trade losers include: the US (-USD22.6bn), China (-20.0bn), Mexico (-USD8.6bn), Canada (-USD7.6bn) and Japan (-USD3.6bn) – see Figure 6.
The most exposed sectors are Electronic, Vehicles, Electrical and Machinery. In terms of financial markets, US yields would remain stable, the USD would appreciate by +5% and there will be a higher regime of volatility.
Under the Trade war assumptions, global trade growth would be cut by -6pp from 4% in volume terms.
The US GDP growth would be cut by -1.7pp which could trigger an increase of +12pp in business insolvencies. Europe could be experiencing just below 0 growth (-1.9pp) which would trigger a rise in business insolvencies of +20pp. China growth would be cut by -1pp as stabilizing policies would reduce the negative impact and there will be broad recession in the emerging markets.
All in all, global GDP growth would be cut by -1.5pp. The reduction in global demand would trigger a fall in oil prices to 40 USD/bbl. The Fed would postpone its interest rate hikes and envisage rate cuts. In both scenarios, the US, China, Mexico, Canada and Japan would incur the largest export losses. Main sectors at risks include: machinery and equipment, vehicles, electronic and electrical sector.
Overall, in terms of export losses the hardest hit would be the US (-USD77bn), China (-42.1bn), Mexico (-USD29.3bn), Canada (-USD26.0bn) and Japan (-USD12.1bn).
In terms of financial markets, there will be a surge of volatility with strong increase of gold prices. The US takes over as a safe haven with US yields to decline, the USD to appreciate by 10% and the US equities to out-perform. A global sell-off on the equity markets is likely with export driven equity expected to underperform.
Figure 6a and b Total export losses by country, USDbn under trade feud and trade war scenarios
Financial protectionism should be monitored closely
An escalation of the trade dispute between the US and the rest of the World is not related to traditional tariffs on goods only and could easily expand on existing alternative protectionism forms. While less tweeted about, other forms of protectionism (Financial, Regulatory, Data, Currency, Environmental, Sanitary, Security, and Intellectual Property) can be very disruptive.
Focusing on the financial risks of an escalation of the tensions between the US and China, the services surplus of the US with the rest of the world could be targeted.
Financial activities in particular are a crucial element of the ongoing negotiations between the US and China as the US side requires further opening of the Chinese capital market. The structure of the US current account also reveals a net positive contribution of revenues generated from investment abroad. One aspect that retaliation could morph into is related to restrictions on foreign direct investments (FDI).
To this regard, the US, but also Europe and China, have been particularly active by limiting FDI targeting sensitive sectors of the national economy. The CFIUS (Committee on Foreign Investment in the United States) looks into mergers implying foreign investors, which could represent a threat for national interests. Several major operations have already been blocked in 2017 and 2018 in the US (see Figure 7); German, French and Italian governments recently advocated to block unwanted FDI from Chinese origin.
In this context, China could be inclined to limit the opening of its capital market, block the access to large high tech companies to its domestic market or also envisage a reduction of its holdings in US foreign exchange reserves, with potentially high consequences for the USD value given the fact that China is the largest holder of US Treasuries in the world.
Note that a potential devaluation of the RMB would result from a marked deterioration of trade relations between China and the US. Companies in sectors that rely on imported materials (energy, agriculture), sectors that are in overcapacity (mining and basic material) would feel the heat.
Outside China, South Korea, Japan, the US and Germany would suffer from increased competitiveness with Chinese products. High tech foreign companies would face stronger difficulties to be competitive when selling into China’s domestic market but also abroad as Chinese corporates become more competitive.
Figure 7 Deals abandoned under current US President