The US trade spat is starting to give us whiplash.
Whenever we think there may be some progress…there isn’t.
In case you missed it, the US is threatening to impose 25% tariffs on an annual US$50 billion worth of Chinese goods. The Chinese are threatening to retaliate with major items like soy and aircraft.
Sunday talks between China and the US have come and gone, again without a deal.
In fact, the Chinese government even issued the following warning, as reported by The New York Times:
‘If the United States introduces trade measures, including an increase of tariffs, all the economic and trade outcomes negotiated by the two parties will not take effect.’
The US wants to protect US industries and workers from international competition. It is also looking to reduce its trade balance deficit with China.
In 2017, according to Statista, this deficit was US$566.03 billion. By far the biggest contributor is China. The US runs a US$375 billion trade balance deficit with China.
But, the US is also trying to reduce its deficit with other trading partners.
Last Friday, the US announced they will be imposing a 25% tariff on steel and 10% tariff on aluminium from the European Union, Mexico and Canada.
Their responses were quick.
Canada said they will retaliate by imposing tariffs on steel, aluminium and several other products coming from the US. Mexico announced tariffs on steel and cold meats.
The EU has filed a complaint with the World Trade Organization (WTO). They have said the door on negotiations is closed for the moment and are also planning reprisals.
The three may be even looking at coordinating their responses against the US.
A couple of things to note about trade spats. First, as you can see, they can escalate quickly.
Second, imposing tariffs can also bring along with it inflation.
A return of inflation in the US should concern you
Remember when the markets tumbled back in February?
Markets panicked back then because a US jobs report showed wage growth was picking up. That is, investors feared that inflation was making a come-back, and that the US Federal Reserve would be tightening monetary policy faster than expected.
After the 2008 crisis, the US pumped money into the economy through quantitative easing for years.
When a country increases the money supply, there’s more money around. This causes prices to increase, creating inflation.
This is something Argentineans, (where your analyst is from) know well and have experienced often. When you increase the money flowing into the economy, prices are bound to go up. Inflation can get out of control very quickly.
Yet inflation in the US has stayed low.
While the US has been increasing the money supply, there has barely been any inflation. How has the US created massive amounts of money while failing to create inflation — or even hyperinflation for that matter?
Well, one explanation could be because of globalisation.
Countries have opened borders and increased trade. It has meant that there are people around the world available to work for lower salaries than in the US. This could be the reason why salary growth has remained low in the US, even at almost full employment.
Plus, the US is also importing more cheap goods, which pushes prices down.
But, an increase in tariffs and a trade war could start reversing globalisation. This could also trigger inflation and higher interest rates.
This is also something Argentineans know well. When you put up trade barriers, less imports come into the country. This means foreign products become more expensive and there is less competition, which creates price increases and triggers inflation.
If inflation spikes, then it will cause the Fed to speed up the pace at which it is increasing interest rates.
And, this could happen at a time when the US Federal Reserve is already looking to reverse years of quantitative easing by increasing interest rates and reducing the money supply through quantitative tightening (QT).
They want to raise interest rates and decrease its balance sheet so as to have some tools for the next recession.
At the same time, the US government is spending more, and have recently approved a big tax cut, which will increase the money in the economy. This will push up the US deficit even more…and could increase pressures on inflation.
A trade war combined with a heating economy could bring back inflation, which would cause the Fed to tighten quicker than expected.
Markets tumbled back in February after there were hints of inflation. If inflation starts picking up significantly, it could trigger a global crisis.
Editor, Markets & Money