Tensions are building between the US and China.
During his presidential campaign, Donald Trump threatened to label China a currency manipulator and impose a 45% tariff on imports.
Trump’s goal is to reduce the US$300 billion trade deficit the US has with China, while getting jobs back into the US.
He didn’t fulfil his promise during his first year of office.
Yet last Thursday, President Trump rattled the markets.
He said he will be slapping tariffs on steel (25%) and aluminium (10%) imports starting next week.
This comes after the US recently approved tariffs on washing machines and solar panels to protect local industries.
As a result of all this, US stock markets fell.
It was a double whammy for markets after the Fed said they may be considering more interest rate rises.
Asian and European countries are considering retaliation.
China is threatening to restrict US soybean purchases. China is top buyer of US soybeans, and a move like that could hurt large farming states in the US.
For now, China may choose to hold off and increase talks to release tensions.
The truth is that the new tariffs won’t affect China much…yet.
The US is the world’s largest steel importer. But, as reported by The Australian Financial Review, aluminium US exports make up 2.1% of China’s production.
And, as you can see in the chart below, steel exports to the US are just 0.2% of China’s production.
[Click to enlarge]
But while steel and aluminium tariffs don’t really affect China, a world with more tariffs could affect China.
China is planning to revive the old Silk Road. This was an ancient network of trade routes that used to connect China to the Mediterranean. China calls it the ‘One Belt, One Road’ initiative (OBOR).
This multibillion-dollar project is a chance for China to expand its economic and political influence across Eurasia. It is a massive infrastructure program that not only includes building roads but rail networks, ports and bridges. The plan is to connect over 60 countries and one third of the world’s GDP.
China has pledged to invest a cumulative US$4 trillion — with no end date — for OBOR infrastructure funding.
If China can pull OBOR off, it could be the biggest geopolitical game changer since the Cold War era.
But it needs free trade to do this.
China wants an interconnected world. Opening the door to more tariffs and a trade war could jeopardise that.
China’s president, Xi Jinping, said during last year’s World Economic Forum:
‘Pursuing protectionism is just like locking oneself in a dark room. While wind and rain may be kept outside, so are light and air. No-one will emerge as a winner in a trade war… China will keep its door wide open and not close it.’
China needs to keep globalisation and trade open in order to keep their large economy ticking along.
The US and Chinese economies are the major drivers of global growth in the world. They are also each other’s largest trading partners. Cooperation between these two giants is vital, as a trade war would be costly for both nations and the world.
Aussie economy caught in the cross-fire?
A confrontation between China and the US could make the global economy even more sluggish. An all-out trade war would be bad news for every open economy in the world…including Australia.
Australia’s steel exports to the US are not huge by any measure.
Yet China and the US are Australia’s largest and third largest trading partners respectively. Australia runs a surplus with China and a deficit with the US.
If there was to be a trade war between the US and China, it could very well catch Australia in the middle.
If the US starts importing fewer goods, China will have to export less to balance its trade account. As a result, if China imports fewer goods, Australia’s exports will weaken, decreasing its gross domestic product (GDP).
The Aussie economy is very much linked to China’s. China’s growth has been fuelling Australia’s economy — it even helped us avoid a recession.
Yet tariffs could put an end to that.
More tariffs and a trade war could mean sluggish global growth, causing a recession in turn.
A recent study by the World Bank simulated a global trade war to analyse the impact it would have.
They estimated that if the US imposed a 40% tariff on all imports, US GDP would fall by 1.2%. If all countries retaliated, US GDP would fall by 5.2%, with the country entering a deep recession.
At the same time, Australia’s GDP would fall by 5.6%.
We saw the effects of tariffs recently in Argentina. More tariffs mean less competition and consumer choice…which makes things more expensive.
More tariffs may boost some industries and domestic jobs but could also boost inflation.
And higher inflation could bring in higher interest rates at a time when debt is at an all-time high…
The global economy is walking a tightrope. And winds are beginning to pick up.
Editor, Markets & Money