Beware: the trade war between China and the US could just be the beginning

SPONSORED CONTENT - China and the US appear to be making progress in their trade war. But investors shouldn't get too relaxed about prospects for global trade, says Jake Trask, research director at forex company OFX.


Where are we now in the US-China trade war?

China and the US appear to be making progress in their trade dispute. In December, the two sides agreed a 90-day moratorium on any further tariff escalation up until 1 March. Sufficient common ground was then found for US President Donald Trump to push back that deadline, though no specific expiry date on this truce has been given by either side. As of the end of April, both sides were expressing hope that a deal could be struck, while China's President Xi Jinping gave a high-profile speech to world leaders in Beijing, where he discussed issues such as tackling state subsidies, increasing protection of intellectual property rights, and maintaining the value of China's currency, the yuan all concerns raised by the US. If agreement can be reached current reports suggest it might be by the end of May then Trump and Xi will sign it at a summit; if not, the battle may heat up once again.

What impact has the trade dispute already had?

The US imposed $250bn-worth of tariffs on Chinese imports last year, and China responded with its own range of tariffs on key US goods. While businesses in various sectors on both sides of the dispute have suffered, there is no question that the trade war has come at a particularly inconvenient time for China. The country has been trying to address bad debts in its financial system by cracking down on lending by banks a sensible move, but one that was always going to affect economic growth by reducing investment in infrastructure and exposing overly-leveraged companies. To have its export industry battered by tariffs simultaneously has exacerbated an already-slowing economy.

Meanwhile, other countries have been caught up in the fallout, notably those most dependent on exports and free trade, such as Germany. The vital German automotive industry 70%-80% of all cars made in Germany are exported has faced several challenges in recent years, including the scandal over emissions, which has so far arguably had more impact on sales than the trade war. However, China is a key market for German car manufacturers, and a slowing economy there hasn't helped. More generally the threat of more protectionism has a "chilling" effect as Dennis Snower, head of the Kiel Institute for the World Economy, told the Financial Times recently: "The German model depends on trade being as free as possible. If you hurt trade flows, then Germany will be hurt."

What longer-term damage could tariffs do?

Tariffs distort global trade flows, encourage retaliation, and can force companies to relocate, sometimes to more expensive locations, in order to avoid existing tariffs or the threat of new ones. In short, they increase costs and decrease efficiency on a global basis, although certain countries and sectors may well benefit as businesses relocate or reorganise their supply chains. In an era where businesses and consumers have grown used to ever-growing globalisation and ever-more complex supply chains, a retreat from globalisation and a return to a more protectionist world would come as a major shock to many. Even the fear that this might happen would be disruptive deterring companies from making investments in certain countries, or making decisions with an eye on politics rather than profitability.

What is the likely outcome of trade talks?

For now, the domestic political situations in both China and the US suggest that pragmatism will win out. China's economy has slowed in the past year amid efforts to tackle its over-indebted banking system, and so an escalating trade war with the US is a headache it could do without, particularly as strong growth is a key part of China's social contract (put simply, whereby the Chinese citizenry assents to living under a centrally-planned dictatorship as long as their standard of living continues to improve). And with a US election approaching in 2020, President Trump is aware that any slide in the stockmarket (which doesn't take kindly to the idea of trade war escalation) or hint of recession (China is much more important to global growth these days than it once was) could cost him votes. So in the short term at least, it seems likely that the two sides will come to some sort of truce.

What about the longer term?

Truce or no, the reality is that these trade tensions have built up for a number of reasons, and those reasons are unlikely to be fully addressed by a single deal. After all, one factor behind Trump being elected in the first place was the (not entirely unreasonable) view in the US that China has long failed to play fair on trading practices, and it seems unlikely that any deal can go far enough to put an end to all disputes over complex issues such as intellectual property rights. There's also the vexed question of how the deal is enforced, which has proved a sticking point in negotiations so far. So in the longer run, don't be surprised to see this tension flare up again.

What about Europe?

Another reason not to get too relaxed about prospects for global trade is that a deal with China would pave the way for Trump to pick an even more disruptive fight with the European Union. After all, with an election just around the corner, Trump might decide that a winning campaign would involve trumpeting his deal-making with China as a success, and turning to getting a better deal for America out of the EU. In short, business leaders shouldn't just hope for the best they need to prepare for ongoing trade turmoil, whatever the near-term outcome of the China-US dispute.

Ask the expert

Jake Trask, FX research director at OFX

What are the knock-on effects of this trade war?

The fall-out from this argument affects businesses and economies all around the world. Tariffs are distorting trade and damaging the ability of exporters across Europe, the Americas and Asia to sell their products. In the foreign exchange markets, these effects are affecting the value of many of the world's most important currencies, exacerbating the difficulties for any business that trades across international borders.

My business doesn't trade with China or the US do I need to worry?

British businesses need to keep a close eye on this trade war, even if they're not trading directly with China or the US. If you're sourcing raw materials or other goods or services for your supply chain, or selling your products overseas, the trade dispute's impact on currency markets will still have a direct effect on your profitability. In short, while this trade war may feel further away for British firms, it's a much bigger issue even than Brexit, due to the headwinds it is causing for the global economy.

How can businesses prepare for potential trade disruption?

If your business is exposed to significant currency risk through your supply chain or customer base, it is possible to mitigate the dangers using various options to lock in exchange rates or hedge against adverse currency movements. That said, with trade talks poised so delicately, making the right decision about when to hedge risk in this way and how to do it is not straightforward. For small and medium-sized enterprises in particular, it can be very difficult to keep track of the day-to-day effects of currency swings, especially when this is unlikely to be at the top of anyone's agenda. That's why it makes sense to talk to a currency specialist about mitigation, rather than attempt to manage this potentially very significant business risk yourself.

Which currencies are most affected by this trade dispute?

Right now, the impasse is propping up the dollar because it's seen as a safe haven in difficult times. The euro, by contrast, has been depressed by the trade war because big exporters such as Germany have seen demand for their goods decline. Emerging markets have also been hit hard, while Australia, for whom China is a crucial trading partner, has suffered too.

What if Trump and Xi reach a deal?

Logically, a positive resolution for trade talks should see a rally for those currencies that have seen the sharpest falls, while also resulting in a weaker dollar particularly as the US central bank now appears to be retreating from the idea of further interest rate rises, which, all else being equal, should depress a country's currency. But of course this depends on the nature of any deal is it short-term or longer-lasting? and also on how much damage has been done to growth and confidence by that point.

OFX has been helping businesses with their foreign payments for over 20 years. With our on the ground local UK experts, award winning technology, and 24/7 always on customer service, our clients are empowered to transact across borders when, where and how they want and plan ahead with confidence even when markets are volatile.

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