Trade tension and China

The war on trade started by the Trump administration is percolating through the world's analytical apparatus. Its conclusion so far seems to be tariffs could be bad for the global pace of economic activity, but only if the economic warfare escalates.

So think in terms of a toddler taking the shine off a sunny day out, rather than forcing everyone to pack up the picnic and go home. Here's the IMF, from Monday's update to the World Economic Outlook, which still pegs global growth at 3.9 per cent this year and next, but...

The balance of risks has shifted further to the downside, including in the short term. The recently announced and anticipated tariff increases by the United States and retaliatory measures by trading partners have increased the likelihood of escalating and sustained trade actions.

And:

In the baseline forecast, the direct contractionary effects of recently announced and anticipated trade measures are expected to be small, as these measures affect only a very small share of global trade so far. The baseline forecast also assumes limited spillovers to market sentiment, even if escalating trade tensions are an important downside risk.

The baseline doesn't include the latest round of proposed tariffs on $200bn of goods, note. For those who want to worry, UBS has sketched out some trade war downsides, which include the pace of global GDP growth dropping by 1 percentage point, mostly due to slower US and Chinese expansion.

Escalating trade war is bad, in large part due to the let's-wait-and-see effect. From UBS:

The 1st order economic impact is obviously through higher import prices (tariffs) which cascade through the supply chains and raise global inflation by about 17bp in our Escalation scenario and 33bp in our Trade War scenario. The effects for the US and China are, however, much larger (70bp and 90bp respectively in the Trade War scenario) and those price effects drive the initial demand effects (roughly half of the negative growth impact). The largest impact, however, comes from supply chain disruption, non-linearities (job multipliers, confidence effects) and cross-country spillover effects, once a critical threshold of tariff disruption is reached. Those are inherently difficult to model and place large uncertainty bands around our numbers.

No point investing in buckets and spades if the toddler is just going to throw them into the sea, after all. The bank has sketched out what to expect:

As Jamie has previously posted, the Mexican angle to Nafta negotiations bears watching, given the clash of the electoral calendar with that for trade talks.

Getting to a full trade war between the US and China requires the latter to escalate both in response to the latest tariff's and the next US step, which many think unlikely given its much larger exposure to exported goods. What UBS pencils in to get the gist is:

For illustrative purposes,we assume a 30% US tariff on all imports from China except smartphones (essentially about $456bn worth of goods) and a 30% China tariff on all imports from the US ($155bn). However, again to achieve proportionality, we suppose China would impose non-tariff barriers (NTBs) such that the total tariffs-cum-NTB effect is equivalent to a 91% tariff on imports from the US.

The point is less the absolute dollar value, but more the number of businesses which find their supply chains are impacted as the need for bigger tariff numbers rises:

Or here's BCA Research with a different chart which gets at the same point:

...modern trade is dominated by the exchange of intermediate goods within complex supply chains. This arrangement has many advantages, but it also harbours numerous fragilities. U.S. firms are particularly vulnerable to supply-chain disruptions because the Trump administration has chosen to levy tariffs mainly on intermediate and capital goods.

Models also tend to assume labour and capital are fungible, but in the short term it seems unlikely workers could move smoothly from trade war losers to those companies which benefit.

It is also perhaps bearing in mind the fall out from a Chinese slowdown. Here's the recent progression of GDP growth from the World Bank:

Financial and commodity markets have got much more used to the idea of a slower pace of economic growth in the People's Republic, with policymakers aiming for 6.5 per cent a year. Still, plunging markets around the world were prompted after that growth figure went from 7.3 per cent in 2014 to 6.9 per cent the following year.

The question it might be worth asking in the context of trade, is what reduction in China's pace of expansion would be something to worry about again?