Trade Wars – Digital Finance Analytics (DFA) Blog

Australia And China’s Iron Embrace [Podcast]

We look at the latest data on iron ore trade between Australia and China – which makes up more than half of our total exports to that country. So are they likely to curtail exports, or are we locked in?

0:00 Start
0:40 Introduction
0:54 Latest trade data
4:50 Ore Price Trends
5:30 Will China Break Free?
6:15 Brazil?
9:00 MIIT Diversification Strategy
12:00 China Local Grade
13:15 Other Markets Including Africa
16:00 Scrap Recycling
19:00 Australia Rules (For Now)
19:40 Australian Options
20:00 Outro

Go to the Walk The World Universe at https://walktheworld.com.au/

Digital Finance Analytics (DFA) Blog

Australia And China's Iron Embrace [Podcast]

00:00 / 00:20:34

Australia And China’s Iron Embrace

0:40 Introduction
0:54 Latest trade data
4:50 Ore Price Trends
5:30 Will China Break Free?
6:15 Brazil?
9:00 MIIT Diversification Strategy
12:00 China Local Grade
13:15 Other Markets Including Africa
16:00 Scrap Recycling
19:00 Australia Rules (For Now)
19:40 Australian Options
20:00 Outro

Go to the Walk The World Universe at https://walktheworld.com.au/

For Australia: After China – What Next? [Podcast]

Associate Professor Salvatore Babones joins me to discuss whether India could become a major trade partner after China. The answer may surprise you!

Digital Finance Analytics (DFA) Blog

For Australia: After China - What Next? [Podcast]

00:00 / 00:28:33

Turkish Lira Under the Bus

More evidence of the global fragility of the financial markets on Friday.

Turkey’s finance minister, Berat Albayrak, unveiled a new plan for their economy on August 10th.

The new economic stance will be one with “determination” — that’s a key part of it, Albayrak says. It will “transform” Turkey’s economy. It will also have a “strategic” and “powerful infrastructure.”

But Donald Trump, tweeted that he would double tariffs on Turkish steel and aluminium products.

As a result, the lira plummeted further. In the course of an hour, it reached a new low of 6.80 to the dollar, marking its worst daily performance in over a decade. It recovered a little afterwards, but has lost about 40% of its value against the dollar since the start of the year.

Many fear the fallout could spread beyond Turkey’s border, prompting traders to abandon riskier assets like stocks in search of safe-havens like gold, yen and Treasuries.

Volatility, as measured by the “fear index”, rose nearly 17%, underlying investor concerns about the broader impact of a possible crash in Turkey’s economy.

The exposure to a slump in Turkey’s economy is “pretty international,” though limited to the banking sector, said Tim Ash, a senior EM strategist at Bluebay Asset Management.

Data from the Bank for International Settlements showed that Japanese banks are owed $14 billion, U.K. lenders $19.2 billion and the United States about $18 billion.

The Turkish Lira also moved the same way against the Euro.

“We’re not going to lose the economic warfare” being waged against Turkey said President Recep Tayyip Erdogan.

Erdogan is boasting of Turkey’s 7.4 percent growth rate in the first quarter. Forget about the exchange rate, he says. “It’s going to be better.”

How Will The Trade Wars Play Out?

From Fitch Ratings.

There is every reason to believe that the United States’ trade dispute with China will get worse before it gets better, and that the US trade deficit will widen further rather than shrinking. In fact, the economic conditions – were they to materialize – that would allow President Donald Trump’s administration to claim victory in the dispute would ultimately undermine its economic policy credibility.

Now that they are on the receiving end of US tariffs, Chinese policymakers have three options. First, they could capitulate, by scaling back many of the “discriminatory practices” identified in the US Trade Representative’s March 2018 report on technology transfers and intellectual property. So far, there is no indication that China is considering this option.

Second, China could escalate the dispute. It could set its own tariffs higher than those of the US, apply them to a larger range (and greater dollar value) of US exports, or offset the impact of US tariffs on Chinese exporters by allowing the renminbi to depreciate against the dollar. Alternatively, policymakers could look beyond trade in goods to consider capital flows and related businesses associated with US firms, effectively allowing the authorities to impede US financial and nonfinancial firms’ Chinese operations. As with the first option, this one seems unlikely, at least at this stage of the dispute.

So far, China has chosen the third option, which lies between capitulation and escalation. China has retaliated, but only on a like-for-like basis, matching US tariff rates and the dollar value of trade affected. At the same time, it has tried to claim the moral high ground, by eliciting international condemnations of protectionism and unilateralism. This hasn’t been difficult, given that several other major economies are currently facing US tariffs. Securing such third-party buy-in is critical for the Chinese leadership’s domestic position. If the government were perceived at home as being bullied by the US, it would have to take a much tougher line in the trade dispute.

For its part, the US actually has rather limited options, despite having initiated the dispute. Even for a notoriously unpredictable administration, a full and unconditional reversal on tariffs seems out of the question. But so is the status quo, now that China has already leveled the playing field by retaliating in kind. That leaves only escalation – a possibility that the Trump administration has already raised by threatening additional tariffs on all imports from China.

Trade War Escalation Would Knock 0.4% off World Growth

An escalation of global trade tensions that results in new tariffs on USD2 trillion in global trade flows would reduce world growth by 0.4% in 2019, to 2.8% from 3.2% in Fitch Ratings‘ June 2018 “Global Economic Outlook” baseline forecast. The US, Canada and Mexico would be the most affected countries.

The imposition of further tariff measures currently being considered by the US administration and commensurate retaliatory tariffs on US goods by the EU, China, Canada and Mexico would mark a significant escalation from tariff measures imposed to date, as noted in a recent Fitch Wire published on July 3 (“Risks to Global Growth Rise as Trade Tensions Escalate”).

Using the Oxford Economics Global Economic Model – a global macroeconomic model taking into account trade and financial linkages between economies – Fitch’s economics team assessed the economic impact of a scenario in which the US imposes auto import tariffs at 25% and additional tariffs on China, where trading partners retaliate symmetrically, and NAFTA collapses.

We factored in new tariffs on a total of USD400 billion of US goods imports from China in our simulations in light of recent statements from the US administration. This is twice as large as the scenario outlined in the aforementioned Fitch Wire. The tariffs under our new scenario would cover 90% of total Chinese goods exports to the US when added to tariffs on USD50 billion of exports already announced.

The tariffs would initially feed through to higher import prices, raising firms’ costs and reducing real wages. Business confidence and equity prices would also be dampened, further weighing on business investment and reducing consumption through a wealth effect. Over the long run, the model factors in productivity being affected as local firms are less exposed to international competition and so would face fewer incentives to seek efficiency gains. Export competitiveness in the countries subject to tariffs would decline, resulting in lower export volumes. The negative growth effects would be magnified by trade multipliers and feed through to other trading partners not directly targeted by the tariffs. Import substitution would offset some of the growth shock in the countries imposing import tariffs.

The US, Canada and Mexico would be the most affected countries. GDP growth would be 0.7% below the baseline forecast in 2019 in the US and Canada and 1.5% in Mexico. The level of GDP would remain significantly below its baseline in 2020. The results only consider tariff impacts, but the non-tariff barriers associated with the collapse of NAFTA could be equally if not more significant as supply chains are disrupted.

China would be less severely impacted, with GDP growth around 0.3% below the baseline forecast. China would only be affected directly by US protectionist measures in this scenario, whereas the US would be imposing tariffs on a large proportion of its imports while being hit simultaneously by retaliatory measures from four countries or trading blocs.

Most countries not directly involved in the trade war would see their GDP falling below baseline, though generally at a much lower scale. Net commodity exporters would be more severely hit, as slower world growth would push oil and hard commodity prices down. On the other hand, for some net commodity importers, the benefits from lower hard commodity prices would more than offset the impact of lower world growth.

Except in Canada and Mexico, a trade war scenario would ultimately be deflationary as lower growth and hard commodity prices would reduce inflation, outweighing the initial direct impact of higher tariffs in raising prices. The US Federal Reserve’s monetary tightening would be scaled back given lower growth and lower overall inflation in the US, with the level of the Fed Funds rate around 0.5pp below baseline.

US Corporate Trade Warnings Portend Softer Capex – Fitch

Growing concerns in the US business community about the potentially adverse effects of tariffs could cause modest deterioration in US manufacturing activity and capital spending by YE 2018, according to Fitch Ratings.

The escalation of the US-China trade dispute and the notable absence of constructive negotiations point to a continuation of trade-related uncertainty for US businesses through the second half of the year.

We expect approximately 3% growth in aggregate capital spending for Fitch’s universe of rated US corporates in 2018, following 6% growth in 2017, due in part to the cash benefits of tax reform. However, warnings that business strategies may be altered and capital projects delayed, along with potential pressure on exports, suggest capex trends could weaken. We currently expect aggregate capex to decline 0.8% in 2019. This may mark a potential inflection point in the current late-stage business cycle.

Several US companies, including Harley Davidson, Brown-Forman, and General Motors (GM), have spoken out on the potential adverse effects of escalating trade tensions. Harley-Davidson plans to move production of motorcycles for EU markets to its non-US plants to avoid retaliatory tariffs that would add an average of $2,200 to the cost of motorcycles exported to the region from the US. Brown-Forman cautioned that trade issues could negate benefits of a strong economy with the uncertainty making it difficult to accurately forecast earnings. GM indicated that potential US auto tariffs would raise prices of its vehicles, reduce its global competitiveness and lead to a loss of US jobs.

Comments by companies across various sectors, including electrical equipment, appliances and components, and food, beverage, and tobacco, were noted in the Federal Reserve’s June meeting minutes and the Institute for Supply Management’s (ISM) Purchasing Manager survey. This reflects broadening concern over the influence trade-related uncertainty is having on business sentiment and growth plans. Moreover, industry groups such as the US Chamber of Commerce and the Alliance of Automobile Manufacturers that support the business community are lodging complaints to the Trump Administration.

US leading economic indicators currently suggest overall business sentiment remains strong and manufacturing activity continues to expand due to a healthy growth outlook. The US Purchasing Manager’s Index (PMI) was near peak levels, rising to 60.2% in June from 58.7% in May. The index has only exhibited slight volatility in response to trade developments over the past year. The Philadelphia Fed’s survey of business intentions, a good bellwether of future capital spending plans, has recently declined slightly from very healthy levels, perhaps in response to protectionist threats.

Eurozone PMIs continue to signal expansion but have consistently declined since the beginning of 2018. Earlier in July, we noted increased trade tensions have raised the risk that additional tit-for-tat measures could have a greater impact on global economic growth than those seen so far. This would particularly be the case given the fact that investment and net exports are key components of GDP.

According to the ISM, expansion in new orders, production and employment drove the increase in the June US PMI reading. Inventories continue to struggle to maintain expansion levels, as a result of supplier deliveries slowing further. Labor constraints and supply chain disruptions continue to limit full production potential and price increases across all industry sectors remain on the rise. Additional rounds of tariffs could place further upward pressure on input costs, disrupt supply chains and weaken manufacturing activity in the near-term.

Risks to Global Growth Rise as Trade Tensions Escalate

Increased trade tensions have raised the risk that new measures may be taken that would have a much greater impact on global economic growth than those enacted so far, Fitch Ratings says.

The US investigation into auto tariffs, possible additional US tariffs on Chinese imports, and the likely reactions of other countries and blocs, point to a potential serious escalation, albeit with an impact that falls short of across-the-board tariffs imposed on all major trade flows.

The US administration’s continuing focus on reducing bilateral trade deficits and the response by China, the EU, Canada and Mexico to existing measures, have increased tensions. So far the scale of tariffs imposed has been too small to materially affect our forecasts for world growth, as we noted in our most recent “Global Economic Outlook”. The additional tariffs raised are very small relative to the GDP of the affected countries and regions.

However, further measures mooted by the US would mark a significant escalation. The initiation of a Section 232 investigation into whether auto imports weaken the US economy and impair national security affects US imports of new cars and car parts that were worth USD322 billion last year. The threat of an additional USD200 billion of tariffs on Chinese imports could prompt China to apply tariffs to all imports of goods and services from the US, which were worth USD188 billion in 2017. China could also retaliate with non-tariff barriers.

It remains to be seen whether US announcements are simply negotiating positions that may be modified. But the detailed preparation of, and justification for, such measures and the possibility of instant and strong retaliation by trading partners present growing risks to trade. If tensions rise further, the US hardens its stance and fully withdraws from NAFTA (which is not our base case), this would magnify the impact. The imposition of high tariffs on US auto imports would represent an existential threat to NAFTA.

Table 2 outlines a scenario in which the US imposes auto tariffs at 25% and additional tariffs on China. Trading partners retaliate symmetrically – in line with their recent responses to US steel tariffs – and NAFTA collapses. This scenario coupled with the existing measures would affect close to USD2 trillion of global trade flows.

Our calculations are not behavioural estimates of the impact of tariffs on GDP, which would be highly dependent on the effect on trade volumes. Nevertheless, scaling the measures relative to the size of the economy helps us to compare outcomes with the trade war scenario analysis we carried out in our study “Global Macro Scenario: US Trade Protectionism and Retaliation” last year.

In this scenario, our calculations would imply a shock to US import prices around 35% to 40% of the size of the shock examined in the trade war scenario, in turn suggesting a potential impact on US GDP growth of around 0.5pp. This would be broadly consistent with some other estimates. The US Tax Foundation estimates that if all tariffs announced by the US and other jurisdictions were fully enacted, US GDP would fall by 0.44% in the long run.

Our base case remains that blanket geographical tariffs between major countries are unlikely, and this was reflected in our unchanged forecasts for global growth in June’s “Global Economic Outlook”. But the downside risks to global growth from trade policy have increased.

A major global tariff shock would have adverse supply side impacts, raising costs for importers and disrupting supply-chains, while reducing consumers’ real wages. The global multiplier effect of lower US imports could be significant. US outward FDI (the largest source of FDI globally) would probably fall. Along with weaker confidence and lower investment, a global tariff shock would also hit job creation.

US’s China Tariffs May Create Risks for Some APAC Corps

The US government’s plan to impose 25% tariffs on imports from China across 1,333 product lines creates risks and complications for affected companies, and could be disruptive for regional and global supply chains, but the direct financial impact on Fitch-rated corporates in APAC is likely to be limited, says Fitch Ratings.

The announced tariffs cover around USD50 billion of Chinese exports, which we estimate would not have a significant effect on the Chinese or global economy. Subsequent and escalating tariff proposals by the Chinese and US governments have increased the risk of a full-blown trade war, and in that event the impact on APAC corporates would be more significant. However, we still believe a negotiated solution is most likely.

Televisions, printers, electronic components and motor vehicles are notable products covered by the US’s initial tariffs – in terms of the value of Chinese exports to the US. The importance of the US as an export market varies across these products. Almost one-third of China’s television exports and 28% of its motor vehicles exports are sent to the US. At the other end of the scale, only 8% of semiconductor shipments and 14% of electrical circuit apparatus go to the US, which should soften the impact on technology companies. Component manufacturers could be affected indirectly by a decline in exports of final products, although the list tended to avoid those products to limit the impact on US consumers.

Companies reliant on products included in the chart – particularly those toward the top – could be the most at risk, at least as far their exports are concerned. That said, the domestic market is more important than exports for many companies with operations in China, particularly Chinese firms. The domestic sales of Chinese automakers dwarf their exports, for example. The US is an important growth market for Hikvision – the only publicly Fitch-rated Chinese technology company likely to be affected by the tariffs directly – but around 70% of its external sales go to domestic customers.

Most Fitch-rated Chinese industrial companies do not export much to the US. Exports account for around half of Midea’s sales, but most go to emerging markets. The impact on Chinese clean-energy companies is likely to be minor. Wind-powered electric generating sets were included on the tariff list, but US imports from China were worth just USD36 million in 2017. Technology barriers have made it difficult for Chinese wind-turbine companies to enter the US market.

Foreign-owned Chinese exporters might be among the most affected by the tariffs. They accounted for 31% of exports last year, and joint ventures another 12%. These figures reflect China’s central role in regional and global supply chains, which could be disrupted by the tariffs.

Companies with the capacity to increase production outside of China might benefit from a shift in US demand, as the tariffs will boost their competitiveness relative to firms that rely on Chinese operations. This could be the case for Asian television manufacturers, such as Korea’s Samsung and LGE, which make most of their televisions in Mexico, Vietnam and Korea. However, a drop in component sales to China is likely to offset any potential upside for these firms. Among Japanese firms, Panasonic is no longer a significant manufacturer of televisions, while Sony focuses on the premium segment where it does not compete directly with Chinese companies.

Tariffs on imports of Chinese components could create complications for manufacturers in the US, highlighting the global nature of supply chains. The credit impact would vary – sectors with global footprints might be less affected, given the ability to shift sourcing and production.

China Can Cope With US Tariffs, But Trade Risks Rising

The US government’s proposal to impose tariffs on USD50 billion-USD60 billion worth of imports from China is unlikely to have a significant impact on the Chinese or global economy, says Fitch Ratings.

The risk that piecemeal protectionist measures escalate into a more damaging trade war has risen in recent months, but China’s measured response so far and US indications of openness to negotiation suggest this scenario should still be avoided.

The US administration has proposed the tariffs in response to what it considers to be unfair Chinese trade policies that have led to the acquisition of US technologies – invoking the authority provided by Section 301 of the US Trade Act. Aerospace, information and communication technology, and machinery will be targeted, with details due within the next two weeks. The administration will also consider measures to block Chinese acquisition of US technology through M&A and press the World Trade Organization to examine China’s technology licensing practices.

USD60 billion is equivalent to around 2.5% of China’s total merchandise exports, or 0.5% of its GDP, but the impact of the tariffs on the Chinese economy would be much smaller. Some of these goods will still end up going to the US, given the lack of substitutes, while others could be diverted to different markets. Moreover, the domestic value-added content of China’s exports is typically only around two-thirds, or less than one-half in the case of ICT goods, which contain a high proportion of imported inputs. Overall, we would not expect these tariffs to create a drag on Chinese GDP growth of much more than 0.1 percentage point this year.

The bigger risk is that the US eventually imposes across-the-board tariffs on China, either because its bilateral trade deficit with China stays large or in the context of an escalating trade war between the two countries. The US accounts for almost one-fifth of China’s total exports, equivalent to 3.6% of Chinese GDP, so broader tariffs could have a sizeable impact on China’s economy, and would have knock-on effects for the supply chain across the rest of Asia. A China-US trade war would also undermine global investor sentiment.

This more severe scenario cannot be ruled out, but we still expect new policies, either from the US or China in retaliation, to continue to fall under sector-specific measures. China has announced its own tariffs targeting USD3 billion worth of US agricultural goods in response to previous US tariffs on steel and aluminium, but Premier Li Keqiang has stated that “a trade war does no good to either side”. Meanwhile, US President Donald Trump has stated that the US and China are in negotiations. In that respect, the 30-day consultation period following the release of US tariff details should temper the prospect of immediate escalation and could provide time for a compromise to be reached.

A more challenging external environment could add to the risk of Chinese policymakers falling back on credit-fuelled stimulus, which would also be a major setback to the deleveraging agenda. Strong external demand was a key factor behind the outperformance of China’s economy last year, which allowed the authorities to focus on addressing financial risks without jeopardising GDP growth targets.