Monday 19th Nov, 2018

INDUSTRY ANALYSIS: The Rise of Global Trade Wars

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THE USA’s weapon of choice, on both the economic and political front, is the use of trade sanctions and tariffs. Trump initiated ‘trade wars’ by employing tariffs, levied on trading partners, to effect change in existing trade agreements. The US has massive trade imbalances with most of its current trading partners and is looking to achieve some equity through reciprocal, fair and free trade.

Doing deals
The President’s first forays have been tariffs on steel and aluminium and imposed on their leading trading partners of China, the EU and NAFTA (Canada and Mexico). These sanctions are seemingly starting to bear fruit, with the EC President, Jean-Claude Junker, coming to an agreement with President Trump. The agreement was struck at a Washington summit and has allowed sanctions to be set aside, while the terms of the agreement are worked upon and finalised. This success is likely to confirm the President’s tactics and ensure a continuation of this policy. The rumours are swirling that the Mexicans are going to come to the party, while the Canadians remain reticent, perhaps enabling a bi-lateral agreement without Canada? The Chinese continue to resist an agreement with the US, although tough negotiations have been ongoing, but the massive trade imbalance should ensure the Chinese negotiate a settlement.

No Turkish delight
Trump is also employing trade sanctions to force political change and curb refractory international behaviour. The US has imposed heavy trade sanctions on North Korea, Iran, Russia and now Turkey. Turkey has been moving towards an autocratic, Islamic theocracy and has been pushing the boundaries with its NATO allies. Turkey, under President Erdogan, has been steadily moving towards a government of totalitarianism. Erdogan has been flexing Turkish military muscle and testing both Western and Russian alliances. The ‘straw that broke the camel’s back’ was the continued incarceration of an American Pastor, Andrew Brunson, who the US has demanded his release. Turkey’s refusal has led to tariffs on steel and aluminium, with the promise of wider sanctions, which has led to the collapse of the Turkish Lira and now threatens the very economy itself.

The success of these trade penalties is becoming clear. The North Korean regime has come to the table, evidence being the Singapore Summit, inaugurating peace negotiations, which many thought was impossible. Sanctions are likely to force the desired outcomes on Turkey and Iran, who cannot resist the impact on their domestic economies and the pressure on their respective populace. Russian sanctions are likely to take a more convoluted solution, due to its military power and popular domestic support. Trump will likely have more success once he finally overcomes political pressures at home, in the form of Russian claims and investigations.

Trade-exposed nations
The US economy is the largest in the world and therefore the largest market for countries to sell in to. It places them in an extremely strong negotiating position in negotiating terms of trade agreements. It is for this reason that President Trump is a great advocate of bilateral trade agreements, as most other trading nations have preferred the multilateral free trade agreements, to dilute the power of the US and gain some unilateral equity. The most trade-exposed countries, such as Australia and New Zealand, are mainly primary exporters and thus tend to be ‘price-takers’. The dependence on trade is the reason they are referred to as ‘exposed’ as the countries’ exports are the major generator of their sovereign wealth. It is for this reason that the Australian/NZ economies have been disproportionately affected by the trade wars. It is reflected in the currencies, with the AUD$ collapsing to trade below 0.7300, from around 0.8000 six month ago.

Central bank influence on the markets
Monetary policy and local economic fundamentals also drive currencies and this has not supported a strong currency. The RBA has been neutral in monetary policy, citing risks to the local economy through debt levels and downgraded GDP growth prospects. The RBA also cited international risks, in the form global trade wars, which threatens the trade exposed economy. The extremely loose and bloated monetary policy is being duplicated across the world, with the ECB, Bank of Japan, RBNZ mimicking. This is in complete contrast to the US Fed, which has been aggressively raising interest rates and tightening monetary policy, thus supporting the strong US Dollar. The exception is the Bank of England, which has a penchant for raising interest rates, but has been crippled by the failure of ‘Brexit’ negotiations. The ECB has signalled that it may look to tighten monetary policy in 2019, due to stronger economic growth and a successful trade agreement with the USA. This has led to a bull-run for the Dollar, with the EUR falling below 1.1400, while the GBP trades around 1.2750. The US economy is gaining momentum and strength, with GDP growth bursting through 4%, while employment and investment surge

Summary
The currency moves have been underwritten by the strong Dollar and the greatest impact has been felt against the reserve USD, while cross rates against the EUR, GBP and Yen remain in a tighter range. The Foreign Exchange protection against this downside must be employed to avert huge FX risk to margins. The risk remains to the downside, although a resolution to the China/USA trade negotiations, could provide relief.

* Paul Bettany is a director with Collinson & Co



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