By Teodor Ispas.
Are we on the brink of a global recession? Many recent economic signs do point towards that direction. The same signs also point towards one of the major causes for this: The Trade War.
In the last two months, the U.S. Federal Reserve has performed dramatic interest rate cuts that are comparable to those enforced following the Financial Market crash in 2008. The effects of this crash were devastating; notably, its effects included the collapse of the U.S. housing market, a severe weakening of the Euro and an overall global economic slow-down which forced numerous countries across the world to adopt severe austerity policies. Furthermore, all of the central world banks needed to perform negative cuts on interests, restricting the credit system to rejuvenate global investments. Since then, central banks – even though they adopted a hawkish attitude towards the market from time to time (most notably in 2012 and 2016) – were never pressured to perform cuts similar to the ones which the Fed is performing at the moment.
These interest cuts have happened as a consequence of Trump’s Trade War with China, and under the pressure of a constant, now imminent, threat of a U.S. Trade War with the European Union. These cuts are more concerning than they initially seem, especially since this past summer the Federal Reserve’s attitude towards the imbalances in the market was quite dovish. An example is that even when the European Central Bank announced early cuts for September, the Fed still seemed to be more optimistic about the market. Whereas this all changed when the Trade War took a turn for the worst and escalated a few days prior to the G7 Summit, as it raised major concerns about a potential recession. Essentially, the Fed cut rates because it is now concerned not just for the U.S. economy but for the financial markets across the world.
The Trade War began when the Trump administration called for tariffs to be imposed on Chinese commodities. Trump claimed that “China caused a loss worth of billions of dollars to the U.S.” and that the tariffs were aiming to pressure China into agreeing to a trade deal that would tip the scale of negotiations in favour of America. China did not succumb and responded by applying certain tariffs on U.S. commodities as well. These tariffs did not hurt the consumers of the two superpowers, or at least not directly. Instead, because certain raw materials which were essential to some U.S. businesses that conducted financial affairs in or with China, were priced additionally, investors started worrying about the impact this would have on the market, specifically on bonds. As a result, the yield curve inverted, and financial experts began looking towards the Fed’s attitude, wondering slightly if Trump was simply playing a game of who blinks first or was serious about the Trade War.
The Trade War goes on, with the Trump administration announcing an additional 25% increase on tariffs on Chinese goods by December – only this time aiming for products rather than commodities. China managed then to respond more strategically, increasing tariffs on oil imported from the U.S. which, despite having had a somewhat negative impact on them, managed to prove that the Chinese are resilient and patient enough to stand up to Trump. Also, the Chinese administration is now maintaining a threat to put certain U.S. businesses that are based in China on their unreliability list. While this won’t directly force the companies to close their HQ’s in Beijing or other big cities from China, it would severely restrict their access to the market to the point where it would be detrimental for them to continue their financial affairs in the country.
The Trade War has severe global implications and could potentially affect the majority of the world states. Not everyone will be affected to the same degree, and some countries may mitigate the consequences of economic warfare in efficient ways. However, current escalations and tensions have made the Trade War a global problem; therefore, it is no longer a sole dispute between the two countries. It is easy to observe how the Trade War has already begun to make its mark on different countries around the world.
Firstly, in the U.S., Trump claims to have been “winning this war all along”; however, the inversion of the yield curve, the increase in the dollar, and a generally pessimistic view from investors state otherwise. Additionally, the main reason why the Federal Reserve cut rates was that they were worried the American consumer would get caught in the crossfire. As the U.S.’ financial state relies strongly on a healthy active consumer, any increase in prices would shake the economy to potentially devastating proportions. That is why Trump decided to delay his additional tariffs on Chinese goods, as these would potentially have damaged the holiday season shopping. In fact, the main economic engine of the U.S. is the American consumer. Anything that would deter the people from spending money hurts the U.S. economy severely. For example, 25% tariffs on Chinese goods have the potential to bring an increase in prices and would make the American consumer more pessimistic and tempted to spend less. The Federal Reserve decided to react earlier than expected and cut rates to mitigate any damaging impact that these tariffs could have on U.S. consumers.
Secondly, other countries could be severely affected also. The European Union is already showing signs of economic weakness as a result of global economic tensions. One concerning aspect is represented by the economic contractions suffered by Germany and the UK in early September. The value of bonds further decreased in Italy and France as a result of the weakness suffered by the Euro. This situation has a lot to do with the Trade War. Even though the EU countries have so far been third parties in this economic warfare, they are still affected because of two important reasons. Firstly, tariffs on commodities destabilised the global market sufficiently so that manufacturing-based economies (such as Germany) were negatively impacted. Secondly, while the U.S. can pick the countries it can tariff, many of its economic policies are still subjected to different international regulations meaning that certain increases on goods/materials cannot be limited to specific countries (i.e. China) but rather impact other global trading partners (i.e. Germany, France, Australia etc).
Thirdly, China has also been affected, but the Trade War only caused the Chinese a direct economic loss of 1%. The indirect consequences are what impact China in reality. Global economic tensions and subsequent uncertainties wired within the global markets caused a domestic economic slowdown for China. The Chinese administration is currently having a hard time trying to stimulate new domestic investment in infrastructure and manufacturing areas. The violent protests in Hong Kong caused China a 3% financial loss in the markets.
However, despite everything Trump claims, China does not suffer in isolation and with no global consequences. A weakened China stimulates a weakened Europe which in return impacts a weakened China, whilst the U.S. is hit by the very same tariffs it wishes to impose on China. The Trade War is damaging the U.S.’ consumer market and puts additional obstacles to Global trading partners (other than China), essentially making it generally harder to invest and conduct business ‘as usual’. Consequently, the entire proceedings hurt both the U.S. and its global trading partners in the same full-circle process used to describe the relationship between China and Europe.
So, what’s the conclusion? It generally can be stated that the Trade War is the global economy’s worst nuisance at the moment – not just simply because of tariffs. It creates uncertainty and spreads doubt among global investors, who rely more and more on short term investments rather than long term ones. This puts certain short-term bonds/stocks on the main stage while economic areas, such as manufacturing and infrastructure suffer. This uncertainty, as shown by the inversion of the yield curve, impacts most countries around the world. Overall, tensions show no sign of diminishing anytime soon and uncertainty causes more and more global investors to doubt the reliability of long-term bonds and investments in general. At the beginning of the month, Trump threatened tariffs on EU goods. With everything unfolding at the moment, from a global perspective, these may seem interesting times but for all the wrong reasons.