Impacts of Trade War

August 27, 2018

 

 

 

 

Traders are struggling to place trade concerns into a coherent narrative. As the instigator of the recent trade tensions with most of its major partners (China, Canada, Mexico and the EU), the U.S. economy could soon see exports take a hit from multiple directions. From another perspective, the U.S. economy is outperforming most of its global peers and therefore may be best situated to weather a protectionist-driven economic slowdown.

 

Currency war, also known as competitive devaluations, is a condition in international affairs where countries seek to gain a trade advantage over other countries by causing the exchange rate of their currency to fall in relation to other currencies. 

 

Trade war risks becoming a dangerous currency war as China weakens yuan the most in 2 years.

 

Not only does the threat of a trade war impact the day-to-day of the currency markets, it is also related to a currency war where countries devalue their own currency so exports can be sold cheaper overseas in order to jump start the economy at home. The problem with currency wars – just like trade wars – is that more often than not there are no winners.

 

The United States’ trade deficit to China no longer seems the top issue in the trade war: A deal for an additional $70 billion in Chinese purchases of US goods was reached after rounds of bilateral negations in May and June. Yet, that didn’t stop US President Trump from abandoning the deal.

For China, it can no longer rely on high growth rates that it enjoyed for decades; the need for industrial upgrading and developing new momentum, such as high-technologies, has become inevitable. In 2017, China announced it had shifted emphasis on quality over speed for economic growth. The Chinese government will support innovations and technologies industries further, as well as promoting the “Made in China 2025” plan.

 

As the world’s largest economies open up a new front in their increasingly acrimonious game of brinkmanship, the consequences could be dire -- and ripple far beyond the US and Chinese currencies. Everything from equities to oil to emerging-market assets is in danger of becoming collateral damage as the current global financial order is assailed from Beijing to Washington. Risk assets and oil prices would likely tumble as worries about growth arise, hitting currencies of commodity-exporting countries particularly hard -- namely, the Russian ruble, Colombian peso and Malaysian ringgit -- before taking down the rest of Asia.

 

The present currency war started in January 2010. The problem with currency wars is that all advantage is temporary and is quickly erased by retaliation. Trading partners retaliate with their own devaluations. Currency cross-rates end up back where they started, with costs imposed due to the uncertainties. Not only is the world not better off but it is worse off because of the costs and uncertainty resulting from the currency manipulations. Once countries realize that currency wars don’t work, they turn quickly to trade wars through tariffs and other trade barriers.

 

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