Trade War Between U.S. And China: Foreseeable Global Financial Crisis

Abstract

The two economic giants- the U. S. and China are on the verge of fighting the most infamous trade war witnessed in the history of this globe. With U. S. being the aggressor, it has already imposed tariffs on China this year worth of 250 Million USD goods. In the quest of attaining global domination, Donald. J. Trump, the President of the U. S. is pushing the global economy towards a yet another financial crisis, riding on the back of his “Nationalism”. Imposition of tariffs has led to less imports by U. S. , resulting in lower exports and revenues for China. But the most likely sufferers will be the emerging economies as anxiety and tension built over this issue will make their financial markets unstable, which can lead to fluctuation of share prices and even soaring interest rates. Moreover, strengthening of U. S. dollars followed by imposition of tariffs will neutralize any benefit a country could get through trading with U. S. , since it creates hindrance on the usual “correction” of balance of trade through market dynamics. All these factors are going to affect the macroeconomic variables of countries negatively, making the economies stagnant. Overall, in the quest of achieving global influence with minimal cross-border dependency and relations, U. S. has decided to sever ties with most of its stakeholders related to International Trade, leaving the emerging economies stranded and leading the world to an imminent global recession. As a precautionary policy, investors can hold inflation-adjusted bonds with longer maturities in order to immunize the portfolios from the foreseeable volatility.

Introduction

United States of America and China are the two largest economies of the world, who act as the “engine” of growth and control “majority of the global wealth”. U. S. has remained at the top of the list of world’s largest economies since 1871, which is expected to reach a humungous value of 20. 41 trillion USD in 2018. However, China, emerging as its closest competitor has started to boom rapidly since 1978 with a GDP growth of 10% annually, immediately after its market reform by converting into an open economy. Today, China has cemented itself as a “manufacturing and exporting hub” of the world with a Nominal GDP of 12. 01 Trillion USD, not far from the U. S. Moreover, in terms of Purchasing Power Parity (PPP), China has exceeded the GDP of U. S. by 21%, grabbing the top position as the largest economy of the globe in terms of PPP (Bajpai, 2018). According to the World Bank, China has had a sudden burst of economic growth in 2017 ever since 2010, due to a “cyclical rebound in global trade”. This has had an impact on trade with U. S. as well, as trade deficit with China rose to a record 375 Billion USD in 2017. As a result, U. S. opted to take actions against China in order to stop it, leading to the infamous trade war.

Background

The United States imports more from China than it exports, with a trade deficit of 375 Billion USD in 2017. Majority of the imports belong to the computer and accessories sector, cell phones and apparel. In order to reduce the cost of assembling, U. S. manufacturers send raw materials in China, since it has cheaper labor cost. On the other hand, China experiences a trade surplus, and only imports commercial aircrafts, soybeans and automobiles from their arch rival. The trade relationship between two economic giants is quite simple. China can produce goods demanded by U. S. at a cheaper rate and U. S. would obviously want goods at lower prices. But with the advent of Donald J. Trump, the President of the United States, trade relations with China have got hostile, as he had promised to make trade “fairer” for U. S. in his election campaigns. As a result, U. S. decided to go for a ‘trade brawl’ with their oldest trade partner in order to establish their global influence. So far, U. S. has imposed tariffs on Chinese products thrice this year, with a total of 250 Billion USD worth of goods. China also retaliated to this, by cancelling all imports for soybeans worth 34 Billion USD. Now the question might rise that why would Trump go for such a drastic step?

The first and foremost reason would be to fulfill his “extravagant” election promise and the hunt for glory. Secondly, he wants to stop the ‘transfer’ of American technology and intellectual property to China, according to him. Trump has thought over the theoretical aspects of restrictions, as tariffs will make domestic goods cheaper, and so Americans will be more inclined towards them, boosting local business and national economy in a whole. It shows that Trump clearly emphasizes on the issue of ‘Nationalism’ and keeping his vote banks satisfied rather than the welfare of the nation. According to BBC News (2018), many U. S. companies and industry groups accepted the fact that their business is being harmed due to the trade war. Moreover, in a whole, the U. S. consumers will be the ones to pay for Trump’s ‘patriotism’, as they will have to buy the domestic goods at a comparatively higher price due to increase in trade restrictions. It will have little effect on trade deficit as people will stop buying the high-priced luxury goods such as computers, electronic appliances etc. This will have a negative impact in the computer business which may even lead to many Americans losing jobs in this sector. Therefore, it’s apparent that trade restrictions are proving to be bane rather than boon for U. S. But what about China? This war would bring no good to them as well, since these two countries have shared a symbiotic relationship when it comes to trade. U. S. reducing imports would mean Chinese exporters suffering from lower revenues, as a result economic growth of both the countries will have a negative impact.

According to Costa (2018), China can retaliate against U. S. in this trade war the following ways:

• Making life difficult for U. S. companies operating in China by increasing their cost of business though taxes and restrictions.
• Restricting tourism in U. S. to cut off their revenue
• Devaluation of currency to make Chinese goods cheaper in other countries, offsetting the impact caused by U. S. tariffs.
• Selling off U. S. Treasury bonds to offset U. S. economy.
• Revamping the domestic growth and expanding trade relations with other countries.

Effect of Trade War on Global Growth

The question should arise that whether this infamous “trade war” will have any effect on the global growth and economy or not. According to Strauss and Romei (2018), economists believe that the restrictions imposed will have a “modest” effect on global growth, given the fact that the bilateral conflict does not turn into a “multilateral” one. This is because international trade contributing to global GDP has fallen in recent years, so the impact of any absurd trade activity would be less. Moreover, the fact that the effect of tariff being minimum on global trade, emergence of other markets due to this trade war will somewhat balance the turbulence caused by the war. But, is it that simple? Can this war go on to create a global financial crisis?

Global Financial Crisis Approaching?

Dissatisfied with the treatment of World Trade Organization (WTO) with the U. S. , President Trump has threatened to pull U. S. out of the WTO. This “mere” threat can create tremendous amount of anxiety in the global financial market, which can lead to increase in volatility in the stock markets, or even can lead to “skyrocketing” interest rates, such as the current scenario in Argentina. This rising state of interest rates can simply trigger the rate of inflation, increasing inflation risk, and the most likely sufferers will be the emerging market economies, as it will aggravate the cost of doing business and will also increase exchange rate risks due to fluctuation of U. S. dollars. Even though currently the growth of trend has no signs of any recession but the rising tension between the two global giants clearly indicates that the trade relations between the two economies will worsen even more. Therefore, investors will have to recognize this issue of “impaired” trade. As a result, according to Schowitz (2018), both the “extent of depth” of the economic aspects will have to be “recalibrated” upwards. This will also affect the decision-making factors of the investors when it comes to international trade, since they will now think twice where to go for a greenfield investment in a foreign country, since the cost of capital and the risks will be very high. This will have negative impact on the investment, making the economy more stagnant. Continuous upsurge of strengthening U. S. dollar is a concern as many of the emerging economies are experiencing a devaluation in their currency. This is a well-built “currency war” as according to Hendrick-Wong (2018), it will lead to less export and more import for America, but to neutralize it Trump imposed tariff to decrease imports, compelling U. S. citizens to buy expensive local goods.

In the end, even though it may seem like an apparent “trade surplus” for emerging economies with U. S. , it won’t be the case as imports of U. S. will also decrease, which will make the economies stagnant based on the degree of trade they’re involved with U. S. Therefore, in the quest of achieving global influence with minimal cross-border dependency and relations, U. S. has decided to sever ties with most of its stakeholders related to International Trade, leaving the emerging economies stranded and leading the world to an imminent global recession.

Recommendation

In order to tackle the possibility of upcoming global recession, according to Schowatz (2018), investors will have to be more “circumspect”. The upcoming hostile U. S. monetary policy, inflation and exchange rate risks aggravated from trade clearly suggest that it will be better to reduce the overall portfolio risk. However, since global growth trend is still upwards, immediate measures to reduce risk will not be imperative. Investors can hold inflation-adjusted bonds with longer maturities in order to immunize the portfolios from foreseeable volatility.

Conclusion

Even though the global recession seems apparent, it will be better to wait and inspect the market closely, since all these scenarios are forecasted. So, it’ll be better to remain composed and vigilant as Schowatz (2018) says, “Prudent investors should moderate their risk exposure and most importantly stay in the game whatever the economy throws in their way”.