The only “winner” in a possible all-out trade war between the West and China will likely be the US dollar.
Uncertainty over global trade policy is at its highest level since 2018-19, when clashes between former US President Donald Trump’s administration and Beijing reached fever pitch. It is still far from those heights, but will come under greater scrutiny as the US presidential election approaches.
Whoever wins in November, new tariffs on imports from China and likely retaliation seem inevitable. China has already warned that if Europe joined the tariff bandwagon, it would constitute a “trade war”.
Mr. Trump’s return to the White House would raise the stakes considerably.
Rising protectionism and shrinking cross-border trade can hamper growth around the world, but the United States – the world’s economic and monetary superpower – has protections that other countries do not.
These include the relatively closed nature of the economy, the global importance of U.S. stock and bond markets, and the omnipresence of the dollar in international reserves.
This is not to say that the United States will not suffer: growth would slow and inflation could increase. But higher inflation delays or possibly eliminates Fed interest rate cuts, and growth in Europe and Asia would be more vulnerable than in the United States.
In short, the pain will likely be felt more acutely in other currencies, none of which have the safe-haven status of the dollar. And in the world of exchange rates, everything is relative.
THREE TIMES MORE DAMAGE
Economists at Goldman Sachs attempted to quantify the risks to U.S. and Eurozone growth by analyzing the 2018-2019 trade war and beyond through three lenses – comments from U.S. and European companies on the trade uncertainty, stock returns around tariff announcements and investment patterns between countries.
They found that an increase in trade policy uncertainty to 2018-2019 levels would likely reduce U.S. GDP growth by three-tenths of a percentage point. The estimated impact on growth in the euro zone would be three times greater.
For a region already expected to grow significantly slower than the United States, at just 0.8% this year and 1.5% next year, according to the International Monetary Fund, this would be a blow. Aggressive monetary easing from the European Central Bank could follow, undermining the euro.
“Further increases in trade policy uncertainty pose a significant downside risk to our global growth outlook in 2024H2 (second half of 2024) and 2025…with larger effects in economies where exports represent a greater large share of GDP,” Goldman’s economists wrote Tuesday.
FARM
The US economy is much less open than its European or Chinese counterparts, meaning trade disruptions should have relatively limited impact.
According to the World Bank, US exports of goods and services accounted for 11.8% of GDP in 2022, compared to 20.7% in China. Eurostat data shows that eurozone exports of goods accounted for 20% of GDP last year.
The persistence and deterioration of the trade deficit for years has been seen as a major drag on the dollar, as the United States has had to suck in huge amounts of foreign capital to cover the deficit and prevent the dollar from falling.
But last year, the U.S. trade deficit was 2.8 percent of GDP, much smaller than the year before and half what it was in the mid-2000s. Offshoring, energy self-sufficiency, and efforts to revive domestic manufacturing all indicate that the deficit will no longer be the drag on the dollar that it once was.
And that’s before a tariff escalation further reduces US imports.
EURO PARITY?
China’s domestic economic problems and geopolitical position are enough to deter foreigners from investing in the country. But it’s no coincidence that foreign direct investment flows to China are falling at their fastest pace in 15 years, just as trade tensions are reigniting.
Chinese stocks are underperforming, barely in positive territory for this year and after a disastrous 2023. Beijing is struggling to hold down the yuan, which is at a seven-month low against the dollar.
European stocks and the euro have not reacted favourably to recent headlines about Brussels imposing tariffs on some imports from China. Given the close trade relationship between the eurozone and China, this is not a surprise.
The euro zone imports more goods from China than anywhere else in the world, and the weight of the yuan in the trade-weighted euro rivals that of the dollar. Trade tensions between China and Europe will hit the euro hard.
And since the euro weighs almost 60% of the broader dollar index, there is naturally a strong inverse correlation between the fate of the euro and that of the dollar.
Deutsche Bank analysts predict the dollar will stay “stronger for longer” this year and next, although momentum could fade as the cycle lengthens.
A more hawkish stance on trade from whoever wins the White House in November, however, would be a major positive development for the dollar and would likely push the euro back down toward parity.
“The dollar underestimates the risks linked to American protectionism,” they wrote on Wednesday.
(The views expressed here are those of the author, a columnist for Reuters.)
