Donald Trump’s presidency in the USA is looking to shake up the global economy. In his first week he has cancelled the USA being part of the Trans Pacific Partnership (TPP) agreement. This includes news of an impending USA-China trade war. But is this something Australians should worry about? Or is this simply part of a psych game between these two countries?
Is a USA-China trade war possible?
A potential USA-China trade war has been presented by several economic, social and political experts. This was made after the USA president elect Donald Trump mentioned on numerous occasions that it will impose as much as 45% tariff on China products. But is this something that will truly happen?
A trade war between USA and China can happen if:
- Protectionist trade policies toward China gets implemented by the USA
- China starts harassing companies operating in China
- USA starts to curb Chinese steel imports
Watch this video to learn more.
In normal economic times, the idea of a superpower trade war would be unrealistic. However, we are in an era where global tensions are high and global finances are stretched, such an event is possible. The world is still yet to recover fully from the collapse of the Wall Street investment firm Lehman Brothers in 2008, which led to a global financial crisis. So is this something we should expect this 2017?
What is a trade war?
Several forecasts has been published by numerous socio-political and economic experts. But before we delve into this matter, let us first understand what a “trade war” truly means?
Trade war can be considered as an economic and social event where a series of tit-for-tat trade restrictions are imposed on “warring” countries that normally trade with one another. These restrictions mostly include changing levels for tariffs, taxes, quotas and volume limits on imported goods. It aims to significantly weaken the other country’s export revenue while encouraging consumers to buy from local manufacturers.
Today, some items made in China are cheaper than those in the USA mainly because they have lower labour costs. By the USA imposing a big tariff on these imports, the prices on these items will be of the same value with US manufactured products.
If this behaviour was to start between these two countries, who will have the upper hand?
This video explains it.
What are the potential impacts of a USA-China trade war to Australia?
On a worst case scenario, that indeed a USA-China trade war happens, how will this impact on Australia?
Saul Eslake, one of Australia’s leading independent economies, has these points to say:
Increase in Australian interest rates
The Chinese Yuan has drastically dropped over the past months. To prevent this from falling even deeper, China is selling USA treasuries and foreign currency reserves.
One could consider this a cunning tactic because by hoarding other country’s currencies, you can easily pull them out and later sell it in big quantities. This lowers their value while increasing your currency’s value.
But is this a good move for China?
It may indeed save the Yuan from dropping, but the more this is done by China, the harder it would be for Chinese commercial banks to source Yuan for themselves. This would most likely result in the Chinese banks lifting interest rates. If this was to happen, banks in south-east Asia and even in Australia would be likely to follow.
Impact of an increased interest rates
The moment interest rates increases the following impact is expected:
Increased cost of borrowing
An increase in interest rates means a rise in the cost of borrowing. This greatly affects business in various manner, as it means costs of running a business will most likely go up, especially for those that are dependent on credit.
Decreased rate of storable commodities
Storable commodities are items that can be stored over a substantial time without losing any excessive loss through deterioration or spoilage. An increased interest rate usually make for a decreased rate on these. This is due to the following reasons as enumerated by Jeffrey Frankel of Harvard University:
- It increases the incentive for extraction today rather than tomorrow
- It decreases a company’s desire to carry inventories
- It encourages speculators to shift out of commodity contracts and into treasury bills
- It appreciates the domestic currency thus reducing the price of internationally traded commodities in domestic terms
This is not good for those business involved in exporting.
Slowdown in Australia’s GDP
Since 2008, Australia’s growth has come from China. No other Organisation for Economic Co-operation and Development (OECD) economy is as dependent on China as Australia is. It takes one third of the Australian exports and has been influential in Australia’s grown since 2008.
With Trump’s attempt to cut some of the percentage points off China’s economic growth – it would most likely affect Australia too.
How will increased Chinese tariff rates from USA affect Australia
With China’s economy potentially taking a hit from USA tariffs that will be imposed on its exports, it will need to balance its books and start importing less.
This is definitely bad news, especially for Australia, whose largest trading partner and coal exporter is China. Its export sector is still riding on the back of a higher-than-expected prices for iron ore, coal and natural gas. But with this decline between now and the middle of the year, how will its economy respond?
Although this remains a speculation, one thing remains certain. With China agreeing and committing itself to the UN Paris Climate Conference in 2015 to cap its coal intake, even without a trade war happening, Australia will indeed see a decreased coal import from them.
What if China wins and USA loses in this trade war?
The above mentioned scenario may happen if and only if China loses the trade war and other countries remain submissive to the plans of Trump. But what if it goes the other way around and USA loses? What would happen?
Brookings EEDU has stated,
“If all countries suddenly retaliated to the USA scheme, the USA GDP would fall 5.2 percent and enter into a deeper recession. Australia’s GDP may indeed fall by 5.6 percent at the onslaught, with China withdrawing its financing to the USA budget deficit, but some of this capital may flow into Australia. Thus, providing a GDP benefit to Australia.”.
The USA-China trade war simply a psych war?
It is likely that all this is just hullabaloo and Trump’s talk of whole trade war is simply a psych war.
In the words of Zhang Yansheng, chief researcher for the Institute for International Economics Research at China’s National Development and Reform Commission, Trump charging 45% on Chinese goods will never happen.
The tariff increase is not fully possible without doing the same with other countries such where USA have trade surplus, too. This includes Europe, Russia and Japan. So just imagine how these countries will respond to an increased tariff rate.
The USA may think that it is still as powerful as it is a decade ago, but the fact is it isn’t anymore. With China awakening and expanding its trading power, especially in the Asia Pacific region, there is no 100% assurance that USA challenging China could result to a win. It could be the other way around.
How should Australian importers and exporters react to the USA-China trade war?
“Regionally, the survey of 3,750 people – an equal number in each of the five countries – found broad agreement that China would be most influential nation in Asia by 2026, with 69% of Australians agreeing China was already dominant, compared with 56% of Chinese.”
This is the result of a study published by the Guardian. It shows that an overwhelming number of Australians believe China has already become the most influential nation in the Asia-Pacific region and more want stronger ties with the rising superpower than with the USA. Thus, a majority vote shows a favour toward the Chinese.
What does this mean for importers and exporters?
There is no doubt that China is crucial to Australia’s economy. It will most likely continue to trade with it amidst any trade conflict arising between China and the US. However, a USA-China trade war would most likely have a negative effect on the Australian economy.
With this in mind, it is for Australian exporters might be wise start investigate other nations for the export produce to better cover their position.
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