Monday, October 14, 2019
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Ismael de la Cruz

​All the repercussions of the trade war between the United States and China

Financial markets analyst

Trump warned, threatened and then carried out their threat. He considered that he had to put an end to what he has called "unjust technology transfer to China" to the detriment of North American production. China reacted and counter-threatened, saying that they would not sit idly by, but would implement tariffs similar in intensity and harshness.


Wall street



However, all this has its origins in March of last year when the USA applied an extra tax on aluminium and steel imports. This decision wreaked havoc with the EU, which reacted by denouncing the United States and China to the World Trade Organization (WTO). Trump retracted and backed down by suspending tariffs on imports coming from Europe. At the end of March, Trump asked the Office of the US Trade Representative to present a proposal for tariffs on Chinese products, a fact that, of course, did not please the Asian giant who immediately retaliated by applying tariffs on 128 US products (apart from taking legal action against the Americans in the WTO).


The issue is that Trump is quite concerned that Chinese companies acquire technological leadership and he aims to restrain China on the issue of 5G, and the Asian giant needs US semiconductor and component companies. If we add to all this that China is on the way to becoming the world's largest economy and that this year it will surpass the Eurozone in terms of GDP and that in the next two years it could represent almost 30% of world economic growth, the United States' concern is not surprising. We have to keep in mind that if we finally see a total war with reprisals, the consequences would be tremendous, but at the level of international trade.


We will have to get used to the idea that the chances of a good trade agreement have decreased significantly and possibly it will not even happen.


The reality is that imposing tariffs means increasing the prices of imported goods to the United States, but of course, if we add that there will be reactions with tariffs from China, Canada and the EU, so that more of the same will happen with the exported goods. This would produce delicate synergies that would completely affect global trade and we would witness an evident loss of purchasing power on the part of consumers. It can be said openly that it would be workers and consumers who would bear the brunt of it. Thus, tariffs on imports reduce and limit the purchasing power of families because the increase in the price of goods purchased abroad cuts their disposable income that has a negative impact on consumption. Moreover, we should not forget that all this situation of uncertainty would cause families and companies to save more and invest less, with which the economy would fall. One issue that Trump does not usually comment on is that protectionism would also have another negative consequence for Americans, the increase in inflation, and if tariffs go on for years or decades, investments would move to other geographical areas. In addition, we have to take into account the damage that would be caused to the confidence of the private sector and the fall of the stock exchanges that would probably force the Central Banks to make cuts in interest rates and other measures.


In Europe, Ireland, the UK and Germany would be harmed. Regarding Spain, we can say that practically 7% of exports would be exposed to commercial war.


Yes, it is true that we are from the least exposed countries because our sales abroad are mainly aimed at the Eurozone, but it is also true that we export some 18,000 million Euros per year to these "delicate" areas, that is to say, of our total sales, 4.8% go to the USA (12,500 million Euros) and 2.3% to China (5,500 million Euros).


Oxford Economics produced a quite interesting report. It basically estimates tariffs of 25% on all imports from China (and they retaliate) US GDP will have an impact of around 0.5% and China's GDP growth would be reduced by around 1.3% in the 2020, falling at an unprecedented annual rate of 5%, while the world GDP would still suffer a significant loss - 0.5%.


In the worst case, and Trump does reach a commercial agreement with China, money would flee equities and seek protection in shelters such as the Japanese yen, gold, public debt, and the US dollar. But let's not forget that another worrisome issue is that of the slowdown in China: its manufacturing activity contracted more than expected in May (49.4 below 50 which is the zone that defines contraction/expansion). It is a fact that the question of tariffs played an significant role in the reduction of orders, the demand of China and in the confidence of consumers and companies.


In the worst case and Trump does not reach a trade agreement with China, the money will come out of equities and seek protection in shelters such as the Japanese yen, gold, public debt, the US dollar.


The effects have been quick to materialise:


The price of Spanish debt fell to a historical low and German debt also, and the US 10-year bond could fall below 2% for the first time since the end of 2016. It is a general trend, the yields of similar maturity in Australia and New Zealand fell to record lows, while 10-year yields in Japan matched a three-year low of -0.1%.


The MSCI Emerging Markets index entered a correction phase in the month of May with a 10% decrease since mid-April. Moreover, it is the emerging markets, particularly in Asia, that are under pressure on multiple fronts with the trade war between the United States and China that affects output chains throughout the region, while a strengthening of the dollar pressures exports.


It is likely that the Japanese Yen will benefit even more from commercial tensions, in fact, it has gained +2% against the dollar in May and is one of the strongest G10 currencies. We could continue to see the yen strengthen against the Euro and against the dollar and if the confrontation does not relax, to sustain further declines in EUR/JPY and USD/JPY (specifically in the latter case, we cannot rule out that this might become the worst of the scenarios the area of the 105).


There are a number of companies in Europe, the United States and Asia that are totally compromised by this issue, so it is best to avoid them. The list is long, so I'll summarize it a bit:


Europe: the Italian-French STMicroelectronics one of the leading companies in the world in semiconductor manufacture, and the German Infineon, one of the largest chip manufacturers in Europe, and the Austrian company AMS.


Wall Street: Intel, Qualcomm, Xilix, Broadcom, Skyworks Solutions, Qorvo, Analog Devices, Apple depends on China both to manufacture and sell the iPhone and a technological war could affect them intensely, NeoPhotonics.


Asia: Sunny Optical Technology and Q Tech.


China has an ace up its sleeve to inflict damage in its offensive: the so-called "rare earths", essential elements for the manufacture of technological products, and the key here is that the US imports 80% of these materials from China. To clarify, we are talking about 17 materials present in every electronic device in the world, fundamental for the creation of renewable energies, used in diesel engines and hybrid cars, in optical fibres, in computer hard disks, and even in weapons systems used by the American army.


The key is that China holds 47% of natural reserves of rare earths (44 million tons) and controls 90% of its production and marketing.


This is why, 27 years ago, the Chinese president said using a killer phrase: "The Middle East has oil, we have rare earths". Recently a member of the Chinese Communist Party (CCP) hit the nail on the head with another phrase: "rare earth production will help us control the life blood of the United States' high-tech sector".


Could all this lead to a currency war? If China decided to take the first step and start a currency war, what it would do would be to drop the value of the Yuan, but that could have a deflationary impact around the world, since a stronger Dollar would restrict global liquidity. For now, the People's Bank of China says that it is not contemplating it (at least that's the official message for the public). The problem is that Trump has a hair trigger. Anyway, it would not be unusual either in the United States: 19 years ago it intervened selling Dollars along with other countries of the G7 in favour of the Euro. Moreover, eight years ago it was the other way around, when they intervened by buying dollars so that the Japanese yen would not become too strong after the tsunami that hit the Japanese country.

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