By Jamie McGeever
ORLANDO, Florida (Reuters) -The only ‘winner’ of a possible all-out trade war between the West and China will likely be the U.S. dollar.
Uncertainty over global trade policy is the highest since 2018-2019, when clashes between former US President Donald Trump’s administration and Beijing reached a fever pitch. It is nowhere near these peaks, but will gain more attention as the US presidential election approaches.
Whoever wins in November, further tariffs on imports from China and likely retaliation seem inevitable. China is already warning that a move by Europe to join the tariff train would constitute a “trade war.”
Trump’s return to the White House would raise the stakes considerably.
Rising protectionism and shrinking cross-border trade may dampen growth everywhere, but the US – the world’s economic and monetary superpower – has layers of protection that other countries do not.
These include the relatively closed nature of the economy, the global importance of the US stock and bond markets, and the ubiquity of the dollar in international reserves.
That’s not to say the US won’t suffer; growth would slow and inflation could rise. But higher inflation may slow or eliminate Fed rate cuts, and growth in Europe and Asia would be more fragile than in the US.
In short, the pain is likely to be felt more acutely in other currencies, none of which have the dollar’s safe-haven status either. And in the world of exchange rates, everything is relative.
THREE TIMES THE HIT
Economists at Goldman Sachs sought to quantify the risks to US and eurozone growth by analyzing the 2018-2019 trade war and beyond through three lenses: US and European company commentary on trade uncertainty, stock returns around tariff announcements, and investment patterns across countries.
They found that a rise in trade policy uncertainty to 2018-2019 levels would likely reduce US GDP growth by three-tenths of a percentage point. The estimated impact on eurozone growth would be three times as large.
For a region already expected to grow significantly slower than the US, at just 0.8% this year and 1.5% next year, according to the International Monetary Fund, that would be a major blow. Aggressive monetary easing by the European Central Bank could follow, undermining the euro.
“Further increases in trade policy uncertainty pose a significant downside risk to our global growth prospects in the second half of 2024 (second half of 2024) and 2025… with greater impacts in economies where exports account for a higher share of GDP takes,” Goldman economists wrote on Tuesday. .
CLOSED
The US economy is much less open than its European and Chinese counterparts, meaning trade disruption should have a relatively limited impact.
According to the World Bank, U.S. exports of goods and services accounted for 11.8% of GDP in 2022, compared to 20.7% in China. Eurostat data shows that eurozone goods exports were worth 20% of GDP last year.
A persistent and worsening trade deficit for years was seen as a major drag on the dollar, as the US had to bring in huge amounts of foreign capital to fill the gap and prevent the dollar from falling.
But the U.S. trade deficit was 2.8% of GDP last year, much smaller than the year before and half of what it was in the mid-2000s. Onshoring, energy self-sufficiency and an effort to revive domestic manufacturing all indicate that the deficit will not be as hard on the dollar as it once was.
And that’s before an escalation in tariffs could further shrink U.S. imports.
EURO PARITY?
China’s domestic economic problems and geopolitical posture are enough to make foreigners wary of investing in the country. But it is no coincidence that foreign direct investment flows into China are falling at the fastest pace in fifteen years, just as trade tensions are once again percolating.
Chinese stocks are underperforming and barely positive for this year and after a gloomy 2023. Beijing is struggling to prop up the yuan, which is at a seven-month low against the dollar.
European stocks and the euro have not responded positively to recent headlines about Brussels’ tariffs on certain imports from China. Given the close trade ties between the eurozone and China, this should come as no surprise.
The eurozone imports more goods from China than anywhere else in the world, and the yuan’s weighting in the trade-weighted euro is similar to that of the dollar. Trade tensions between China and Europe will hit the euro hard.
And because the euro has a weighting of almost 60% in the broader economy, there is obviously a strong inverse correlation between the fortunes of the euro and the dollar.
Analysts at Deutsche Bank predict the dollar will remain “stronger for longer” this year and next, although momentum may weaken the longer the cycle lasts.
However, a more combative stance on trade from whoever wins the White House in November would be a major positive for the dollar and likely push the euro back to parity.
“The dollar underestimates the risks of US protectionism,” they wrote on Wednesday.
(The views expressed here are those of the author, a columnist for Reuters.)
(by Jamie McGeever; editing by Paul Simao)
