Potential implications of a US-China trade war

In March, US President Donald Trump announced his proposal of import tariffs of 25 per cent on steel and 10 per cent on aluminium from China along with additional tariffs on approximately US$50 billion of Chinese products. In response, China retaliated by raising import duties on 128 US products with an annual worth of around US$3 billion. So, is this a sign that a global trade war is imminent? If so, what potential impact could it have on Australia’s economy?

We’re not at trade war levels yet, but the potential for further protectionist measures is a real threat

Applying these tariffs—essentially taxes on products produced overseas to protect local industries from foreign competition—is being ‘sold’ as an attempt to help the US and China support their domestic industries. But the reality is they would also likely lead to higher costs for all consumers.

For example, if Trump’s proposed steel and aluminium import tariffs get the green light and lead to a reduced supply of foreign steel and aluminium and in turn a greater reliance on US steel, this is likely to increase the overall cost of steel to US businesses. The flow-on effect could potentially result in higher costs for consumers of US-made products such as cars, electronics, and canned food and drinks.

The broader application of tariffs and protectionist policies also has the potential to reduce global trade while there is also an argument to be made that industries protected by tariffs do not have the incentive to remain, or become, globally competitive.

So, why would the US consider a trade war with one of their major global trading partners?

While globalisation has brought many benefits to consumers, it has been a painful process for those working in industries that cannot compete on a global scale. It is especially tough for people whose livelihoods are reliant on industries largely displaced by globalisation and automation – and it is fuelling the rise of populist politics and protectionism.

Trump is eager to reduce the US trade deficit with China and his protectionist agenda was integral to his election as seen by the prominent levels of support in the US ‘Rust Belt’ – previous manufacturing strongholds that suffered high levels of losses in local blue-collar industries.

Australia is an open, trade-dependent nation reliant on China and the US – so this is a concern

While the prospect of a trade war may seem to provide some benefits to Australian exporters, it’s important to delve deeper. Latest statistics (2016) show China is Australia’s largest two-way goods and services trading partner valued at $155.16 billion followed by the US at $64.28 billion1.

Given the value of our trading relationships with both China and the US, its means they exert a strong degree of influence on Australia’s future prosperity, making the idea of a trade war more concerning too.

The current proposals are a watch-and-wait but an all-out trade war is possible

While the potential for trade wars presents a risk to global equity markets, much of the recent volatility has been caused by concerns that issues around tariffs and trade barriers will escalate. At current levels, the proposed tariffs on both sides represent a small and manageable impact to global growth and inflation, however the threat of an all-out trade war cannot be completely discounted.

With US mid-term elections later this year, we are likely to see a continuation of populist policies from the Trump administration. The proposed tariffs on foreign steel and aluminium are a continuation of the agenda on which Trump’s election platform was built. But an all-out trade war is not in Trump’s, or anyone’s interest. The President’s initial act may turn out to be a tactic to negotiate a more favourable position for US-China trade discussions.

The most probable and preferred outcome is for both the US and China to reach agreements at the trade table, rather than continuing to impose barriers for trade between the world’s largest economies. However, the path towards this outcome is unlikely to be smooth, and as an investor, we recommend reviewing your portfolio to ensure it is well diversified to ride out any interim volatility.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward-looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Dixon Advisory is a holistic family wealth management firm supporting over 8,000 Australian members to manage their wealth for retirement through self managed super funds (SMSFs).

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