The Initiation of Trade Wars? Battles? Skirmishes?

A review of the issues and challenges

Blu Putnam, Chief Economist, CME Group

The biggest current threat to global growth is a trade war.  There are other risks, too.  The U.S. Federal reserve is unwinding quantitative easing and raising rates, but is making the policy shifts very gradually, with careful market guidance.  Governments are focused on whether they need to cut taxes, not raise them; so, no growth risks from fiscal policy.  Consumer confidence is relatively high around the world, from mature industrial countries to young emerging-market nations.  Equity market valuation might appear high to some, but stock market corrections do not cause recessions unless there is a financial panic – and systematic risks from financial institutions are much lower than when the last crisis occurred in 2008.  After considering the other risks, we stand by our analysis that if the current synchronized global economic expansion is derailed, the most likely cause will be a trade war.  YET, we are optimistic.  So far, the actions taken earn only the terminology of “Skirmishes,” but if they escalate to “Battles” and then a “Trade War,” we will need to re-assess the risks.  Here is our review of the issues and challenges.

The trade skirmishes began in earnest in March 2018 with the US imposing tariffs on steel and aluminum in the name of national security. The US temporarily exempted Mexico and Canada pending progress on the NAFTA negotiation, held open the possibility that other countries might be exempted, but did not exempt Europe. The European Union is expected to retaliate with highly focused tariffs, from jeans to bourbon to motorcycles, designed to hit some hot-button pain points involving name-brand companies. Later in March, the US leveled tariffs on China, aimed at intellectual property.

In progress in the spring of 2018 are the US-Canada-Mexico negotiations over the North American Free Trade Agreement (NAFTA). While technical committees involved in the negotiations reportedly have made some progress on the small issues, the big issues that separate the US from Canada and Mexico revolving around domestic-content rules (think autos) and how to handle disputes (the US wants a system more to its liking), are far from being resolved. Indeed, while the US rhetoric about unfair trade practices is often aimed at China, the steel and aluminum tariffs can also be seen as bargaining chips in the NAFTA negotiations. Our take-away is that the US is only a very short step away from announcing its intention to withdraw from NAFTA. We note that announcing the intention to withdraw triggers a six-month waiting period. At the end of the six months is when the final decision to withdraw or not would be made.

One should not ignore the Brexit negotiations between the United Kingdom (UK) and European Union (EU) for the UK to exit the free trade zone, as they are not going well – actually they are not moving much at all. The UK has tended to negotiate as if they were equals with the EU. By analogy, though, if this were a card game, the EU holds four aces and the UK does not have a single pair – yet the UK continues to poker bluff for better terms, even though everyone’s cards are on the table for all to view. The strategy is not working because there are some fundamental inconsistencies at its heart. The first problem for UK Prime Minister Theresa May is that the Conservative Party is split with some ‘hard’ Brexit advocates and some ‘soft’ Brexit advocates. Another problem for the UK is Ireland. May has promised to treat Northern Ireland the same as England, Scotland and Wales. She has also promised the Democratic Unionist Party (DUB), whose 10 votes she needs to remain in power in Parliament, that she will keep an open border between the Republic of Ireland and Northern Ireland. It is very hard to conceive of how one keeps an open border with Ireland without putting some border controls in place between Northern Ireland and the rest of the UK. And, how do you keep free trade between Northern Ireland and the Republic of Ireland yet impose different rules on the rest of the UK versus the EU? It just does not add up.

Thus, the odds have risen that either the Conservative Party will revolt and select a new Prime Minister, or the DUB will withdraw its 10 votes and force a new election. If there is a new election, the Labour Party would have a reasonable chance to win; indeed, it might even be favored. What this means for trade between the UK and EU is that the UK is currently headed down a path in which it will miss the 2019 deadline for a deal to leave the EU, and the EU may just say good-bye and force a ‘hard’ Brexit, meaning more political repercussions in the UK and damage to UK trade with the EU.

There has been some action toward freer trade. In March, a group of 11 nations, without the US, signed the Trans-Pacific Partnership, renaming it the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which cuts tariffs among the member nations. The signing of the CPTPP underscores the US withdrawal from a leadership role in multi-lateral global affairs and reaffirms the intent of many other countries to strengthen mutual trade ties. This has the potential to reshape long-term trading patterns in goods, services, and commodities in a way that would disadvantage US-based companies and producers.

The trade pact in Latin America is gaining new traction, in part as a reaction to US protectionism. Mercosur, effectively the “Common Market of the South,” is likely to move to lower tariffs with other countries and regions outside South America so as to better diversify their trade relationships. In Africa, 44 countries have signed a new free trade pact – although the two richest nations, Nigeria and South Africa, remain aloof.

In short, the sources of trade tensions are getting increasingly serious, yet there are signs of freer trade, too. On the negative side, the US is moving unilaterally to impose tariffs. The renegotiation of NAFTA is about to hit major roadblocks, and no Brexit deal is in sight, increasing the odds of a “hard” exit for the UK and the worst case for UK-EU trade. On the positive side of the ledger, Pacific Rim nations, the CPTPP-11, are moving to create a customs zone without the US Freer trade is coming to South America as Mercosur is re-energized. African nations are bonding together. The glass is half full, but there are many risks.

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