If there is something that the biggest critics of the IMF can agree on in a broad consensus – it’s the fact that the leaders of the important international organization have never been overly optimistic. Caution, suspicion, and detailed meticulousness, mixed with rational pessimism have always characterized their worldview. For the very same reason, the press conference, held on January 22nd, 2018, was so unusual.
All of the journalists attending the traditional event, which was held in order to update growth forecasts of the global economy, found it hard to ignore the broad smile spread across Maurice Obstfeld’s face, as he made his way to the center of the stage in the crowded room. Obstfeld, the head economist of the IMF, a stern man on an ordinary day, sat down on his chair, holding a bundle of briefs and messages from which he would read shortly afterwards, the way someone would grip the winning lottery ticket minutes before redeeming his winnings. The presence of Christine Legarde, managing director and chairwoman of the IMF, likewise attested to the importance of the moment, especially in light of the fact that the honorable chairwoman does not usually attend these events.
Despite the half-forced reservations and the stern tone that typically characterizes their media statements, the bottom line that emerged that day was clear and very optimistic regarding the immediate future: the global economy was accelerating faster than expected. Previous projections were revised upward and the rates of growth in world output and trade were higher than initially assumed – both with respect to the year 2017, which had just come to an end, as well as looking forward to the coming years.
After two consecutive years of contraction, for the first time since 2014, there has been an increase in global growth, which climbed to 3.7% – the highest it has been in the last six years. Added to this optimism was the fact that much of the growth was actually due to developing economies – those that in the past clouded global growth and lagged behind had seized the reins, giving a firm forward push to the economy. The rate of these economies’ growth in 2017 was double what they had recorded only five years prior, in 2012, and the highest it had been in a decade. Unemployment in the Euro Zone continued to decline, returning to the level it had been at in the period prior to the sub-prime crisis, at a time when employment markets in the US and many of the OECD countries were already in a period of full employment.
Global trade in 2017, as published in that same update, came in as a surprise, totaling an increase of 4.7% – the highest it had been in years and almost a full percent higher than the forecast predicted by the fund only one year earlier. That same forecast, published at the very beginning of 2018, also included a sharp update in the outlook for trade growth for the coming years (2018-2019) – which was likely an important factor in the optimism among IMF economists with regard to the outlook for positive growth of the global economy in the coming years.
However for all the declarations that were released to the media before and during the “festive” event, throughout the entire press conference, including Obstfeld and Lagarde’s detailed briefings, and even during the question-answer period allocated for journalists, the pair of words, “trade war” was conspicuously absent. The threat of a war as a concrete scenario at hand was not mentioned at all, although this possibility was hovering in the air for a long time. How long? At least from the very first day that US President elect Donald Trump sat down behind the ancient Resolute desk in the Oval Office, perhaps even earlier. Ironically, that very same day, January 22nd, 2018, just a few hours after the guests dispersed following the traditional media update, President Trump signed a special, maybe even historical order which is now considered to have been the opening shot of the current trade war; a war that shook the world and its markets in a way we had never seen before – at least not since that famous and traumatic crisis that erupted at the end of the last decade.
Imposing 30% customs tax on the import of solar panels (and washing machines), per the presidential order, was like sticking a finger in the eye of the Chinese giant and the first practical move after years of foreplay. Just about a month later, the White House announced additional customs taxes, this time on steel and aluminum imports. This act, tantamount to a declaration of war (according to the president’s own statement), which was aimed first and foremost at China, could not, of course, go unanswered. In response, China announced taxes on the import of metal and steel products as well as various agricultural products from the USA with a “scope of impact” of around $3 billion – and from there on in the conflict began to escalate and deteriorate at an astonishing pace, which surprised even veteran warhorses of the world trade arena. They have already gone on to define it, not surprisingly, as “the greatest trade war in history”.
The exchange of blows and combative statements between the leaders of these superpowers intensified significantly within a short period of time and became more powerful, more aggressive and more frequent, with each side aiming for their opponent’s weak point. The militant rhetoric between the sides sometimes sounded like it was taken from the familiar conflicts of our (Middle Eastern) region. So too did the dynamic between them develop into a kind of inevitable deterioration and escalation – with one side (the USA) threatening a more aggressive action if the other side (Chine) dared to respond in kind. In both rounds, together, the USA imposed sanctions on China to the tune of about $50 billion, primarily on industrial hi-tech products (the first round coming to about $34 billion and the second at $16 billion). Each time the American act was met with an equal and immediate Chinese response of reciprocal tariffs on agricultural goods (primarily soybeans) and industrial products (chemicals as well as both ground and aviation vehicles).
Following the second Chinese response, Washington raised the stakes dramatically: imposing tariffs on Chinese goods, which came in at no less than $200 billion. (10% beginning in September 2018, which were supposed to increase to 25% beginning January 2019, were it not for the declaration of a ceasefire). If the first step that the US initiated in the series of skirmishes was like sticking a finger in the proverbial Chinese eye, this move more closely resembled a fist straight to their bleeding face. This time Beijing blinked first and announced a customs tax increase on American goods of “only” $60 billion. For the first time, Trump may have realized the advantages of a trade deficit, which in this case became an effective bargaining chip in a commercial clash with a rival empire.
In total, in the three rounds announced up until the ceasefire was reached, the US imposed tariffs on Chinese goods and products totaling around $250 billion. About half of China’s annual export to the United States, which accounts for more than 10% of China’s total exports to the world, has now been placed under a heavy customs wall. China retaliated with a total of about $110 billion worth of customs taxes imposed on the US.
It is important to remember that the Chinese trade giant – the largest trading country in the world – operates as a central junction for global trade, which together with the US is actually the pulse center of the global economy. China and the USA alone are responsible for over a third of the world’s production, about a quarter of global imports, and more than a fifth of total exports. The combined trade of these two commodity giants totaled about $8 trillion last year.
Which is why the dramatic moves made recently by the Trump administration, and those which may yet come into effect in the future, have significant negative implications, not just for China itself – which alone accounts for about 35% of global annual growth. According to The Economist, 30% of goods exported from China to the USA are manufactured in a third country, so these measures will not only harm the Chinese economy, but also, or perhaps primarily, will upset many countries in Asia and in the entire world, certainly smaller and medium-sized countries, who rely on trade as their primary engine for growth.
The impact of the trade war, as we recently observed, is immediate and global and conducted on more than one level, and the results of this clash of the titans was felt by everyone. The IMF has already adjusted its global growth forecast for the next few years and deducted almost half a percent of growth in the emerging markets. The world trade growth forecast for the coming years was offset by the IMF in the last few months by an average of almost one percent. Accordingly, and unsurprisingly, the world’s largest shipping company, Moller-Maersk, recently warned that in certain scenarios, the trade war could affect about 2% of global container trade over the next two years.
Nor did the finance markets remain unaffected. The war, which took place a year ago, did not succeed in destroying the celebration on the American stock exchanges, which reacted with surprising indifference to all the dramatic developments. This was true until recently. It seems that immediately after the business became serious, and Trump so staggeringly raised the stakes against Xi Jinping, Wall Street became nervous and the indices began to drop.
The leading indexes in the US, which were doing great with double-digit yields, fell sharply in light of the dramatic escalation and wiped out all the handsome gains they had accumulated throughout the course of the year. The VIX index (the fear index, an indicator of expected future volatility in the American market) plunged in October – signaling the nervousness and high volatility in the markets. The NASDAQ, which since the beginning of the year has accompanied the intensification of the trade war, while showing a nice double-digit return by the end of September, saw almost all the gains it had had within a few months wiped out, as did the S&P500. Alibaba and Ebay, giants of online trade, have become central to the battle frontline, posting a write-off of 30% of their value at a certain point this year. Even the tech giants, Apple and Alphabet, which recorded great returns last year (until October), suffered negative sentiment in the markets and are now trading in negative territory, with Amazon plunging to 25% of its peak value in the past year.
In contrast to the American stock market indices, those in China are indicative of a real catastrophe. The leading stock exchanges crashed while huge losses were written off in short order: The Shenshen SE Composite, for example, lost 30% of its value since the start of the year, and the Shanghai SE Composite fell about 22% with a phenomenal loss of value at around $5 trillion. Last August, the Financial Times reported a negative historical milestone, when, for the first time since 2014, the Chinese stock market fell to a lower value than the Japanese.
A punch in the gut
There were those who compared the trade war between the US and China to a drinking contest. The winner with the higher tolerance will remain standing, and according to rational economic analysis, China will be the first to waver and fall from an imbalance at the negotiating table on the way to signing an agreement of surrender. The first significant round of fighting came into force last July and lasted for several months, so it is still difficult to determine who is winning or losing, but it is certainly possible to see which way the wind is blowing, and it does not portend any good for the American side.
Because, not particularly surprisingly, the Chinese Central Bureau of Statistics stopped all trade publications, starting from March of last year, one can only rely on data from the American Bureau. Given the gloomy data from the latter, it can be assumed that given the practical possibility, the administration in Washington would have chosen to censor the publications, as did its counterpart in Beijing.
According to data from the US Central Bureau of Statistics, since the new customs tariffs came into effect in early July, US exports to China plunged by 7.5% (in the third quarter of 2018, compared to the same period in 2017) – reversing the positive trend that was recorded in the previous two quarters (growth of around 9% in exports in each quarter) and reversing the overall trend in exports for all countries. What is even more surprising is that the US import from China actually grew in that same period at a rate of 7.5%. So, ironically, in the first months of the intensification of the fighting, the US trade deficit with China increased, and in the third quarter of 2018, swelled to a total of more than $115 billion, significantly higher than the deficit recorded in the same quarter a year earlier, amounting to $103 billion (third quarter of 2017). In October alone, the deficit rose to $43.1 billion – the highest deficit ever. Accordingly, the US total deficit grew to a huge $55.5 billion, the highest it has been since October 2008.
It seems that China’s plan of retaliation, which was aimed from the start at the vulnerable belly of Washington – American farmers – was a major blow. In some industries, agricultural exporters suffered severe and painful declines, while others were nearly entirely wiped out. Grain exports, for example, which in the same quarter in 2017 amounted to a total of $380 million, were almost completely wiped out, with a decline of 97%, to just $12 million. Soy bean export, America’s largest agricultural export, plunged at the dramatic rate of 92% (from $1.7 billion, to less than $135 million in the last quarter). The same happened in dairy export (with a drop of around 47%), meat (dropping 42%) and cotton (dropping 40%).
Additional sharp drops were felt in the traditional American industries, such as steel and iron (dropping around 43% in exports) and aluminum (dropping around 52%) – but the Chinese directed their most significant counter-attack straight to the heart: the automobile and energy industry. Within one quarter, gas exports dropped 35%, and coal export collapsed by 75% compared to the same quarter the previous year. Car sales from the United States to China dropped at a rate of 44% – a fall of more than $1 billion in exports. Tesla sales, for example, crashed last October by 70% compared to October of 2017, with the company selling just 211 cars.
Doom’s day scenario
At the 20-G conference held in late November in Buenos Aires, both parties agreed to lay down their arms and declare a 90-day ceasefire during which they would try to reach an agreement. Accordingly, the Americans agreed not to raise the customs threshold to 25%, but to leave it at 10%, while the Chinese agreed to act immediately to increase imports from the US and reduce the trade deficit.
It is clear to everyone that the general interest is that both sides reach an agreement as soon as possible. If things move in the right direction and both sides express good will to reach a compromise, the 90-day limit will not be a factor either. If necessary, the ceasefire will be extended for a longer period, perhaps indefinitely. But if, heaven forbid, the negotiations fail and end with an outburst – an entirely likely possibility in light of the past and the bad blood that has already been spilled – the escalation will be very quick and very painful.
So what would happen in such a scenario? The first step would be to eliminate the delay mechanism attached to the $200 billion package – which would immediately be taxed at a rate of 25%. If China responds (and it is clearly expected to respond), the US will push another enormous pile of poker chips into the table and place the new bet at the unthinkable level of a 267 billion dollar “all in” move – which would bring all of China’s exports to the US, hundreds of billions of dollars annually, under harsh customs restrictions. China is expected to respond by raising the customs tax on all imports from the US – around 130 billion dollars-worth per year – to a rate of 25%.
In such a scenario, the International Monetary Fund expects US growth to be hit at a rate of 0.3% a year by 2020, while China will suffer a more painful blow, a 1.2% cut in growth in 2019 and around 1% in 2020. The global economy will lose 0.2% growth in these years – a rate that might appear minimal, but would in fact constitute a loss of $2.5-3 trillion in terms of purchasing power.
Further escalation, more palpable in light of the many declarations made by the American president on the matter, could include imposing a 25% tariff on all imports of vehicles and their parts to the US – an estimated $350 billion a year. In this scenario, the damage to the US economy would be felt in a much more real way and would be expected to bring about a 0.6% reduction in GDP growth. Japan too, as well as the USA’s other close trading partners – Canada and Mexico – are expected to be hurt by such a move, with China and European countries actually benefitting in the short run, due to the demand expected to be directed to them as a result of rising prices.
But even if certain countries in Europe are likely to profit temporarily from such a scenario, the situation is unlikely to last long. According to IMF economists, such a tense and volatile environment would most likely undermine investor confidence and could quickly deteriorate into a decline in investment volume and plans of many firms. According to this scenario, countries that rely on trade and investment as a major growth engine may suffer the most painful blow.
Of course, in such a situation, corporate profits will be immediately affected, as has already happened in the realization of the “lighter” scenarios that we ave recently experienced. Harm to profits and the anticipated reduction in the volume of future investments are expected to increase the need for financial efficiency and lead to a wide sweep of layoffs, reductions and cutbacks. The financial markets will respond quickly and drastically, and from there a scenario of global recession and financial tightening by markets is right around the corner.
Even if the pessimistic scenario does not play out, and the conversations don’t end explosively, it seems that we are facing months of long and exhausting negotiations, which will add great uncertainty to markets that are already suffering from a trigger-happy situation, nerves and unpredictability. It is also too soon to assess and conclude how the world will look the day after the agreement (if it is reached), and which side will emerge victorious (if any). But one thing can be determined with relative certainty about the current state of affairs – everyone is losing.
Translation by Zoe Jordan