Trade War Threat To Australia

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

To date Australia has been somewhat of a spectator in the mounting global trade war, but further escalation threatens to drag Australia in.

-Trump’s tariff skirmishes threaten to trigger wider trade war
-Australia vulnerable to slowdown in Chinese demand for commodities, services
-Trump’s moves could rebound, dragging US down and taking world with it

By Nicki Bourlioufas

Australia can weather the storm stirred up by President Trump’s tariffs so far, say economists, but the horizon will darken considerably if the situation degenerates into an all-out trade war. Possible consequences include a slowdown in the global economy, a further rise in the value of the US dollar and disruption to capital flows.

For Australia, the immediate risks include lower commodity prices and lower Chinese demand for exports, including education and tourism. For Southeast Asia, any China slowdown will have a major impact on the integrated supply chain linking economies such as Malaysia, Singapore, South Korea and Taiwan, with knock-on effects on Australia.

Trump’s measures, and China’s retaliation, have injected uncertainty into the global economy, and there is anecdotal evidence this is causing some US businesses to defer planned investments. As well, there are signs that international investment decisions may be driven by the desire to get inside tariff walls rather than by economic efficiency. This was evident in Harley Davidson announcement it will move some production out of the US to avoid retaliatory EU tariffs.

Tit-for-tat blows escalate cycle of retaliation

Concerned about the US trade deficit with China, President Trump kicked off his trade war with tariffs on imports of steel and aluminium. These indiscriminately hit US allies including Canada, Japan, Mexico and the EU as well as China, but after tense negotiations Australia was able to win an exemption. Another crucial trigger point looms tonight, July 6, when a 25% tariff on US$34bn (A$46bn) of imports from China is due to kick in. Public hearings are being held in the US on a proposal to increase this target by US$16bn.

Tan Kai Xia of GaveKal Research says: “If Donald Trump follows through on all his threats – imposing tariffs on a further US$200-400bn of imports from China on top of the US$50bn already targeted, slapping tariffs on US$300bn of imports of cars and car parts, and withdrawing from Nafta – the disruption to global supply chains could be great enough to push the world economy into recession.

Tan concedes that the current the consensus appears to be that a trade war will hurt the rest of the world more than the US. “However,” he says, “in a world of emerging inflationary pressure and little excess capacity, it is possible that exporting economies will be able to pass the cost of tariffs on to US consumers, pushing up US inflation and interest rates and slowing real growth.”

Australian commodities and service exports in line of fire

Tony Kelly, Senior Economist with NAB Group Economics, agrees, saying that while measures currently being threatened would affect the global economy, the impact would likely be manageable. “However, if their implementation kicked off a further and more widespread cycle of retaliation, it has the potential to lead to a more sizable shock to global growth, which would also impact on Australia.”

China a major consumer of commodities “and so any downturn in its economy would impact on Australia”. Key Australian services exports, such as tourism or education, may also be hit as a reduction in China’s income bites.

“Lower commodity prices would be expected to produce a weaker AUD,” he says. A lower currency would offset, to some extent, the impact of falling international commodity prices for domestic exporters. “However, a lower currency would also raise import prices (as would the tariffs being put in place), cutting into Australian living standards.”

US could be shooting itself in the foot

Tamur Baig, chief economist with DBS, takes a slightly contrarian view, arguing although China’s exports to the US are worth more than the trade flowing the other way, the US’s lower growth rate makes it more vulnerable to a slowdown. An all-out trade war could shave a quarter of a percentage point of GDP off both economies’ GDP output in 2018, and at least double that in 2019, he says.

Considering that China grows at 6-7% and the US at 2-3%, “we believe the damage would be greater to the US than on China”, Baig says. “First, China’s retaliation will most likely extend beyond goods to trade in services and to the operation of US companies on mainland China. Second, the US is pursuing trade wars on multiple fronts, extending the skirmish against its ostensible allies like Canada and the EU. In each skirmish the US targets different economies and consumers, but the retaliation from each counterpart falls on the same group of American consumers and businesses.”

A contrarian view also comes from Rio Tinto ((RIO)), which in a June investor presentation said “trade tensions are unlikely to materially affect steel demand” noting “strong external demand for Chinese exports despite an increase in trade tensions.”

Against that, BHP ((BHP)) chief executive Andrew Mackenzie said in March, when tensions first flared, that Trump’s plans to impose tariffs on imported steel would harm the global economy and was "a black day for the world and business".

Indeed, given that the US is still by far the largest economy in the world – with GDP of US$20.5tr against China’s US$14trn – the barrage coming out of Trump’s America is bound to ricochet around the world, hitting Australia on the way through.

****

Australian investors should note thus far, in an unexpected left-field twist, the Australian share market has actually benefited from the risk off sentiment that has gripped global financial markets in recent months.

To read more about this:

Safe Haven Shelter In A Dichotomising World

Oil Becomes The New Defensive

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms