Trade Wars Have No Winners
August 17, 2018
There has been much talk – and limited action, so far – about the “trade wars” the U.S. has begun waging with other parts of the world: chiefly China, Europe and emerging markets (EMs). Every day, especially in the U.S., commentators ask who’s winning, and who’s losing?
The first thing to clarify is that everyone loses in a trade war – there are no winners.
Tariffs are essentially taxes imposed on domestic consumers. Rising consumer prices constitute inflationary drivers that ultimately result in higher interest rates. China is unlikely to experience more significant economic pain than the U.S. from tariffs imposed by the Trump Administration.
The two countries are so interconnected that it is virtually impossible to take restrictive trade measures that will not backfire. For example, U.S. tariffs on Chinese steel have had the unintended effect of hurting General Motors1. GM buys 90 percent of its steel from U.S. producers, but those producers raised their prices, reacting to lower supplies on the market.
China has had time to prepare a long list of measures to hit back at the U.S. Chinese tariffs on U.S. soybeans – imports were running at $15 billion annually – are already hurting American farmers. Who is winning? Brazilian producers, who have been celebrating higher spot prices!
Europe also has hit the U.S. back with surgical precision, targeting Kentucky bourbon, Harley Davidson motorcycles and blue jeans – products that impact the constituencies of prominent Republican leaders in the U.S. Congress. Possibly because of these retaliatory measures, and China’s, the Trump Administration reversed plans to raise tariffs on European cars.
Meanwhile, Russia is in a much stronger position than might appear. Coming out of a deep recession, and four years into U.S. and European sanctions over Crimea, the country has an underleveraged corporate sector, a cheap currency and is benefitting from higher oil prices.
Turkey is in a hole it feverishly dug, the result of short-term – and misguided – strategies focused only on winning elections. With a global backdrop that has become less supportive, Turkey faces the prospect of capital controls and an International Monetary Fund relief plan (with strings attached) – or a continued spiral downwards, if Ankara continues to bluster. Yet because they are country-specific, Turkey’s problems are unlikely to cause real trouble for other EM countries.
Emerging markets are being dragged down by knee-jerk reactions, mistakenly assuming that contagion is inevitable, world growth will slow, and U.S. inflation will rise, triggering higher interest rates. Strength in the U.S. dollar has renewed, which many EM investors persist in believing is a direct negative.
While EM valuations reflect this overly negative scenario, U.S. bonds, equities and currency all seem to be ignoring slower growth possibilities in 2019. This mismatch is untenable.
Investors should treat this situation as an entry point for EM equities. The longer the mismatch continues, the higher the likelihood of a sharp snap back on both sides. The trigger may be evidence that EM corporate cash flows (outside Turkey) are broadly unaffected; or perhaps rising inflation, tax cuts and higher oil prices will raise U.S. interest rate expectations.
EM companies that could benefit from the winds of protectionism coming from the U.S. include agriculture producers in Latin America, European aerospace, and technology and engineering companies that could pitch for business in China without competition from U.S. producers.
Trade wars will inevitably accelerate the established trend of increasing trade between EM countries, enhancing Emerging Market oriented businesses to the detriment of trade with developed nations.
The full-blown trade war is getting closer, but it is not too late to step back. In the long term, there may well be partial winners in these U.S.’s trade wars. But they will not be the main protagonists and they will almost certainly not be American.
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Kim Catechis is Head of Global Emerging Markets at Martin Currie, a subsidiary of Legg Mason. His opinions are not meant to be viewed as investment advice or a solicitation for investment.
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