The US-China trade war began in March 2018 after U.S. President Donald Trump decided to impose 50 billion dollars (about 44.5 million euros) in tariffs on Chinese products, alleging unfair practices.

This war is now entering in a new phase. The U.S. government has raised tariffs from 10% to 25% on imports from China worth $200 billion from 10th May onwards. In response, China has announced that it will impose tariffs of between 5% and 25% on U.S. products worth $60 billion, starting June 1.

After the last increase on 10 May, the average tariff in the US is around 4.2% (1.7% in 2017, before the conflict), more than double that in the rest of the OECD countries and even above the large emerging economies, with the exception of Brazil and India. China had the average tariff at 3.8% before the conflict and is is estimated to be around 5% from 1 June.

The additional threat would be for the US to increase tariffs on the rest of China’s imports (by an additional $300 billion), which would raise the value of products affected by the trade war, including China’s retaliation, to around $750 billion. As a result, the average US tariff would rise to over 7%.

If, in addition, the conflict extends to U.S. imports of vehicles and components and adding the corresponding reprisals, the goods affected by the tariff increases could be close to a trillion dollars. This amount would represent around 6% of global trade and 1.0% of world GDP.

Implications

The intensification of tensions between China and the US may have various implications going further amidst fear of start of next recession:

Growth: It is estimated that the global GDP could be reduced by 0.3%, compared to the central scenario, in a horizon of two years. The impact per country would be uneven. Among the big countries, China would be the most affected, followed by the US and EU. In either case, the shock appear to be intense enough to jeopardize global expansion.

Inflation: The effects on inflation can only begin to be quantified in the case of the US. For example, if the impact of the 5 percentage point increase in the effective tariff in the US were fully passed on to consumers, it would add 1.1 percentage points to inflation. In any case, the “real” impact would be significantly lower, because not all products affected by tariffs would be consumer goods, there would be adjustments in exchange rates that could affect prices, companies would be able to absorb part of the effect on their profits and households would replace some of the products affected by tariffs.

Financial Markets: From a stock market point of view, there is a high risk of markets overreacting. Possibly, the worst case scenario is that fears of a recession will shoot up again. The positive thing is that, on this occasion, central banks are more cautious and more flexible in the face of any financial turbulence that may occur. The sensible thing is to consider, as a central scenario, that tensions are going to continue, but in the hope that positions will be approached with a view to the G20 summit at the end of June.

Bottomline

Until the upcoming G20 meeting in the end of June, positive developments are not seen and till then market will overreact negatively.

One of the most important keys will be the length of the conflict. The longer the open conflict continues, more the damage will be to the global economy. and above all, to the financial markets across the world. Naturally, the US and China market will take a major hit. From an investor’s point of view, the most likely scenario is that tensions and volatility will persist.