14th January 2020
In October, the US government imposed new tariffs on a range of products imported from Europe. The 10% tariffs were in response to what the US says are illegal subsidies paid to European aircraft manufacturers. These are not the first tariffs imposed on European goods by the Trump administration-in 2018, tariffs were imposed on steel and aluminium imports from around the world
The tariffs will be levied on about $7.5 billion a year in goods and are sanctioned by the World Trade Organisation (WTO). The move follows nearly 20 years of litigation following complaints by Boeing about the subsidies Airbus receives.
The US is targeting products exported by the four countries that give Airbus subsidies-namely Spain, the UK, Germany, and France. Products include cheese, wine, whisky, clothing, tools, and olives. However, the tariffs also hit other countries that export the same products-in particular, cheese exports from Italy.
This may trigger a tit-for-tat trade war. The EU has already threatened to impose similar tariffs on imports from US-based Boeing, which also receives subsidies from the US government.
Some economists believe an escalating trade war between the US and EU would trigger a global recession. The impact of the ongoing trade war between the US and China is being felt far and wide, and the new trade war will only increase economic uncertainty around the world.
The trade war has already escalated to an extent. The US has now proposed additional tariffs on French goods in response to a new digital tax imposed by France on companies like Google, Amazon, and Apple. The digital tax has been in the works for a long time with most European countries complaining about the low tax rates paid by large tech companies. France's digital tax is not aimed specifically at US companies, though US companies will pay the most.
Italy, Turkey, and the UK are also proposing similar digital taxes. While these taxes are not necessarily unfair, US tech companies do have considerable lobbying power in Washington. That means there is every chance the US government will be persuaded to retaliate.
One US official said the US could slap import duties as high as 100% on imports from France.
Cheesemakers in Italy have responded to the tariffs by requesting subsidies from the EU. Italy is not supposed to be a target of the trade war, but Italy's cheese industry has become collateral damage. The irony is that the US tariffs that are a response to EU subsidies may lead to further subsidies in Europe.
Some European officials have also suggested a carbon tax on imports from countries that don't do their bit to reduce carbon emissions. That may be a completely different issue, but it would still fuel the escalation of a trade war.
The US dollar has actually weakened against most currencies since early October when the tariffs were announced. After hitting a two year high of 99.67 at the end of September, the Dollar Index has traded as low as 96.53. This is not necessarily related to the tariffs which as they stand are not large enough to have a direct effect on either the Euro or the US dollar.
If the trade war does escalate, the effect is more likely to be increased uncertainty and volatility along with deteriorating market sentiment. This will impact equity markets and other "risk-on" assets like emerging market currencies. In particular, the currencies of commodity-producing countries like Australia, South Africa, and Brazil would be vulnerable.
Global market volatility typically benefits the USD and Gold in the short term. Gold is probably the asset to watch, as it looks like it may be poised to resume the rally that started in September 2018.
The USD may initially react positively to a sell-off in risky assets, but its longer-term direction would be affected by other factors. The GBP may also benefit if certainty over Brexit increases, while uncertainty creeps into other markets.
There are two other factors that may affect the way a trade war will play out: Donald Trump's impeachment trial and the 2020 US elections will affect the way the US responds in the next year.
If Trump survives the impeachment trial, he will be emboldened to continue with his policy agenda. His focus will be on building support ahead of next year's election. He will want to show strength, but also prevent the US economy or stock market crashing before November.
How emboldened he becomes will also depend on how much support he gets from Republican senators.
In the seemingly unlikely event that Democrats do manage to remove Trump from office, short-term uncertainty will rise. The Democrats would want to end the trade wars, but that would take time-and they would have to take the White House first. In the interim, the US political landscape would be even less predictable than it has in the past, and this would drive market volatility.
Either way, 2020 is shaping up to be an interesting year for the global economy and markets.
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