How Trade Wars can Affect Your Business and the FX Market

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The 2018 global trade war began with a single United States safeguard tariff on washing machines and solar cell panels in January. It subsequently picked up steam as the year progressed and developed into an all-out trade tariff war. Its cause centers on President Trump's ostensible belief that trade deficits with countries around the world are hurting the U.S. economy, in particular the manufacturing industry.

By imposing tariffs, Trump aims to cut the deficits and therefore, he claims, boost the domestic U.S. manufacturing sector.

By imposing tariffs, Trump aims to cut the deficits and therefore, he claims, boost the domestic U.S. manufacturing sector. However, leading economists believe that the tariffs will either harm the US economy or have no effect whatsoever.

The Trump administration has targeted China, the 27-member European Union, and neighbors Mexico and Canada. Despite the U.S. president's warnings not to retaliate in kind to U.S. tariffs, the affected countries have done exactly that.

Retaliatory action has seen tariffs imposed on U.S. goods sold abroad and led to a tit-for-tat trade war that has shaken global financial markets and driven exchange rate volatility. Among the trade announcements, the U.S. imposed tariffs on $34 billion of Chinese imports in June. China responded with tariffs of its own on $34 billion of U.S. imports. But it's not just the countries at the center of the trade war that will be adversely affected.
 

 It is not just the countries at the center of the
    trade war that will be adversely affected. 


Countries whose economic health is particularly reliant on trade or foreign investment may suffer. One example is Australia, whose economy depends heavily on China. Any slowdown or damage to the Chinese economy as a result of U.S. tariffs is likely to feel a knock-on effect as it creates downward pressure on the AUD.

What happened with trade wars in the past?

In 1930, soon after the beginning of the Great Depression, President Herbert Hoover signed into law the Smoot-Hawley Act. This bill proposed a series of tariffs on over 20,000 foreign goods sold in America. The intention was to help U.S. industry by weakening foreign competition, but the policy was a disaster whose main consequence was a worsening and entrenching of the economic depression in the U.S. and Europe.

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A mere four years later, President Franklin D. Roosevelt signed the Reciprocal Trade Agreements Act, which reduced tariff levels and welcomed trade and cooperation with foreign countries once again.

Much like today's trade war, foreign governments responded in kind with their own tariffs, leading to huge declines in international trade, and further entrenching depression in the U.S. The main difference, however, is that today the world is far more intertwined and interdependent, and so a trade war is potentially much more damaging.

Coming to understand this interdependence in 2003, President George W. Bush soon abandoned the steel tariffs his administration implemented in 2002 after European partners threatened to retaliate with tariffs of their own.

How do trade wars affect global currency markets?

Implementing tariffs on imports of goods from another country, or group of countries in the case of the E.U., is highly likely to reduce the purchase of those goods. The simple reason is that the tariff adds an extra cost, making the product more expensive. This can therefore lower investment in the country that bears the brunt of tariffs, leading to weakened economic growth and higher prices.

In the case of countries that are caught in the crossfire of trade wars, like Australia or Sweden, their home currencies might see declines as a result.

Economic slowdown generally leads to lower investor confidence in the affected country. If this happens, financial assets and entire markets, from equities and bonds and even currencies, can depreciate in value.

In the case of countries that are caught in the crossfire of trade wars, like Australia or Sweden, they too may suffer weakening investor confidence, and their home currencies might see declines as a result. While the initial rounds of tariffs didn't impact currency markets in a meaningful way, the Australian dollar and Swedish krona declined in June 2018 after U.S.-China tariff threats ramped up. The Mexican peso and Canadian dollar have also both suffered declines as a result of the Trump tariffs.

Meanwhile, investors have looked to the traditionally “safe haven" currencies of the U.S. dollar, Swiss franc, and Japanese yen to escape the volatility elsewhere in the currency markets. This has helped all three currencies to strengthen.

It is yet unclear how much further tariffs may impact the major currencies. It will likely depend in large part on their severity and the ramifications that they may have on domestic growth.

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What happens to currencies when a tariff is introduced?

When a country, whether it is the U.S., China, or another, imposes tariffs on another jurisdiction, it creates doubt over that jurisdiction's economic outlook and raises the likely outcome of a retaliatory tariff decision. When there are doubts over the economic outlook for a jurisdiction, investors are more likely to pull their capital from it, which leads to currency declines.

We have seen investment in the U.S. dollar rise because of its reputation as a safe haven currency, but whether this continues or not if confrontational rhetoric turns into further tariffs remains to be seen.

How does the trade war affect manufacturers?

Manufacturers and exporters both now find that to access the same foreign market they have to account for a new tariff on top of their usual costs.

The American steel and aluminium industries might see a rise in profits, as they could feasibly charge higher prices because demand for newly tariffed foreign imports of steel and aluminium recedes. Elsewhere though, many manufacturers now have to pay higher prices to import products that have been levied new tariffs.

It's much the same for a range of exporters who now find that to access the same foreign market as before the trade war began, they have to account for a new tariff on top of their usual costs.

To plan for new tariffs on their goods and supplies, manufacturers may be forced to raise their prices, which merely transfers the increase in cost to the customer, or the business distributing the goods to the end consumer. From motorbike to peanut butter companies, and from technology to jeans manufacturers, a wide and diverse range of company could be affected across the world.

How does the trade war affect businesses that work with foreign currencies?

If the U.S. dollar continues its consolidated strength, U.S.-based exporters may find it harder to sell goods and/or services abroad. Further trade war escalations with China, in particular, will likely cause concern across the globe, weakening confidence in other currencies, including the euro, British pound, Canadian dollar, Mexican peso, and Australian dollar. U.S.-based importers will however benefit from greater purchasing power, although tariffs on U.S. goods may raise prices, if applicable.

For companies outside the U.S. with exposure to foreign currencies, continued escalations in the trade war will likely create considerable volatility in FX markets. The mooted tariffs of $200 billion on Chinese goods would see a huge shift in the scale of the trade war and would almost certainly see currency declines across the globe.
 


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