The trade war’s collateral damage

In choosing to ratchet up trade tensions with China at this juncture, the Trump administration seems to be overlooking the importance of both the emerging market economies and China to the global economy.

President Donald Trump listens to remarks by US Trade Representative Robert Lighthizer before signing a memorandum on intellectual property tariffs on high-tech goods from China, at the White House in Washington, U.S. March 22, 2018. REUTERS/Jonathan Ernst

This is all the more difficult to understand considering that according to IMF estimates the emerging market economies now constitute a greater part of the global economy than do the advanced economies. It is also difficult to understand considering that not only is China now the world’s second largest economy and its principal engine of economic growth, it is also a principal determinant of international commodity prices — which is the lifeblood of many emerging market economies.

In the best of times, increased tariffs on its exports would have constituted a significant shock to an economy as open as that of China. However, these are not the best of times for the Chinese economy. There are clear signs that, even before the escalation of trade tensions with the United States, China’s economy was already slowing as a result of measures being taken by the Chinese authorities to rein in China’s large credit bubble. The last thing that the Chinese economy now needs is a shock from abroad to its all-important export sector at a time of credit tightening.

Something similar might be said of the rest of the emerging market economies. In the best of times, a slowing in the Chinese economy and an accompanying swoon in international commodity prices would not be good for those economies. However, these are far from the best of times for the emerging market economies. Those economies are already having to cope with a move by the Federal Reserve to a tighter monetary policy stance that is causing a sudden stop in capital flows to those economies.

As if to underline this point, already before the escalation of trade tensions with China, emerging market currencies of countries like Argentina, Brazil, Indonesia, Mexico, South Africa, and Turkey were all in free fall. The last thing that these economies now need is a faltering Chinese economy that will only accelerate the capital flow reversal to the United States.

Hopefully, something will be done soon to defuse Chinese-US trade tensions. If not, the US and the advanced economies should brace themselves for shock waves emanating from the emerging market economies. And those shock waves would be coming at a time when financial markets in the advanced economies are already being roiled by the threat of an escalating trade war.