Global economic expansion should continue through to the end of 2019
The trade war between the United States and its trading partners have created a number of risks for the global economy. So, how is the global economy faring? How will the retaliatory tariffs imposed by the US and China, among others, affect the global economy?
The US economy is on course to post strong showings in 2018. The US real GDP grew at a 4.1% pace during the second quarter. The underlying details were even stronger than the headline number, with real final sales surging as inventories were drawn down sharply.
Part of the second quarter’s strength came from efforts to produce and ship products ahead of retaliatory tariffs. The inventory draw-down pulled production forward and left inventories exceptionally lean throughout the supply chain. Despite a fading boost from fiscal stimulus and rising short-term interest rates, rebuilding inventories should keep output growing at around a 3% pace in the second half of 2018.
Other economies are not faring so well. Real GDP growth in the Eurozone slowed modestly in the second quarter at 2.1%. The Eurozone entered 2018 on a high, having racked up its most rapid expansion in a decade during 2017.
But growth slowed sharply in the first three months of this year, a setback that can be partially attributed to unusually cold weather and labour strikes in Germany and France. The failure of the economy to rebound in the second quarter shows other forces may be at work.
Trade tensions in the Eurozone heated up in the second quarter of 2018 as the Trump administration threatened a 25% tariff on auto imports from the European Union (EU). A recent Washington summit has since calmed the nerves of trade watchers, as the EU and the US agreed to work towards removing trade barriers.
A full-blown trade war, should one come to pass, probably would not completely derail the Eurozone economy. Exports to the US totalled just 2.5% of Eurozone GDP in 2017, meaning that the effect from tariffs could be painful, but not large enough to meaningfully drag on the overall economy.
Although trade tensions present a downside risk, we look for the economic expansion to remain in place, and forecast that real GDP will grow roughly 2% in 2018.
The dollar’s continued rise is injecting further risk into emerging markets, particularly those which have been borrowing heavily in the US currency and benefitting from foreign investment, such as Turkey, Hungary, Argentina, Poland, and Chile. Countries with large US currency debts and big foreign capital flows are at risk as the dollar climbs.
There is reason to believe the rest of the year will be calmer for the dollar, meaning less risk for emerging markets and other volatile assets. Against major currencies like the euro, the dollar has stopped climbing. A good deal of divergence between growth and monetary policy in Europe and the US already looks priced in. Where the dollar’s strength has exposed weak links in emerging markets such as Turkey, it may continue to cause problems.
The bigger picture will be influenced a good deal by the trade dispute between the US and China, and whether the Chinese yuan continues to fall, raising depreciation pressures on other currencies.
The US and Mexico have agreed on the key sticking points between the two countries that had held up renegotiating of the NAFTA for over a year. The deal still needs approval by the US and Mexican legislatures, and negotiators still hope that Canada will join as well.
The Trump administration has heralded economic strength as a source of leverage in its quest to force rivals to make concessions to the US on trade. Those talks are entering a new phase, with an understanding with Mexico on the NAFTA, and an agreement to hold off on tariffs against Europe after a Washington visit by the European Commission president.
The US and China, meanwhile, are making little progress in behind-the-scenes efforts to restart formal trade talks. A trade war with the US would weigh on Chinese economic growth, but it probably would not bring that economy completely to its knees.
Chinese real GDP rose by 6.7% (year-on-year) in the second quarter of 2018. Chinese authorities have already reacted to mitigate the negative impact of $265 billion in US tariffs by easing monetary policy and allowing the renminbi to depreciate more than 6% against the US dollar.
Given China’s limited capacity to retaliate in kind to the proposed tariffs, Chinese authorities are likely to undertake non-tariff actions to impede US business interests in the region, such as imposing more stringent customs controls targetting US goods, and seeking out allies to help generate a global response to US protectionism.
Emerging markets could become collateral damage in an escalating trade conflict where the US is squaring off against China and Europe. Export-dependent Asian economies may be especially vulnerable, and major stock markets in the region have tumbled in recent months.
A significant portion of US-bound exports from countries like Malaysia, South Korea, and Thailand pass through China, given its central role in the global supply chain. The trade conflict is also slowing a revival in global growth, stoking worries over demand for raw materials and hurting the economies of commodity exporters.
The first round of US tariffs has begun to reverberate globally, and the economic effects are likely to become more apparent if they remain in place -- and as other countries retaliate. But for many US trading partners, the tariffs may be just one of many challenges they face.
In recent weeks, there has been lot of discussion with the Turkish economy spiralling into a volatile situation. Turkey is too small in the scope of the global economy to trigger a broader global crisis.
Turkey remains in the early stages of a balance of payments crisis. A sudden stop to capital inflows has occurred, and the next step for Turkey involves spending cuts and an emphasis on boosting exports to help generate foreign currency required to pay for its large external obligations.
The medicine will be bitter, but the sooner Turkish authorities follow through with interest rate increases, capital controls, and fiscal spending cuts, the more likely they can mitigate the economic fallout.
Looking forward, we expect that the global economic expansion will remain intact through at least the end of 2019. Although many central banks have started the process of slowly raising interest rates, monetary policy remains accommodative in most economies, which should continue to support the global economic expansion.
The tariffs and counter-tariffs imposed by the US and their trading partners, respectively, remain a downside risk to the global economic growth outlook. Although the direct threat to the global economy from the tariffs enacted so far is relatively low, trade data are already showing signs that tariffs are affecting activity.
In addition, the second-order effects, such as a potential decline in the stock market and corresponding fall in household net worth/consumer confidence, are another threat that could compound any direct effect on growth from a full-blown trade war.
We remain hopeful that such a scenario never materializes, and that ongoing discussions between the US and its major trading partners prove fruitful.
Monaem Sarker is a politician, columnist, and Director General, Bangladesh Foundation for Development Research.