A full-blown trade war would punch a hole in global economic growth because of reduced trade volume, supply chain disruptions, and lost confidence.
Quantifying just how much damage an entrenched trade battle could wreak upon the international community is a trickier task, but J.P. Morgan has come up with three scenarios.
In J.P. Morgan’s first model, the U.S. is assumed to raise tariffs on all imports by 10 percentage points, with no retaliation. In the second, the U.S. action is met in equal fashion, with other countries that are the targets of U.S. tariffs imposing a 10-percentage-point increase in tariffs on imports from the U.S. In the third scenario, the entire world raises tariffs by 10 percentage points, a phenomenon J.P. Morgan calls a trade war.
John Normand, the bank’s head of cross-asset fundamental strategy, said he believes that the third, worst-case scenario could reduce global growth by a “material” amount of at least 1.4 percent over the next two years.
Source: J.P. Morgan
“Our economists acknowledge that such frameworks underestimate the likely damage that comes through disrupted supply chains, plus the feedback loops from tighter financial conditions,” Normand said in a note to clients last week. “Policy uncertainty has a habit of denting consumer and business confidence, which in turn lowers household and corporate spending. The team’s proprietary, composite measure of developed market business sentiment already shows such a drop, but from above-average levels due to U.S. tax stimulus.”
Though Normand acknowledged that those worst-case fears have yet to materialize, the J.P. Morgan researchers added that global growth could slow by about 0.4 percent if countries targeted by the United States respond by slapping equivalent tariffs on Washington.
That scenario appears more like the one President Donald Trump finds himself stuck in after Canada started collecting duties on a variety of U.S. products on Sunday, including orange juice, yogurt, and whiskey. The Canadians will be reinforced by Mexico and China later this week in responding to the Trump administration’s tariffs when the two countries take aim at the U.S. pork and soybean industries.
Meanwhile, the European Union’s initial duties worth $3.2 billion took effect June 22. The majority are duties of 25 percent and include a slew of U.S. products, including motorcycles, boats, whiskey and peanut butter. The three U.S. allies declared the new tariffs in direct response to the Trump administration’s choice to levy imported steel and aluminum products.
A cornerstone of Trump’s campaign, the U.S.-centric philosophy remains key to the president’s economic program in office. Trump has for months used his pulpit and economic tariffs to try to effect change in trade deals the administration deems unfair and ultimately harmful to American economic interests. Calling for “fair and reciprocal” trade relationships, Trump has promised to dissolve the new U.S. tariffs only after more favorable deals are struck with trading allies.
Trump’s battle for more balanced trade could end up helping the economy. The trade deficit appears to be on the decline, falling to a seven-month low in April, according to the Commerce Department. The trade gap dropped 2.1 percent to $46.2 billion, the smallest since September.
If the trend continues, trade could contribute to gross domestic product in the second quarter, buoyed by strength in the manufacturing sector and consumer spending.
The warning from J.P. Morgan’s Normand, however, represents just the latest iteration in a string of cautious notes from the bank’s analysts in recent months detailing the possible dangers of “Trumponomics.” Marko Kolanovic, the bank’s head of quantitative strategy, estimated in June that the Trump’s tough trade tactics have caused the destruction of more than $1 trillion in market value.
“By attributing the trade-related news flow (positive or negative) to the performance of the U.S. market, we estimated the impact on U.S. equities to be negative 4.5 percent” since March, Kolanovic said in his June note. “Taking the current market capitalization, this translates into $1.25 trillion of value destruction for U.S. companies. For a comparison, this is about two-thirds of the value of total fiscal stimulus.”
Kolanovic, who heads J.P. Morgan’s global quantitative and derivatives strategy, predicted the stock market correction earlier this year and highlighted complacency and high leverage in the market as warning signs. Further, the strategist highlighted the impact of trade and protectionist ideology as “significant” market headwinds.
“A negotiation strategy that includes bluffing/threats can be successful in a two-party negotiation setup, but is more likely to deliver self-defeating results in a complex system such as global trade,” he said. “The value destroyed by a trade war might be reversible if policies are reversed, while the positive impact of fiscal measures is likely to remain. This would likely catalyze a rough 4 percent market rally.”