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Trade War and How It Affects Forex Markets

Author: Martin Moni
Martin Moni
All publications of the author

Last week on Friday, October 11, 2019, President Donald Trump announced that the US and China had agreed on a commerce truce. This followed a commerce conflict that has been ongoing for over 15 months between the two largest economies in the world. As you would expect, such a clash would have major consequences for many industries, and the Forex market is no different.

In case you’re wondering why talk about this now when commerce conflict seems to be ending, think again. Following President Trump’s announcement last week, it now appears he may have jumped the gun about what was agreed upon. According to insiders familiar with the matter, Xi Jinping will not sign the commerce deal until several more things are hammered out this month. Therefore, suffice it to say that commerce talks are still ongoing and it is unclear so far what will come out of the talks. It is for this reason that all FX traders need to be aware of how these proceedings affect the Forex arena so as to prepare themselves. (These are the: Top 10 Most Outrageous Forex Arena Scammers)

Everything you need to know about the commerce talks so far

In order to understand how the ongoing commerce conflict has affected currency arenas, first, you need to know how it all began. The truth is that commerce tensions between the US and China have existed for decades. Moreover, Trump had always advocated for levies ever since the 1980s as a way for the US to cut down its commerce deficit. However, for the purpose of this post, we shall only focus on the commerce conflict during the American leadership since it has had the most impact on financial markets.

What’s happened so far?

2017 was a quiet year in commerce as the two leaders made a tentative deal to resolve any commerce conflicts between the two countries.  Then in February 2018, the first levies were implemented by the US. A 30% levy was imposed on imports of solar panels, except those from Canada, and a 20% levy on imports of washing machines. These levies were worth $8.5 billion and $1.8 billion respectively. In response, China’s Ministry of Commerce (MOFCOM) started investigations into sorghum imports from the US. Considering that sorghum is the United States’ cereal grain crop and China imports 79% of that, this was quite a significant threat. (Have you ever asked yourself: Should You Invest In CFDs Or Stocks To Make More Money?)

It was the first time the American leadership had escalated the commerce tensions, but this was not alarming. Previous administrations had also used the same tactics and they were always resolved without any serious impact on either economy or the markets. But the US president wasn’t done, going further to propose levies on over 1,300 Chinese imports including weapons, TVs, aerospace, and even medical devices. These levies were proposed in a case against China with the World Commerce Organization (WTO) citing discriminatory practices by China such as theft of intellectual property. (Do you know: How Is Spread Betting Different From Forex Exchanging?)

Then in March 2018, more levies were implemented, this time on steel (25%) and aluminium (10%) imports. The only countries exempt from these levies were Australia, South Korea, Argentina and Brazil for steel imports and Australia and Argentina for aluminium imports. This meant that, although China accounted for only 3% of US steel imports, the levies affected a lot more countries including allies in Europe. (These are the: 10 steps of successful market participants)

In April 2018, China retaliated by imposing levies on 128 products such as pork, recycled aluminium, fruit and wine from the US ranging from 15% and 25%. The total of these levies was worth $3 billion with the threat of additional levies on 106 products such as soybeans and automobiles worth $50 billion at 25%. Despite commerce talks in May that same year, no resolutions were made and the status quo remained.

Both of these countries enjoyed a brief period of truce toward the end of May when China agreed to buy more US products, but it wouldn’t last long. The final official levy list from the United States Trade Representative (USTR) was announced in June. List 1 included 818 products that would suffer a 25% levy while list 2 included 284 products still under consideration. These levies would be implemented on July 2018. Beijing promptly released its own list of products in two rounds – the first including 545 products worth $34 billion to suffer a 25% levy from July. The second list under consideration had an additional 114 products worth $16 billion. The commerce was officially in action, with the second round of levies going into effect in August. (Choose from: The 3 Most Trusted Exchange Authorities in The World)

By September, things had only got worse with the third list of US levies being proposed by the American leadership. This list $267 billion worth of Chinese imports, which would bring the total products under levies up to $517 billion. This would effectively place levies on all of China’s exports to the US considering $505 billion worth of products were imported from China in 2017. These levies were finally implemented, starting at a rate of 10% and set to increase to 25% at the start of 2019. (Do you know: How much money FX agents make?)

China, in retaliation, increased its levies on $60 billion worth of US imports with the proposal to increase these to $110 billion of US products. Such an increment would also be equal to all US product imports by China. It is probably why the two countries agreed to a 3-month truce during the G20 summit in December 2018. During this moment of truce, there would be no increase of levies, but the US had already placed levies on $200 billion worth of Chinese imports.

The proposed truce would be extended indefinitely after several successful commerce talks, until May 2019 when the talks broke down. Levy rates were increased from 10% to 25% on $200 billion worth of Chinese imports with the additional $325 billion of commodities such as mobile phones and laptops being placed once again under consideration. For US imports worth $60 billion, levies were raised to between 10% and 25%. It is also around this time when Huawei was banned by the US and China threatened to expand the levies to $75 billion of US commodities. (Do you know: Which Are The Best Commodities To Commerce In The Autumn?)

On September 1, 2019, the commerce was would escalate further when Washington imposed levies on $125 billion more Chinese imports. Since then, there have been no further increases in levies, but rather exemptions for particular products. Then everyone was pleasantly surprised when the US president announced a commerce truce last week. Nevertheless, there have already been levies imposed on $550 billion of Chinese commodities and $185 billion of American commodities.

What are levies and commerce conflicts for?

President Trump once said that commerce conflicts are good and easy to win, but this doesn’t seem to be the case. The president probably didn’t expect that the commerce conflict would drag on for so long and besides, he doesn’t seem to understand how levies work if you take note of his statements to make China pay for the commerce conflict. In case you don’t know why and how such policies are implemented, here is a quick and very broad guide. (Concepts Every Trader Should Understand: Leverage, Margin, and Hedging)

A levy is simply a tax imposed on imported products imposed by a particular country to discourage imports. Countries may impose a levy if they want to prevent further imports and promote local industries. For example, if a country imports a lot of steel for its industries, it may impose a levy on steel to make it more expensive. In response, industries would opt for cheaper steel produced from within the country, thus promoting the local steel industry.

In the past, though, levies were used to raise revenue by a country, which is probably what the president was thinking about. By promoting local industries, the government is able to earn more in the form of taxes. Add to that, the additional levies are a source of revenue as long as the products are still being imported. (These are: The Best FX Events And Expos To Attend Every Year)

Because of the benefits of levies to both the local industry and economy, some economists suggest that it may actually be good to place levies. The only problem is that there isn’t an optimal levy rate for every industry, and it often leads to dissatisfaction by the country’s commerce partners. They, in turn, tend to implement levies of their own, and this can quickly lead to a commerce conflict.

Such is the situation observed between China and the US. These economic measures lead to a commerce conflict when both countries lean toward making themselves self-sufficient and not relying on the other.

Will this end anytime soon?

Unfortunately, there are no clear signs that the current commerce conflict will end in the near future. Despite there being a commerce truce at the moment, both countries are still not in agreement over this fact as mentioned before. Inasmuch as the US president claimed that the two countries had agreed to a truce, there has been no official announcement from China’s administration. (Can A Forex Agent Avoid Sending Trades Directly To The Interbank Arena?)

Under the latest truce, China agreed to buy between $40 billion and $50 billion worth of US commodities particularly agricultural products. The US agricultural sector has been perhaps the most hurt by levies with Chinese levies affecting soybeans, pork, cranberries, etc. The effect was so severe that the US administration had to pay $28 billion in subsidies for agricultural products. The current situation has made many to think that the president has taken this simple gesture by China as a victory when in reality there’s still a long way to go. (All you need to know about: Options trading)

You should also consider that there have been other commerce truces between the two countries, but they were always ignored for further levies and an escalation of the commerce conflict.  To understand why no commerce truce has really worked, it is important to know the underlying problems.

The first and most significant is a lack of agreement between the president and his commerce advisors. Figures such as Peter Navarro have a hawkish stance whereby they believe a commerce conflict may be used to force structural changes in China’s economy. By placing massive levies on China, they hope that the country would be forced to change its economic model in regard to industrial policy, subsidies, and intellectual property. Such hardliners as Navarro are not against even decoupling the US from China and reducing the reliance of the US on China. They argue that such leverage would put China in a better position should there be conflicts politically or even in the military. (You should: Learn How To Use Position Exchanging In The FX Arena For Profit)

Others like Benn Steil of the Council on Foreign Relations believe that the recent truce is actually a victory for China since they get to purchase agricultural products like soybeans and energy products like natural gas. Since these are products China needs, it will actually be a benefit to China. And even if the truce leads to long-lasting peace, such figures don’t believe it will mend relations between China and the US.

For the president himself, he has to be cognizant of the coming elections just over a year ahead. Approval ratings for the president are at all-time lows partly because of the ongoing commerce conflicts. Many companies have been forced to lay off workers due to lower revenues due to the import levies. And those who haven’t laid off their workers have had to absorb the extra cost and be content with lower margins.

From all these, it is difficult to tell whether the commerce conflict will continue if the ceasefire will continue. For that, we just have to wait and see because the US president can be very unpredictable.

What has been the effect of the commerce conflict?

This long-running commerce conflict has not been without its consequences to the world economy and financial markets, and here is how:

Effect on the economy

Many orthodox economists say that commerce conflicts are bad for everyone and that there is never a clear winner. Since the start of the ongoing commerce conflict with China, the American economy has experienced a mixed bag of benefits and downsides, but overall the result has been negative. There have been a few niche companies that have benefited from levies, such as those that make alloys out of fiberglass, galvanized steel and plastic. These companies have benefited from the high prices of steel and aluminium due to the levies.

However, economists warn that the true effect of the levies is yet to be felt since large scale construction industries use futures to lock in future prices of steel and other construction materials. This means that such industries have not yet been affected, and when they are the consequences will be dire. Despite a few industries reaping benefits from the situation, things are actually very dire with warnings of a potential recession being issued. There are many signs of this, all of them pointing at a suffering economy in the US and, potentially, globally. (Here is: All you need to know about futures commitments)

On July 31, 2019, the FED cut interest rates in response to the economic situation and is already buying bonds as a method of quantitative easing. During the announcement, the FED cited uncertainty over commerce policy had contributed to the decision. Inflation rates falling also contributed to the decision. This happened because of a decrease in investment by business leaders. It is interesting how the administration claimed that a decrease in corporate tax would promote local investments, yet the opposite seems to be happening. With so much uncertainty in the economy, investors are unwilling to spend any more than they have to in case the feared recession hits. Taking into account the Fed’s QE measures, it is possible that there will be more rate hikes either this year or early 2020.

On a larger scale, the global economy has also suffered as a result of the commerce conflict between China and the US. At the start of the calendar year 2018, the IMF reported global GDP growth of 4% in 2017 with all signs pointing to even higher growth. Now the IMF is projecting that GDP growth will be 3% down from 3.2% expected in July due to continued global commerce fiction. This is a very dangerous situation because, if the number was to drop to 2.5%, it would mean that several countries would already be in a recession. The current figures are also the lowest since the 2008 global financial crisis, showing just how bad the situation is. (Can You Actually Get Your Money Back From A Fraudulent Dealer?)

The good news is that the global economy is expected to bounce back to 3.2% in 2020, but there is more risk to the downside than there is to the upside. And just looking at how far down the global economy has come shows the negative effect of the commerce conflict for the entire world.

Effect on financial markets

In the financial markets, the main observation has been an increase in volatility as investors keep an eye on the proceedings in the commerce conflict. Whenever there is positive news about the commerce conflict, markets react positively too. For instance, the announcement of a commerce truce on Friday made the S&P 500 jump almost 2.5% on the expectation of better economic growth. Thereafter, the same index would drop several points on Monday when the Chinese authorities said they needed more talks before they were convinced.

This back and forth between China and the US has made the markets very volatile, and investors have been turning to safe havens such as gold. Since the start of the year, the value of gold has soared by over 15%, even surpassing $1,550 at the start of September when the third round or levies was implemented. It didn’t come as a surprise because investors always divest from equities in favour of gold and other assets during economic uncertainties. (Learn the: 5 tips to forming the most promising coin investment portfolio)

For investors in the stock market, the trick has been to keep a close eye on the goings-on in the news in order to make wiser decisions. Forex traders, on the other hand, have actually noticed the opposite happen. As the US equities market has continued to grow at a rapid pace, the US dollar has also grown stronger as the USD index chart below shows. Nevertheless, it too has suffered from increased volatility and rapid shifts in price every time levies are implemented.

The FED’s decision to lower interest rates at the end of July also had a major negative effect on the DXY, with another possible rate cut expected at the end of this month. When the Chinese government decided to devalue their currency, it made the US dollar even stronger and thus less competitive. Perhaps the Fed will attempt to devalue the dollar in return to help win the commerce conflict as well as increasing the inflation rate toward the target and stave off a recession. (In case: You Wanted To Know How Many Traders Lose, Now You Know)

To find out, we just have to wait and see. So far, there have been a lot of events surrounding the commerce conflict and the ripple effect has been felt all over the world. As a trader, all you can do is be watchful and ready to act. All signs currently point to a possible recession, so this is the time to make risk management a priority in all your trading activities. (This is: How to protect yourself from margin call)

And remember with disaster comes opportunity; there are many more markets to invest in and myriad currencies. So, diversify your portfolio to make more money and stay protected from any market volatility. (Learn more about the: Growth Of The Forex Arena In Africa And Other Developing Countries)

 

In case you were curious about the latest in the commerce conflict situation, here is a short clip to get you up to date:

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Risk Warning: Your capital is at risk. Statistically, only 11-25% of traders gain profit when trading Forex and CFDs. The remaining 74-89% of customers lose their investment. Invest in capital that is willing to expose such risks.
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