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The U.S.-China Trade War: The Global Economic Fallout

When the two biggest economies go head to head in a trade war, the world should pay notice

The longer-term consequences for global supply chains, U.S. business sentiment, and consumers' purchasing power are growing. Some economists espouse the view that U.S. tariffs on China could have longer-term benefits if they lead, for example, to a further opening of its financial services For the EU as a whole, involvement in U.S. and Chinese production represents a bit more than $400 billion, or 2.4% of GDP

By: S&P Global

In a first look at trade tariffs the U.S. and China have recently slapped on each other, economists at S&P Global Ratings believe the direct effects on the world's two largest economies are likely to be minimal—if the levies remain in place for the rest of 2019. However, the indirect macroeconomic effects are likely to be many, varied, and capture other trade-dependent economies in their nets like Europe and Canada. Beyond the macro level, the direct hits on specific sectors, lower-income consumers, and small and midsize enterprises (SMEs) with exposure to tariffs are likely to be sizable.

The U.S. Is Still Weathering The Storm

While the trade war brewing between the U.S. and China will likely have minimal direct macroeconomic effects on either country in the near future, the longer-term consequences for global supply chains, U.S. business sentiment, and consumers' purchasing power are growing.

A meaningful slowdown in domestic demand from the trade dispute will likely lead to rate cuts. For now, the central bank is in wait-and-see mode, but the chance of an "insurance" rate cut has increased. 

We expect the 25% tariffs, combined with reciprocal retaliation from China, if they hold for the year, will directly shave off only about 30 basis points from growth in the next 12 months but perhaps a bit more in secondary effects such as tighter financial conditions and increased uncertainty reducing business appetite for investment.

While that will slow growth, it is not enough to threaten recession in the world's largest economy. Typically, U.S. strategy in such a dispute is to force a trade partner to drop restraints on American goods, raise the value of its currency (thus making U.S. products more competitive), or to buy some time to reach certain domestic production capacity levels.

And some economists espouse the view that U.S. tariffs on China could have longer-term benefits if they lead, for example, to a further opening of its financial services and insurance markets to American entities

Europe Is Not Immune At first glance, it appears that the European economy has more to fear from Chinese retaliation against American exports than from U.S. tariffs on Chinese goods and services. This is because the share of European content in U.S. production is twice as high as it is in Chinese production. This sharp difference is no surprise, once we consider that the opening of the Chinese economy is a recent development compared to the historical links that tie the European and U.S. economies. For the EU as a whole, involvement in U.S. and Chinese production represents a bit more than $400 billion, or 2.4% of GDP. The European sectors that are most exposed—that is, those whose involvement in U.S. and Chinese production far exceed the EU average—are transport equipment, motor vehicles, rubber and plastics, chemical products, and pharmaceuticals. All of these sectors have medium to high technological content. So, countries such as Germany, France, the U.K., and some Nordic nations will see the direct effects of U.S.-China trade friction.

The world's two biggest national economies are also the two biggest trading partners for the EU, with the sum of EU trade (both exports and imports) with the two countries representing 8% of EU GDP.

For many European economies, trade carries almost as much weight as domestic activity. For eurozone countries, the average rate of economic openness (the sum of exports and imports relative to GDP) is close to 37%—10 percentage points higher than in the U.S.