TRADE WARS
As part of the latest Monetary Policy Committee Statement, the Reserve Bank Governor, Mr Lesetja Kganyago indicated that the South African Reserve Bank (“SARB”) had “spent some time during this meeting reviewing a trade war scenario. This featured a universal increase of 10 percentage points in US tariffs, with retaliatory measures by other countries. The scenario showed higher inflation and interest rates globally, as well as greater risk aversion in financial markets. In response, our model projected the rand depreciating to nearly R21 to the dollar, with domestic inflation reaching 5%.” In this month’s Financial View we unpack why trade wars are negative.
What is a Trade War
A trade war occurs when countries impose tariffs or other trade barriers on each other in response to trade disputes. These measures are typically intended to protect domestic industries from foreign competition or to retaliate against unfair trade practices. Trade wars, however, can escalate quickly, leading to a cycle of retaliatory actions that can ultimately harm both economies involved.
Donald Trump, in the infancy of his second term as US President, has indicated that his trade policies will continue to emphasize the “America First” approach, leading to potential trade conflicts with several countries. The first step that he has undertaken is to reintroduce tariffs on imports from countries like Mexico, and Canada, who in turn have responded with their own retaliatory tariffs – as it stands, we already have a trade war. But Mr Trump is not done yet, he has indicated that China, Europe and the UK will all be subject to additional trade tariffs.
Why Trade Wars are bad for inflation
Increased Costs for Consumers and Businesses
When tariffs are imposed, the cost of imported goods rises. Businesses that rely on these imports face higher production costs, which they often pass on to consumers in the form of higher prices. For example, if the US imposes tariffs on steel and aluminum from Canada, American manufacturers of cars, appliances, and other goods that use these metals will see their costs increase. This leads to higher prices for consumers, contributing to inflation.
Disruption of Supply Chains
Global supply chains are intricately linked, and trade wars can disrupt these connections. When tariffs are imposed, companies may need to find new suppliers or relocate production, which can be costly and time-consuming. This disruption can lead to shortages of goods, further driving up prices. For instance, tariffs on Chinese electronics can lead to delays and increased costs for tech companies that rely on Chinese components such as Apple with the iPhone.
Retaliatory Measures
Trade wars often lead to retaliatory tariffs, where countries respond to tariffs by imposing their own tariffs. This tit-for-tat reaction can escalate and create a cycle of increasing costs. If the US imposes tariffs on Chinese goods, China may retaliate with tariffs on American agricultural products. This not only affects the prices of goods directly involved but can also have broader economic impacts, leading to higher overall inflation.
Reduced Competition
Tariffs can reduce competition by making imported goods more expensive compared to domestic products. While this might seem beneficial for domestic industries in the short term, it can lead to complacency and reduced efficiency. Without the pressure of competition, domestic producers may not have the same incentive to innovate or control costs, leading to higher prices and contributing to continuing inflationary pressure.
Impact on Economic Growth
Trade wars can slow economic growth by creating uncertainty and reducing investment. Businesses may delay or cancel expansion plans due to the unpredictability of trade policies. Slower economic growth can lead to higher unemployment and reduced consumer spending, which can have complex effects on inflation. While reduced demand might lower inflation in some sectors, the uncertainty and reduced efficiency can still lead to higher prices.
Sector-Specific Impacts
Certain sectors are more vulnerable to trade wars than others. For instance, the agricultural sector can be particularly hard hit by retaliatory tariffs. Farmers may face reduced demand for their products, leading to lower incomes and higher prices for consumers. Similarly, industries that rely heavily on imported components, such as electronics and automotive, can see significant cost increases.
What is the risk for South Africa
The South African economy is not fully diversified as we generally are great at pulling things out the ground (mining) and putting things into the ground (agriculture) but limited elsewhere. Our manufacturing capacity has dwindled over the last couple of decades, and we are now very reliant on imports in a number of sectors within the economy. With this lack of self-sufficiency, we are directly impacted by cost pressures elsewhere.
Mr Trump has also signed an executive order to cease almost all foreign aid. South Africa is directly impacted by this as we are very reliant on PEPFAR which is vital for HIV/AIDS care in South Africa. Since it established PEPFAR in 2003, the US government has invested over $110 billion in support of the global HIV program. According to estimates it has saved 26 million lives and prevented millions of new HIV infections in more than 50 countries across the world. South Africa receives in excess of $500 million a year from PEPFAR and so without this aid we would have to take over this funding ourselves, crippling the already embattled taxpayer and consumer.
So, who loses in a Trade War
Unfortunately, the answer is that we all lose. While trade tariffs are often implemented to protect domestic industries, they can have unintended consequences, including higher prices and rising inflation. By increasing the cost of imported goods, reducing competition, and disrupting supply chains, tariffs contribute to higher prices and inflationary pressures. These effects can have broader economic implications, affecting consumer spending, business investment, and global trade dynamics. If the Rand does indeed depreciate to nearly R21 to the dollar we in South Africa will be in for a very tough time when imported goods like oil, affect the price of fuel at the petrol pumps. This will affect all goods and things will really get difficult for the man in the street.
In times of uncertainty diversification remains the best tool at your disposal. Have the appropriate exposure to all asset classes, both local and offshore so that you can enjoy growth in the good times and have the necessary protection in the bad times.
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