The Rise in Protectionism and the Prospect of a Global Trade War

The risk that a trade war will impact the global economy has clearly increased over recent months. The first U.S. salvos, followed by the retaliatory measures of other countries, have caused tensions to rise. As things currently stand, the situation is still contained but unclear, and increased tariff barriers remain bilateral and with the United States. Nonetheless, it begs the question: Could a real trade war put an end to the current global economic growth cycle?

In the last year, protectionist decisions by President Donald Trump had no impact on global trade. In fact, in 2017, real GDP grew rapidly in the United States, the eurozone and, to a lesser degree, China. This improvement in global economic conditions increased the volume of trade worldwide. However, the pace has visibly slowed since last winter. Annual growth in global trade was down to around 3.5% in the spring, well below the 5% recorded before January. The fear now is that the increasing number of protectionist measures implemented by the United States and retaliatory measures by other countries is increasingly slowing both global output and international trade.

The Economic Effects of a Trade War

Most of the analyses point in the same direction: a widespread lowering of tariffs would damage the global economy. Also worth noting is that, according to most estimates, tariff hikes would not necessarily lead to a global recession. International trade is linked mostly to the movement of goods, while economies are increasingly dedicated to services. This situation may limit the damage. However, given the state of the current economic cycle and, in particular, its length, a trade war could still make things much, much worse. It could undermine household and business confidence and restrict the volume of international trade enough to cause the current growth cycle to come to a complete stop. There is also the fear that the economic models do not take the complexity of value chains fully into account, thereby minimizing the consequences of complications at the border. Furthermore, Interactions with the financial markets could give rise to some ugly surprises.

A Trade War and the Financial Markets

A widespread escalation of tariffs and raised trade barriers would clearly have consequences for the financial markets, starting with the currencies that react immediately to the ups and downs of trade balances and related economic growth. As a result, the currency market could become more volatile. The economic models suggest that implementing protectionist measures leads to an increase in the value of a country’s currency. In addition, other countries may want to retaliate by allowing their own currency to depreciate (currency war). However, the inflation caused by the higher cost of imported goods could lead to higher interest rates, a factor that causes the value of a currency to rise. In the case of the United States, a trade war that threatens global economic growth could result in a safe haven effect, which, in turn, would increase the value of the U.S. dollar.

As we just saw, interest rates would also react immediately to an even greater escalation of trade tensions. Nevertheless, the net effect is less clear, since several factors could offset each other. On the one hand, the diminished prospects for growth could prompt real interest rates to remain low. On the other hand, the impact of protectionist measures on prices are expected to feed inflation expectations. Inflationary pressure may also motivate the central banks to keep their rates higher than economic growth or job creation figures would require. Some commentators, such as Alan Greenspan, the former Chair of the Federal Reserve, see in all this the possibility of a return to stagflation. A trade war could also open another front: foreign financing of the huge U.S. federal debt, especially if weaker economic growth inflates deficits even more. In addition, some countries could limit the movement of capital.

Meanwhile, stock markets have clearly been jittery since the Trump administration announced its first protectionist measures in January. All the news suggesting an escalation of the trade conflict between China and the United States has also had generally negative repercussions on the main stock market indexes in the U.S. and elsewhere. Moreover, Chinese stocks were already officially in a bear market. As we have seen this summer, other factors can still lead the stock market to appreciate. However, raising trade barriers can only hurt the profitability of big corporations, which generally operate in more than one country. Competitiveness and productivity would suffer from the complications imposed on global value chains. The importance of the export sector for the Canadian economy is such that the Toronto stock market is particularly sensitive to the ups and downs of international trade. A major slowing of the international economy could also undermine raw material prices.

Graph – Global trade slowed since the beginning of the year
Graph – Global trade slowed since the beginning of the year Sources: CPB - Netherlands Bureau for Economic Policy Analysis and Desjardins, Economic Studies

The author

Francis Généreux

Francis Généreux

Senior Economist
Francis Généreux holds a Masters degree in Economics from the Université de Montréal and a Communications degree from the Université du Québec à Montréal. He has been with the Desjardins Group for over 20 years and is now a Senior Economist. He is responsible for monitoring global economic conditions and performing analyzes and forecasts for the US economy. He has authored several studies and has participated in drafting numerous publications produced by Desjardins Economic Studies.