By business reporter David Taylor
I can’t recall a time in recent history when there was so much uncertainty.
Unfortunately uncertainty and insecurity go hand-in-hand. The world seems full of insecurity right now — no better represented than by the looming threat of a trade war between Australia’s largest and third largest trading partners.
I asked one of Australia’s leading independent economists, Saul Eslake, what a trade war between China and the United States would mean for Australia.
He’s normally quite conservative with his commentary but on this occasion he actually said to me: “We just have to hope that it doesn’t happen.”
Global economy already struggling
The world hasn’t yet recovered fully from the collapse of the Wall Street investment firm Lehman Brothers on September 15, 2008. That single event was the catalyst for a credit crunch that ultimately led to the global financial crisis.
Despite countless politicians telling us everything will be okay, a seemingly endless developed-world property boom and, of course, cheap money (from ultra-low interest rates), the world economy continues to sputter along.
Everything is not OK.
The whole concept of a superpower trade war wouldn’t even be a possibility if we were in — for want of a better word — “normal” economic times.
It’s a possibility now, though, because President-elect Donald Trump has laid much of the blame on China.
He’s made a link between China allegedly manipulating its currency and many of America’s (and indeed the world’s) economic woes.
What many Americans in the rust belt know is that right now there aren’t enough jobs to go around, but Mr Trump has promised to fix that — via, potentially, a trade war with China.
What exactly is a trade war?
A trade war usually involves a series of tit-for-tat trade restrictions imposed on “warring” countries which normally trade freely with one another.
Restrictions can include measures such as tariffs (taxes) and quotas (volume limits) on imported goods.
The idea is to significantly weaken another country’s export revenue, and encourage consumers to buy from local manufacturers rather than their overseas competitors.
For example, why would you buy a fridge made in China when you could buy a cheaper one built and designed in the United States?
Right now Chinese fridges are cheaper, partly because Chinese unit labour costs are cheaper, but whack a big fat tariff on those imports and the tables (or should I say fridges) will turn.
Likely trigger point for trade war is close
This is where it gets interesting, if it hasn’t reached that point for you already.
Mr Trump doesn’t officially take over the presidency until January 20, but we know he’s already getting organised for the role.
As such, everything and everyone that could be negatively affected by his promised policies are manoeuvring into position to avoid being hurt or left worse off in any way.
As far as China is concerned, the country is right now attempting to prop up its currency to avoid it sinking further against the US dollar — think Weekend at Bernie’s — something it’s aware Mr Trump is watching.
Why do countries push their currencies down in the first place? Largely to make their exports more competitive.
If you don’t have to hand over as much money in the currency exchange because your currency is worth more than the country’s currency you’re buying from, you’re financially better off and you’re more likely to want to buy goods from that country.
Having a competitive exchange rate can be a real advantage.
The Chinese yuan has been slowly depreciating. China argues it’s a by-product of trying too hard to keep the currency from rising but Mr Trump isn’t buying it and he’s vowed to do something about it.
Both Westpac’s head of market strategy Robert Rennie and academic Mr Eslake believe Mr Trump will use the exchange rate of 7 renminbi (RMB) to $US1 as the trigger to declare China a “currency manipulator”. The exchange rate currently sits between 6.90 and 6.95.
The higher this number, the less valuable the yuan is compared to the US dollar.
Once he declares China a currency manipulator, he essentially has a mandate to impose huge trade restrictions on the country.
We already know that could include imposing tariffs of up to 45 per cent on all goods imported from the world’s second largest economy.
How will Australia be affected?
The obvious question then is how could all of this affect Australia?
I want to give you two very broad examples of what might happen in the event that the renminbi continues to fall against the USD dollar, to 7 renminbi and beyond.
Firstly Australia’s exports, and therefore GDP, could take a big hit because China is Australia’s largest trading partner.
If China’s economy takes a hit from US tariffs being imposed on its exports it will have no choice but to “balance the books” and import less itself.
Right now Australia’s export sector is riding on the back of higher-than-expected prices for iron ore, coal and natural gas, but that’s expected to fall back — quite abruptly it’s thought — sometime between now and the middle of the year.
If that coincides with a significant reduction in the volume of exports China is willing to take from Australia, we could see a few sweaty palms down in Canberra.
Secondly, one way China is trying to stop its currency from falling to 7 renminbi to $US1 is by selling US treasuries and foreign currency reserves.
It’s a sneaky little move central banks like to make. You see, by hoarding other country’s currencies, it means that when your currency is falling, you can pull them out and sell big quantities of them in an attempt to lower their value — and raise your currency’s value.
The problem is the more the People’s Bank of China does this, the harder Chinese commercial banks find it to source yuan for themselves.
This raises the cost of their borrowing, and, as such, they’re often forced to lift interest rates to compensate for that.
Of course, if Chinese banks are forced to raise interest rates, so will banks in south-east Asia and eventually here in Australia.
It will also have a dampening effect on the Chinese economy, which will in turn hurt Australia.
The silver lining on the cloud
If that all sounds a bit grim, there is a silver lining.
Anecdotally it appears China is doing everything in its power to stop the yuan falling too far against the greenback. So far it’s actually working.
What’s scary is how close the exchange rate is to a level that numerous commentators have predicted Mr Trump will use as a trigger to start a trade war with Australia’s largest trading partner.
All we can do now is watch and wait.