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The economic impact of trade wars

June 2018

Trade: not a zero sum game

The effects of a full-scale trade war will extend far beyond the US and China threatening stagflation worldwide.

When trade breaks down, everybody loses. Our calculations show a full-scale trade war between the US and China – which we still think is unlikely – would tip the global economy into stagflation and lead to a sharp decline in world stocks.

Our model, which is based on IMF estimates, shows that if a 10 per cent tariff on US trade were fully passed onto the consumer, global inflation would rise by about 0.7 percentage points.1 This, in turn, could reduce corporate earnings by 2.5 per cent and cut global stocks’ price-to-earnings ratios by up to 15 per cent.

All of which means global equities could fall by some 15 to 20 per cent, assuming that US bond yields rise in line with inflation. This in effect, would turn the clock back on the world stock market by three years. Under such circumstances, the shares of Chinese exporters and cyclical US stocks – in particular expensive sectors like consumer discretionary – would probably suffer the most.

However, the impact of a trade war will be felt far beyond the two world's largest two economies. In some instances, open economies in such as Taiwan, Korea and Singapore in Asia and Hungary, the Czech Republic and Ireland in Europe could be more vulnerable than the US and China (see chart).

globalised economies at risk
Global value chains participation rate*, % share in total exports
Global value chains participation rate, % share in total exports

*Participation rate is defined by WTO as foreign value-added content of a country's exports + value added supplied to other countries' exports. Source: Pictet Asset Management, CEIC, Thomson Reuters Datastream

The picture that emerges from our analysis is similar to what investors have previously experienced. The history of financial markets shows that the erection of trade barriers is bad for equity markets: the S and P 500 fell 10 per cent in the three months after US President Richard Nixon imposed a 10 per cent tariff on imports in mid-1971.
As the IMF’s chief Christine Lagarde rightly observed, nobody wins a trade war.