July 2017

Trade finance economist Dr Rebecca Harding explores whether current uncertainty will ever become risk or if this is the new normal

The one thing that can be said about the economic and trade world as we reach the mid-point of 2017 is that it is uncertain. Goods trade accounts for some US$21trn of activity in the global economy. Trade finance intermediated through banks is some US$5.6trn of that. But global trade growth, which during the heat of globalisation grew at more than two times the rate of global GDP growth, is now growing at just 0.8% of GDP growth. We do not know specifically why this is happening but it has triggered mixed responses across the world. The universal commitment to free trade and globalisation is now confused with growing economic nationalism, in the US in particular, and this creates an uncertain world with uncertain outcomes.
 
2016 and the early part of 2017 have changed the world of economics and trade rhetorically but not yet materially. Big changes in the UK, Europe and the US as a result of Brexit, of recent and pending elections and of the first year of Donald Trump’s presidency have created a “phony war”. So far, nothing is different, but the silent voice that says everything is about to change will not go away. Although many of the changes to trade started before 2016, the politics of trade, but not the economics, have changed.

So are there risks in the current situation?

Trade slowdown

The short answer to this is yes. Even on current projections trade looks to be slowing down (see Figure 1) compared to its growth between 2010 and 2015.
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Figure 1 shows a clear drop in import and export activity for the US and the EU, and
forecasts a drop in export activity for the UK and Asia Pacific between 2016 and 2020 compared to 2010–2015. The projections are based simply on the momentum of the data – there are no assumptions about GDP or policy changes. In effect, the chart shows where trade is going over the next few years if everything stays as it is right now.

As such, it presents a worrying picture for the US and the UK in particular. US trade growth will be slower over the next few years and UK export growth will be slower than it was in the period between 2010 and 2015. This points to two things:

  • First, the momentum in the data suggests that the US is already reducing its dependency on trade. It has a large domestic economy and is likely to be more reliant on that than on its external position. For the current administration, this is good news, but recent economic growth has been fuelled by strong exports and so it makes the need for a fiscal boost greater. This is a double-edged sword since higher interest rates and inflation could have a longer-term dampening effect on consumer demand, proxied in trade terms through slower imports.
  • Second, the UK’s export boost from a weaker sterling looks to be short-lived as growth slows in the run-up to the post-Brexit era. This is not a surprise. The UK’s trade is only mildly correlated with the value of sterling (0.2%). In other words, changes in the currency do not have much of a long-term effect on the volumes and values of exports. The projected rise in imports shows, however, that consumer demand will remain strong. If the US dollar remains strong and the sterling weak, this adds to inflationary pressures in the UK economy and, therefore, increasing the likelihood of a shift towards looser monetary policy. This trend would be exacerbated by increases in tariffs as a result of Brexit.

UK and US trade flows

The reasons why these represent risks for the UK and the US are clear when a more detailed look at trade with key partners is examined. The UK’s trade with global regions is illustrated in Figure 2.
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The UK

At first glance the chart shows that although UK exports to the EU 27 and the EU currency area are projected to fall, export growth to the Asia-Pacific region (APTA) may be as high as 7.4% annually to 2020. This is a pattern that has been gaining some momentum for the past few years, particularly since the investment of BMW in the UK, which has boosted car exports to China for example. Export trade to the Middle East and North Africa is also projected to grow and much of this is in aerospace and engineering-related supply chains. Trade with North America seems set on a downward path – clearly UK Prime Minister Theresa May’s visit to the US in January 2017 has yet to show through in the projections.

There are two key points here:

  • Generally speaking, imports look set to grow faster than exports. Some of this may simply be due to the weakness of sterling making imports more expensive but it does suggest that even on current conditions our exports are not growing fast enough to cater for increases in imports. Imports from the Asia Pacific region (notably China) are the clear exception but as the UK exports just over half to the Asia Pacific region compared to what it imports (US$46.6bn compared to US$87.5bn) this explains why growth of imports might be slower.
  • Exports to Europe, both the EU27 and the Eurozone, are set to decline and the increase in export trade with Asia Pacific, even on current trends, is insufficient to make up for this loss. We project exports to the EU27 to be worth US$197.6bn by 2020 while exports to the Asia Pacific region to be worth around US$57.6bn, or just under 30% of the value of European exports by 2020.

The US

In contrast to the UK, the US’s trade openness, that is trade as a percentage of GDP, was 18.6% on average between 1980 and 2013. Compared to a global average over the same period of around 45%, this just demonstrates the size of the US domestic economy. US jobs are created more as a result of domestic demand than from trade. It follows that it will be global trade, the flows and patterns of trade around the world, rather than just US trade, which will be transformed if current statement of intent translates into real action.

The US will not necessarily be the main beneficiary of the “bilateralism” of its trade policy. Longer-term growth to 2020 presents US trade policy with several issues (see Figure 3) irrespective of the intent behind recent changes:

  • US imports from Asia Pacific will grow at more than 1.5 times the rate of exports to Asia-Pacific. China is the exception, where  US exports will grow more quickly than imports. But as the US imports from China at nearly five times the rate that it exports to China, this faster rate of export growth is unlikely to have much long-term impact on US net trade.
  • Exports to NAFTA look likely to increase more rapidly than imports. NAFTA works well for the US and any trade war with Mexico or disintegration of the regional trade area could damage US exports as much as it hurts Mexico.
  • Germany argues that the ECB keeps interest rates low which keeps the euro low; President Trump argues that Germany benefits from the low value of the euro and certainly the US will be importing from Germany at nearly twice the rate of growth that it exports to Germany. We expect faster growth in US imports from both the EU27 and the eurozone as well.
  • However great the desire may be to create a bilateral trade partnership between the UK and the US, the UK is the US’s sixth largest country trading partner and, as an export destination less than half as important as either China or Mexico.

The momentum of trade to 2020 suggests that nothing between the two countries will change.

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New territory

Calculating the timescale and impact of current policies accurately is what makes the environment in which banks and businesses now find themselves so difficult. We have not been here before. The changes feel seismic but they are only rhetorical at present. What we do know is that trade growth itself has slowed since 2012. To some extent this can be attributed to shorter supply chains, greater local content, lower commodity prices and tighter trade finance conditions caused by tighter compliance and monetary regimes.

But what we can’t say is how policy will translate into changes to regulatory, tariff or sanctions regimes in the future. We do not know how many multilateral agreements there will be in five years’ time or whether these will be replaced by convoluted bilateral agreements with national interests at heart. This uncertainty is the real risk to the system.

Dr Rebecca Harding is an independent economist and the founder and CEO of Equant Analytics, a big data analytics and supply company specialising in trade and trade finance.

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