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Trade War Poised to Roil Global Finance

It’s been a year (Aug. 14, 2017) since the White House launched a trade war with China. For now, there appears to be no end in sight
If both sides continue with tit-for-tat tariffs, the inflation would lead to further increases in interest rates  and give rise to disturbances in the currency markets.If both sides continue with tit-for-tat tariffs, the inflation would lead to further increases in interest rates  and give rise to disturbances in the currency markets.

The trade war between the US and China risks substantially disrupting the international financial system, Princeton University economist Nobuhiro Kiyotaki says, cautioning that the repercussions of tariff-induced inflation would ripple through the currency and equities markets.

The impact "may spread to the financial system," Kiyotaki told Nikkei in an interview. If both sides continue with tit-for-tat tariffs, "the inflation would lead to further increases in interest rates and give rise to disturbances in the currency market and a stock market slump," he argued.

The global financial crisis of 2008 led to such safeguards as the Dodd-Frank reform legislation in the US. "Regulations were strengthened, and big banks have become safer than before the crisis," Kiyotaki said. But "I'm concerned about the risks in areas outside the reach of regulations," he said, citing the trade war itself as an example.

The Turkish lira's plunge indicates the level of uncertainty surrounding emerging markets. "The falling exchange rate for an emerging country will have domestic factors, but it will also include the US effect," Kiyotaki said.

Recognized for his research on financial crises, Kiyotaki has advised Japan's cabinet-level council on economic and fiscal policy.

 

Facing Risks

Kiyotaki sees the debt-ridden national budget as one of the biggest risks facing Japan. The problem as it stands now "is considerably perilous", he said.

"They need to create a contingency plan against a financial collapse," Kiyotaki argued. He said such a plan would include spending cuts, increased tax revenues and a reduction in the value of Japanese government bonds through inflation.

He did not give a timeline for the collapse but warned that one can come relatively quickly. "If foreigners start purchasing large volumes of Japanese government bonds, it will likely trigger it," Kiyotaki predicted.

In this scenario, a lower Japanese savings rate creates an environment where JGBs can no longer be refinanced solely at home. Then, with the requirements stemming from international investors, interest rates would surge.

To avoid that fate, "the Japanese government has no choice but to make long-term budgetary commitments," Kiyotaki said. This would include raising the 8% consumption tax to 10% in October 2019 as scheduled, he explained.

Kiyotaki painted a rosier picture of Japan's overall economic landscape. "Prices and nominal wages have secured positive growth rates, and deflation has already halted," he said. On the Bank of Japan's inflation target, "there is no need to give up, but it's not necessary to be rigidly fixated on 2%, either," he said.

One major side effect, according to Kiyotaki, is the excessive financing on apartment construction. This activity has been driven by wealthy people seeking to avoid the inheritance tax.

No End in Sight

It’s been a year since the White House launched a trade war with China. On Aug. 14, 2017, President Trump instructed US trade representative Robert Lighthizer to investigate Chinese policies under Section 301 of the US Trade Act, Riley Walters, a policy analyst at The Heritage Foundation, wrote for The Daily Signal.

One year later, two important questions remain: What has Trump’s trade representative achieved, and how long will the trade war continue?

For now, there appears to be no end in sight. Instead of free and fair trade, with zero tariffs and zero barriers, the United States and China may end up less free and fair on trade.

Round One: In July, the Office of the US trade representative placed an additional 25% tax on $34 billion worth of goods imported from China. Beijing responded by adding its own 25% tax on $34 billion worth of American exports to China.

Round Two: Starting Aug. 23, the office of the trade representative and US Customs and Border Protection will collect an additional 25% tax on $16 billion worth of other goods Americans buy from China. Beijing announced it would respond again by also increasing a 25% tax on US exports to China.

Round Three: Earlier this month, the president instructed Lighthizer to consider increasing the tax on an additional $200 billion worth of Chinese goods from 10% to 25%. Trump quipped that he’d be willing to tax everything Americans buy from China. These taxes could go into effect as soon as early September.

Beijing instead will plan on increasing taxes on roughly $60 billion worth of US exports to China—roughly half of all US products exported there. And these products will be taxed by an additional 5 to 25%.

In total, at least $360 billion worth of products of the $711 billion in cross-border trade in 2017 could see an increase in taxes by the end of this year.

Initial estimates put the potential effect of tariffs on imports from China and China’s retaliation, at upward of 450,000 American jobs lost.

 

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