An ongoing trade battle between the United States and China has magnified the impact of tariffs on commodity prices and economic growth. As we’ll soon see, trade barriers have a ripple effect on global markets, influencing everything from commodities to foreign direct investment (FDI).
Like any other market, commodities are influenced by a range of technical and fundamental factors. In the current macroeconomic climate, trade tensions are having a direct impact on commodities such as agriculture and crude oil. That’s because the two largest superpowers, the United States and China, have engaged in a tit-for-tat trade war that threatens to throw global economic growth off stride.
The impact has already been felt. China’s economy is fresh off its worst year of expansion in nearly three decades and the International Monetary Fund (IMF) has already lowered its growth outlook this year and in 2020 over the perceived trade threat. As a large consumer of commodities, China’s slowdown has had a direct impact on how commodities are priced.
Learn here about how an interest rate hike can affect commodities.
The Role of Tariffs
As we have already seen, the U.S. and China have both lobbed tariffs at one another in an effort to balance the terms of trade between the two countries. The so-called tariff war was instigated by the Trump administration, which felt that China was engaging in unfair trade practices including the theft of intellectual property from U.S. technology companies.
A tariff is simply a tax or duty paid on a particular class of imports or exports. In the case of the U.S.-China trade war, tariffs are being applied to imported goods from the other country.
For example, President Donald Trump initially announced a 10% tax on $60 billion worth of Chinese goods. This was later expanded to target $200 billion worth of Chinese goods imported into the United States each year at a rate of between 10% and 25%. In response, China slapped tariffs on $60 billion of U.S. products.
By taxing imports, policymakers are essentially passing on the costs to consumers. A 20% duty on a product made in China will make it costlier for Americans to purchase that product. If enough Americans don’t buy that product, its demand falters and shipments from China will begin to decrease.
The rationale for tariffs is easy to understand. By taxing foreign-made goods, policymakers can protect domestic industries, including nascent ones, ensure national security and promote price stability for certain products and services sourced domestically. In the case of the Trump administration, tariffs may serve a political role in uniting voters against unfair trade practices.
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It’s no surprise that commodities have been at the center of the global trade dispute. One of the first threats China made in response to the United States was to buy less American-produced soybeans. American soybeans made their way onto China’s tariff list back in 2018, a move that could have devastated domestic producers. Lucky for them, China later purchased $180 million worth of the commodity in a show of good faith.
The trade war has also triggered volatile swings in commodities such as crude oil. China is not only the world’s second-largest economy, but the largest consumer of energy. By reducing economic growth in China and around the world, the trade war is influencing perceived and actual demand for crude. As demand drops, so does the price.
China’s impact on commodities cannot be overstated. The World Bank predicts that even a 1% drop in China’s GDP growth could lead to a 6% dip in commodity prices over the next two years.
The Trump administration’s protectionist trade policies also extended to neighboring countries like Canada, whose exports of lumber, steel and aluminum have also been subject to tariffs. Tariffs on Canadian lumber, a long-disputed commodity, were forecast to have a direct impact on the U.S. real estate industry. The National Association of Home Builders predicted at the time that lumber tariffs could hike U.S. single-family home prices by over $1,200.
Tariffs on Canadian steel and aluminum products could potentially hurt the U.S. economy just as much as its northern neighbor. These commodities are critical for industries as diverse as construction, automotive, aerospace and food and beverage manufacturing.
Don’t forget to check our commodities section to know more about the different types of commodities.
The Bottom Line
Although protectionism has become fashionable politically, it can have potentially devastating consequences if not wielded carefully. The good news is the Trump administration is using protectionism as a bargaining chip to level the playing field against nations it believes have skewed free trade overwhelmingly in their favor. It remains to be seen whether an all-out tariff war can be averted in the not-too-distant future.
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