Fears of a Trade War Push Gold Price Higher
Gold has been considered a safeguard against uncertainty and fears for centuries. As the possibility of a trade war escalates, investors are again looking at gold as a protector of value.
The threat of a trade war between the U.S. and China has serious consequences for businesses, jobs, and global growth. Financial markets are also closely watching developments.
What is a trade war?
A trade war happens when countries try to harm each other’s trade through the imposition of tariffs or quota restrictions. Although the U.S. is a major player in global trade, it doesn’t mean the country can act unilaterally without suffering the consequences. There is a great interdependency among economies and a trade war will inevitably lead to retaliatory measures.
Who benefits from a trade war?
Trade plays an important part in improving the standard of living of people around the world. Global trade is also an important driver of growth and a recession usually results in a strong downturn in trade, with dire consequences for many businesses.
In 2017 the U.S. had a trade deficit of $566 billion, as the country imported inexpensive products from overseas. However, exports were still $2.3 trillion, which means that the export industry needs access to world markets. A trade war will mean that China will impose retaliatory trade measures like tariffs and restrictions on U.S. goods and services. This will hurt the U.S. export industry with businesses struggling, increased unemployment and contracts being cancelled. Regaining the business in future may not be easy.
Basically a trade war has no winner, it means that economic growth suffers, jobs are lost and confidence is eroded.
How does Chinese trade threaten the U.S. and what steps are President Trump proposing?
President Trump has for years accused China of using unfair trade practices and creating an uneven playing field that benefits the Chinese economy. China is further accused of pursuing western technology and intellectual property. As a result, a backlash against China is also brewing in the G20 countries.
During the second half of March President Trump followed through on the threats when he imposed annual tariffs against Chinese imports. The list of products on which a tariff would be imposed is worth almost $1 billion; which will happen if the two countries don’t resolve their differences within a certain time frame. It also proposes to limit China’s freedom to invest in the U.S. technology industry. As expected, the Chinese government reacted within hours by threatening to hit $3 billion U.S. goods with tariffs.
Why the gold price benefits from a trade war
A trade war, or even strong rumors of one, has investors scrambling for safe assets – of which gold is high on the list. Why is this? The first factor is uncertainty, something for which financial markets have little tolerance. There is also the damage that a trade war can do to economic growth as businesses struggle and unemployment increases. A trade war sees higher inflation, weaker growth down and increases the demand for safe-haven investments like gold.
Currently the threat of a trade war overshadows the possibility of higher interest rates and indications are that rates will remain relative low in coming months. This favors a lower U.S. dollar and benefits the gold price. One of the reasons is that a weaker U.S dollar means a cheaper U.S. dollar gold price for other countries. In contrast, higher interest rates and a stronger dollar usually result in a lower gold price.
There are also indications are that China is looking into paying with yuan for their oil imports. As the biggest importer of oil, this could also lead to a weaker dollar, and a higher gold price.
What is the longer term outlook?
The future is obviously uncertain, but it is clear that Washington and Beijing will need to work out the problems bi-laterally. This may need World Trade Organization (WTO) dispute mechanisms as well as working with other multilateral organizations.
The worst case scenario for world trade is a situation of tit-for-tat retaliation. This will mean tariff hikes, sanctions and blocked business ventures. It is a no-win situation for virtually everybody and could see the breakdown of key trade relationships and markets.
While this is bad news for the world economy, which still has vivid memories of the 2008 financial meltdown, it is at least good for the gold price.