US exports are dropping as the world starts to buy less of its manufactured and agricultural goods. Photo: Stockphoto

Trade war looms as tipping point

Wednesday, 8 August, 2018 - 09:27

The trade war between the world’s two biggest economies is the latest sign of potential economic trouble just over the horizon.

Tell anyone in Perth there are signs of a gathering storm and they are likely to think you’re referring to the recent wild winter weather. For those with a weather eye on financial markets, however, a storm of an entirely different type comes to mind.

Despite making life a little less comfortable, the rain has been a blessing for Western Australia’s farmers, who are fully aware of the drought conditions in the eastern states.

In terms of the international economic winds, however, the forecast is potentially bad news for everyone.

Right now, three months into a trade war between China and the US, no-one knows the outcome of what is a deeply significant event; but unless one, or preferably both sides, give(s) ground, 2019 is shaping as a grim year, perhaps as grim as 2008 and the GFC.

No-one wants to read a prediction like that, and with luck Australia will dodge the worst aspects of a fight between the world’s two biggest economies. However, as all business people know, while you can’t plan for luck, you can plan for the worst and hope for the best.

Consider a few of the tell-tales blowing in the stormy winds.

• Copper, a metal with the nickname of Dr Copper, thanks to its time-proven reputation for predicting future economic activity because it is used in just about everything from electronics to construction, has slipped quietly into correction territory with a price fall of 16 per cent in less than two months.

• Nouriel Roubini, the US economist who made his name by predicting the 2008 crisis, is telling anyone who will listen that the trade war means that we’re heading for a slump in 2020.

• Housing prices in Australia’s two biggest cities, Sydney and Melbourne, are falling rapidly; and while people in Perth have been in a property slump for five years, a correction in bigger cities has national economic implications because it means most of the country suddenly feels poorer and that means households will spend less, redirecting their income into servicing mortgages.

• Car sales are following property as consumers tighten their belts, with sales in July down a whopping 7.8 per cent on the same month last year.

• Larry Fink, not a household name in Australia, but the world’s most important investor (because he controls the trillion-dollar BlackRock funds management business), is predicting a sharp share price fall if the trade war gets worse.

• US investment bank Morgan Stanley told clients recently to prepare for a fall because most of the good news, such as tax cuts, had been factored into prices (meaning only bad news ahead).

• The US, despite a forecast by its president, Donald Trump, that trade wars are easy to win, was hit with its first ill-wind since the war started when its trade deficit rose in June for the first time in four months. Data showed exports dropping as the world started to buy less of its manufactured and agricultural goods.

• China’s latest tit-for-tat tariff increase, a proposed 25 per cent hit on US oil and gas, will further hurt the US because of the recent return of energy as a major export.

• The economic pain of the trade war might be greater in China than the US, but China is a command economy, and if the government demands that people suffer for the national good they don’t have a choice, unlike the in the US.

• A widely ignored warning from RBC Capital Markets predicted “pandemonium” in the iron ore market because of declining economic conditions in China as the trade war bites.

If RBS is correct, and the iron ore price does fall from its current benchmark price of $US68 a tonne to a forecast $US49/t, then the WA economy will feel the hit more than anywhere else in Australia.

Most WA iron ore producers will remain profitable at $US49/t, but those mining low-grade ore will feel the added pain of a hefty discount being applied by Chinese steel mills, which prefer high-grade, less-polluting, ore.

In the case of Fortescue Metals Group, which has been receiving 64 per cent of the benchmark price, its revenue per tonne could fall as low as $US31.40/t, a level at which further belt-tightening can be expected.

Everything that has happened since Mr Trump launched his trade war has been predictable, even though few critics have been prepared to spell out exactly what it means to have slowing global trade.

What might be a wake-up call is the widening of the US trade deficit at a time when Mr Trump had been predicting a trade recovery.

Unpleasant as it might be to even consider a return to the grim conditions of 10 years ago, it would be wise to start planning for the worst and hoping for the best.

What metals moves mean

Copper may be the bellwether metal signalling a turn for the worse in financial markets, but two other metals are doing much the same job at the moment.

Gold, which ought to be rising as economic conditions worsen, is doing precisely the opposite. The price has slipped into a technical correction (down 10 per cent since January) largely because the US is continuing to ratchet up official interest rates, which exposes gold’s Achilles heel as a non-interest paying asset.

Lithium, the wonder metal at the heart of the electric car revolution, is also heading south thanks to the pincer squeeze of slower-than-expected sales of electric cars and a faster-than-forecast increase in the supply of lithium.

The lack of demand for electric cars should not come as a surprise because much of the early drive came from government subsidies. As has been proved in one of Europe’s greenest countries – Denmark – sales fall away when the subsidies drop.

Range anxiety, a lack of charging points, and a long charge time are other issues that will be overcome, but not for some time.

On the supply side, Australia’s lithium mining boom is showing signs of being a market killer, with Macquarie Bank diving into the oversupply problems this month when it forecast a growing glut of lithium carbonate (a basic battery ingredient) with a surplus of 72,000 tonnes this year, swelling to 194,000t next year – by which time the price will have collapsed from an average of $US12,625/t to $US7375/t.