From Trade Wars to Real Wars: Global Risks Multiply

The drama of April, in which the US President Donald Trump unveiled, and later suspended, high import tariffs affecting most of the trading world, has given way to a slower-moving but equally significant set of events in the US and world economy.

The reduction of proposed tariffs between China and the US, the two biggest economies in the world, has been significant. In mid-May the two governments agreed after talks in Geneva that US tariffs imposed on China would be 30%, down from 145%, while earlier smartphones and related technologies were exempted. China’s tariffs on US imports were agreed to be 10%, reduced from 125%. 

Many tariff reductions, however, are temporary, for 90 days, they are still at a significant level. The Yale Budget Lab calculated the effective tariff rate to be 17.8%, compared with just 2.5% at the start of President Trump’s second term.

On 10-11 June, Chinese and US trade negotiators met again, this time in London, and agreed to continue the reduced tariffs. 

In addition, China agreed to relax export restrictions on rare earth metals – of strategic importance for several US industries including batteries, medical devices and in the defence sector – while the US eased restrictions on export of hi-tech chips for AI, and visas for Chinese students.

Much attention has been diverted to the fiscal position, following a downgrading of US sovereign credit by Moody’s in mid-May from AAA to Aa1. 

The credit agency cited the very high debt of $36tn, little indication that it was set to be curbed, and that the sheer amount of debt was not fully compensated for by the substantial strength and depth of the US economy and global use of the dollar.

Yields on 30-year Treasury bonds have touched 5%. They have also risen in other major currencies. 

This is a sign of low confidence generally in economic and fiscal management. It intensifies difficulties of fiscal management in the US by increasing the already-high proportion of spending taken up by servicing the debt.

Alongside these trends there is a closely related feature: Elevated inflation. In May Doug McMillon, the CEO of Walmart, stated that the giant US retailer has not been able fully to absorb the higher costs of imported goods caused by tariffs.

For much of the past two decades, goods inflation has been kept low by the integration of east Asian economies, with cheap manufactured exports, into the global economy. This was interrupted by the disruption to supply chains caused by the Covid-19 pandemic and the Russian invasion of Ukraine.

 Goods inflation had started to fall since 2023, but now there is the upward pressure from tariffs and tensions over trade. Inflation is becoming ‘sticky’.

Inflation has not risen significantly yet, nudging up 0.1% to 2.4% in May. But many companies front-loaded imports ahead of the scheduled 2 April announcement of high tariffs, and that effect will wear off. There are other factors contributing to elevated inflation.

 With an ageing population, and curbs on immigration in the US, wage inflation is likely to remain an issue; similarly, commodity prices face upward pressures.

The rise in value of physical assets such as gold is a sign of weakening confidence in paper money and an expectation of higher inflation.

Interest rates will likely have to be kept at a moderately high level, given inflationary pressures, and may even be increased. Jay Powell, chairman of the Federal Reserve, in a speech in mid-May, referred to the possibility that ‘inflation could be more volatile going forward.’

While sticky inflation does erode the effective level of the public sector debt, amounting to a soft default, it comes with costs. Those responsible for setting interest rates will find it difficult either to contain inflation or to encourage growth, resulting in a risk of stagflation.

Meanwhile in geopolitics, military matters have started to outweigh trade and tariff issues. Just two days after the London talks, conflict between Israel and Iran escalated with exchange of missile fire, with the Israeli government convinced that Iran was accelerating its plans to develop atomic weapons. 

On 18 June reports emerged that US President Donald Trump was preparing a massive strike with a ‘bunker-busting’ bomb, more powerful than anything possessed by Israel, to take out a suspected nuclear weapons site in Iran. This may be a negotiating tactic, and shortly after he announced a two-week delay on strikes to allow for talks.

The oil price has risen since the escalation of the Israel-Iran conflict, from below $65 a barrel at end May to above $75 by mid-June, adding to inflationary pressures. 

The intensity and duration of this conflict, and the wider political and economic impacts for the region and beyond, are impossible to project, and they add to already heightened global uncertainty.