Global GDP could take a $600bn hit in 2021 due to US-China trade war

Earlier this month, the US took tariff rates on $250bn of Chinese exports to 25%

Apple and Huawei logos are displayed outside a mobile phone retail shop in Shenzhen, China's Guangdong province. The trade war will be long, messy—and expensive, according to Bloomberg economists. AP 

The US-China trade war has entered a dangerous new phase. Tariffs are up and there is the threat of more to come. A quick fix is still possible, with Presidents Donald Trump and Xi Jinping set to meet at the G-20 summit in June. But at this point, it looks more likely that the trade war will be long, messy – and expensive.

Bloomberg economists Dan Hanson and Tom Orlik have mapped out the main scenarios. Their headline conclusion: if tariffs expand to cover all US-China trade, and markets slump in response, global GDP will take a $600 billion hit in 2021, the year of peak impact.

On May 10, the US took tariff rates on $250bn of Chinese exports to 25 per cent. Retaliation was swift, with China raising tariffs on certain US goods in a range from 5 per cent to 25 per cent. Two years out, Bloomberg Economics’ modelling suggests that output in China and US would be lower by 0.5 per cent and 0.2 per cent respectively, relative to a no-trade-war scenario. Global output would also come down a notch.

Scenario 1: current tariff levels

What happens if tariffs increase?

The US has threatened 25 per cent tariffs on all Chinese imports if a quick deal can’t be achieved. Such a move would surely be answered. “If you want to talk, the door is open; if you want to fight, we’ll fight to the end,” said a Chinese TV anchor, capturing the mood in Beijing.

Plugging in 25 per cent tariffs on all bilateral trade, the model shows output declines of 0.8 per cent, 0.5 per cent and 0.5 per cent for China, the US and the world in mid-2021.

Scenario 2: escalation to 25% tariffs on all bilateral trade

Financial markets are already wobbling with each new trade-war headline, and China’s stock market in particular has seen a spate of sharp daily moves. Even so, equities in both China and the US are up on the year, suggesting investors are still betting a deal will be done. If they are wrong, and heavyweights like Apple get slapped with tariffs, that raises the possibility of a sharp correction.

Mr Hanson and Mr Orlik’s nightmare scenario adds a 10 per cent equity market drop to the across-the-board 25 per cent tariffs. In that case, China, US and world GDP would be 0.9 per cent, 0.7 per cent and 0.6 per cent lower in mid-2021. In this situation, the equity market drop acts as a further headwind to consumption and investment, compounding the impact.

Scenario 3: tariff escalation plus equity market shock

The fallout from any of these scenarios would spread well beyond the US and China, the world’s two biggest economies.

With China the biggest potential loser from the trade war, the yuan – already overvalued according to Powell’s model –stands out, along with the Thai baht and Canadian dollar.