A Fungibles Trade War

Nick Hubble

Plenty has happened since we examined the bizarre trade war developments yesterday. Donald Trump’s meeting with the EU’s Jean-Claude Junker can be summarised with this Bloomberg quote:

Trump said he hoped for a “very positive” outcome from meeting with Juncker but complained of “massive tariffs” and “massive barriers” at the start of discussions at the White House between the two leaders on Wednesday. As a result, he said, the U.S. is “losing hundreds of billions of dollars” to the E.U.

“We have to follow,” Trump said. “You could call it retaliation, but I’d rather just say that we want reciprocal.”

It looks like Trump’s tactics are working. He supposedly has a deal with Junker to cut tariffs.

But as we established yesterday, politicians are hypocritical. Their announcements and policies contradict and are counterproductive. The results are an amusing tangle of rhetoric and bungles.

But what’s the outcome?

The first thing to realise is that it’s hard to have a trade war in fungibles.

Consider two siblings in a bath. One pulls the water towards them and declares, “Ha, I took your water!” The other immediately begins hoarding their own stash of liquid at the far side of the tub. Soon, the splashing gets out of hand.

This is what’s going on in global trade politics at the moment.

The US places sanctions on Iranian oil. Anyone who buys it will be in trouble. Some Iranian oil customers like the EU struggle to comply. Others, like China, don’t care. The Turkish foreign minister says he doesn’t care either:

“We buy oil from Iran and we purchase it in proper conditions.

“What is the other option?

“While we are explaining why we will not obey these sanctions, we have also expressed that we do not find these U.S. sanctions appropriate.”

In the end, the EU buys less oil from Iran. And the Chinese and Turks buy more. The net effect is not much.

The Chinese placed tariffs on US soybeans. Bloomberg reports they’ll buy from Brazil instead. And so the US will export more to the EU market. While the EU buys less from Brazil…

[…] the 25 percent tariff China slapped on U.S. soy imports earlier this month promises to reshape the global market for the commodity. The U.S.-China tiff means it’s likely that Brazil, the No. 2 producer, will end up selling more soy to China as a result. That’s something that traders anticipate, based on the higher price Brazilian soy is fetching over U.S. supplies.

Facing a reduced Chinese market, U.S. soybean exporters have few options other than to target the EU. And the fact that Brazilian shippers will be sending more cargoes to China means less competition in Europe. Rabobank International Ltd. predicted in June that the U.S. may overtake Brazil as the biggest soybean importer into the EU.

The net result isn’t much. Except a change in how busy particular shipping routes will get.

It’s not just soybeans and oil.

The Germans have announced the construction of a new gas terminal. It comes in the midst of Trump’s spat over Europe’s reliance on Russian gas.

According to the media, the new terminal is unlikely to break even for many years. But it was demanded at political levels. Presumably to open up the German gas supply routes to American shipped gas.

If the Europeans begin to take American sanctions on Russian gas more seriously, they’ll have alternatives to turn to. Namely the US gas suppliers.

But then the Russians will just sell more to the US’ other customers instead…

What makes gas, oil and soybeans special? They’re fungible. And trade wars on fungible goods make as much sense as hording water down your end of the bathtub.

A fungible good is something that is not special. There are others exactly like it.

I’m writing this in a house surrounded by rice paddies. One grain of rice is much like every other grain of rice. If you were to deposit your bushel of rice at a warehouse for a week, and the warehouse gave you a different bushel when you redeemed it, you’d be none the wiser. Nor better or worse off.

The same goes for money, gas, oil and a huge list of other goods. German cars, Kobe beef and Scottish whisky are the opposite. They’re special and not interchangeable.

If trade war policies target a particular nation’s fungible goods, the result will simply be an adjustment of supply chains. Instead of A selling to B and C to D, trade war policies will just rejig the line up. A sells to D and B to C.

In a way, this is excellent. It’s a political victory without imposing the sort of damage that a tariff on German cars does.

But realigning supply chains is costly. And the politics can backfire.

If the US manages to disrupt Russia’s costly gas pipelines, and supplants their supply, that’d create fascinating problems in eastern Europe. Many nations there are pro-EU, but reliant on Russian gas flow revenue.

In trying to free western Europe from Russia’s gas dependence, Trump may be meddling with eastern Europe’s financial future.

Anyway, the point is that a Fungibles Trade War is a false trade war. Watch cars and services, not oil and soybeans.

Are currencies fungible?

The ultimate fungible is money. One pound is the same as another. Nobody keeps track of which particular banknotes are in their wallet.

But where does that leave central banks and currency wars? They’re the favourite tool of trade war agitators. But do they work?

Well, a pound is not the same as a dollar. The interest rate you get in the bank or government bond is different in the two currencies. What you can buy differs too.

But the exchange from one currency to the other is fairly efficient. Compared to other goods, anyway.

So is it the exchange rate that’s the key? The way the exchange rate moves can have a real impact on trade?

Maybe. The problem is that trade is now immensely complex. Many exported goods require imported components in the first place. And services are very flexible when it comes to location. So currencies don’t really hold as much sway.

My point today is that trade wars don’t function like they used to. The globalised economy is too efficient and complex.

Trade has itself become a complex system. If you mess with it, the consequences are hard to predict and not linear. The same trade policy can have wildly different outcomes in different contexts.

Even if the trade war is only political posturing, politicians don’t understand what they’re dealing with. The hidden potential for an unexpected crisis is real.

Until next time,

Nick Hubble
Capital & Conflict

Category: Economics

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