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The US-China trade war has generated negative sentiments in the global economy with Malaysia not being spared the ramifications. FILE PIC

THE US-China trade war seems to have transited to a new phase — the currency war, despite talks of a reconciliation between the two during meetings.

In June, President Donald Trump had agreed to hold off on additional tariffs to be levied on Chinese goods after meeting Chinese President Xi Jinping in Japan.

And just a few weeks ago in China, both leaders met, but the Chinese government refused to accede to demands by Trump, especially on large-scale purchases of American farm products, such as soybeans. In retaliation, Trump imposed a 10 per cent tariff on another US$300 billion worth of Chinese goods.

This latest development has rattled markets all over the world. As a result, China has allowed its currency, the yuan, to weaken quite significantly, breaking the key mark of US$7 against the greenback, its first for more than a decade. China is hoping to neutralise the impact of additional tariffs imposed on its products as announced by Trump, which will take effect next month.

Weakening the yuan is clearly a disadvantage for US and other imported products if countries do not adjust their exchange rates accordingly. Will the US and the rest of the world move their currency in tandem with the yuan? Will there be more cuts by central banks all over the world, especially in the emerging markets? These are just examples of new issues which have been added on to the uncertain and volatile global economy.

This new development has strengthened the negative sentiment in the global economy, trade and financial markets. If the trend continues, it could, in the short term, affect the growth momentum and global trade of the world economy, as well as cause a disruption in the global supply chain, which can result in greater volatility in the financial markets.

The International Monetary Fund recently downgraded its forecast of the world economy to 3.2 per cent from the 3.3 per cent for 2019 and it is expected to slide further. Global financial markets seemed to run amok early this week when the Dow Jones Industrial Average, S&P 500 and Nasdaq were in the red. They recovered after the Trump administration backed off on imposing tariffs on some Chinese imports, such as cellphones and laptop computers. Clearly this is a new level of volatility.

The question now in everybody’s mind is whether this latest development would cause a global financial crisis in the near future. There are mixed views on this. The US Smoot-Hawley Tariff Act, a protectionist trade policy of the US, perhaps can give us some clue. The bill for it was signed into law by then US President Herbert Hoover in 1930. This act imposed tariffs on some 20,000 imported goods at that time.

And when some of the US trading partners retaliated, it became a “trade war” of the 20th century. While economic historians are still debating whether this act had caused the 1930s’ Great Depression, there is little doubt it had contributed to its severity.

Hence, this US-China trade war would, no doubt, affect any effort to revive the global economy in future.

As a small and open economy, Malaysia has been negatively affected. Already, the gross fixed capital formation has contracted in the first quarter of this year by 3.5 per cent, compared with the 0.6 per cent in the previous quarter. Private investments have plummeted, exports and imports have contracted and the ringgit has depreciated against the US dollar and other major currencies worldwide and in the region.

Even Malaysia’s Nikkei Manufacturing Purchasing Managers’ Index has slipped further. Thus, it is important that measures be devised to lessen the impact of the US-China trade war. We are walking on a tight rope — we have to balance the need to manage the debt level on the one hand and to stimulate growth on the other.

As of now, the priority is to focus more on improving growth, increasing and intensifying consumer and infrastructure spending, and deepening and diversifying trade markets.

Above all, we need to restore investors’ confidence in our economy. The sooner we can do this, the better.

The writer is Associate Professor of Economics, School of Economics, Finance and Banking, Universiti Utara Malaysia

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