Standard Life Investments

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Investment Week - Trade Winds


Trade winds

Between 1980 and 2007 global trade grew to account for 27% of the global economy. Global trade in industrial goods, commodities and services was worth $14 trillion in 2009. During this period of expansion, trade barriers were lowered, removing restrictions on the trade of goods and services. Free movement of capital also underpinned the expansion as did the tolerance of substantial trade imbalances.

Global trade is changing. The magnitude and direction of flows has altered, reflecting the new world order. Amongst the fastest-growing trade routes are those between the commodity producers in Latin America, South Africa and Australia to emerging Asia. Intra-Asian container trade is now larger than trade between either Asia and Europe or Asia and North America.

In the aftermath of the Global Financial Crisis (GFC) one of the pillars of globalisation, trade, came under extreme stress as letters of credit and other forms of trade finance were crunched alongside other credit instruments. National regulators discouraged cross-border business as the focus on counterparty risks increased. More recently, the earthquake in Japan and floods in Thailand provided evidence that physical impediments to trade also matter and can lead to significant disruptions to the global supply chain.

Costs are rising

It was inevitable that costs would rise as a number of banks retreated from cross-border business. The remaining players were further constrained in who they could deal with, because of counterparty risks, and most faced significantly higher funding costs. Basel III provisions have subsequently encouraged banks to shed their trade assets, which are unlikely to count as regulatory capital. This means government bodies, such as the UK’s Export Credit Guarantee Department have perforce become more active to fill the gap. The requirement is especially acute in relation to trade finance for smaller companies, which are less well catered for by the banks.

For shipping companies, the business model has also changed. While healthy enough in volume terms, the container shipping market is set to grow 7% in 2012, freight rates are falling and are likely to stabilise at a lower level. The unbalanced demand and supply in shipping capacity is likely to put further downward pressure on freight rates at the same time as fuel prices are maintained. Overcapacity in container shipping could persist for four years. Based on current rates, some shipping companies cannot break even. Several are now planning substantial restructuring and others are idling vessels in order to survive. If global growth slows, as predicted, more will struggle.

Agreements and disputes

Trade agreements in future look set to move from a multilateral to a bi-lateral basis. After a decade of wrangling over the current World Trade Organisation (WTO) trade round, the G20, representing 85% of the global economy, finally appeared to capitulate on the Doha round at their Cannes meeting, calling for ‘fresh credible approaches to furthering negotiations’ in 2012. In contrast, regional and bilateral agreements, where interests are more likely to be aligned, have flourished. These include those between ASEAN-Japan, AEAN China and the Korea-US Free Trade Agreement.

As far as tariffs and protectionism are concerned, capital controls in conjunction with the financial sector and then sovereign debt crisis is a less benign backdrop for trade. QE, which has the effect of easing monetary conditions in the country concerned and boosting competitiveness, has been described variously as currency manipulation or protectionism by the back door. If fiscal stimulus to boost growth is conditional on buying local goods, trade relations soon deteriorate and retaliatory moves on tariffs often ensue. 57 complaints have been filed with the WTO since January 2008. Of these, the US, China and the European Union have each been involved in 20 or more.


Having established that trade may be vulnerable to financial, i.e. credit-related, or physical events, what might the future hold? Physical disruptions arising from weather or geological incidents are hard to predict but not unlikely. Economic impacts are easier to envisage, for instance the consequences of deleveraging and austerity or spill-over effects from the Euro zone crisis:

If austerity catches on across wider regions, global GDP growth is likely to moderate further. Trade has then the potential to become part of a negative feedback loop. The uncertain political landscape will likely prompt more politicians to spout protectionist rhetoric and possibly push for restrictive trade policies. Trends such as outsourcing and offshoring tend to reverse when domestic unemployment is high, reducing trade volumes.

The UK has become more insular with respect to the global trade in goods. Its exports account for around 4% of global trade compared to 5.3% in 2000 and half of its exports are to its near neighbours in the euro zone. Close trade as well as financial links with the rest of the EU make the UK particularly vulnerable to contagion through trade. In contrast, US trade linkages with the EU are much looser so here the main transmission mechanism will be financial rather than trade.

Frances Hudson, Global Thematic Strategist, Standard Life Investments

First published in Investment Week on 05th December 2011