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Trade Wars? | 18th August 2014

War may not be the right way to describe trade sanctions but mutually assured destruction is  |  It may be stretching a point, but if war, as Clauswitz said, is the continuation of “Policy by other means”, then the imposition of further trade sanctions on Russia this month by Europe and the United States is just that. The policy since the start of the crisis in the Crimea has been to isolate Russia, make it see the error of its ways and bring it back into the global economic fold so as not to disrupt the fragile recovery in Europe; its logical continuation is to start a trade “war” – effectively disarming Russia in economic terms. We paraphrase but, as sanctions deepen, the objective appears to be an attempt to “disarm” Russia economically while rendering it economically “impotent. ” With the IMF GDP growth forecast for Russia at 0.2% this strategy may well be working already.

However, Eurozone growth is similarly sluggish. Eurozone growth was zero; the German economy contracted and the French economy stagnated. Germany’s Statistical agency, Destatis, argued that the decline in German growth was due to trade. At least some of this may be because of the brewing situation in the Crimea and the impact of sanctions. Figure 1 illustrates that German car exports to Russia into 2015 are flat with a drop in the last 2 quarters of 2014 and Russian exports of oil to Germany are pretty much flat for the next 12 months.

 

2014-08-18_tradeWars_fig01

 

Figure 1  |  Value of German car exports to Russia and oil imports from Russia, USDm, June 2001-July 2015
Source  |  DeltaMetrics 2014

 

This does not tell a nice story for Europe’s biggest exporter even if the slower growth in oil imports from Russia suggests that Germany is reducing its dependency on Russian oil. It will take a while for Germany to re-source its oil and while that is going on there is uncertainty in Germany’s energy supply which may in itself cause its manufacturing engine to slow.

Yet the dependency of the EU 28 on Russian imports, in spite of sanctions, is likely to slow only gradually as illustrated in Figure 2.

 

2014-08-18_tradeWars_fig02

 

Figure 2  |  EU 28 trade with Russia (USDm)
June 2001-July 2015 versus USD per Euro, Last Price Monthly, June 2001-July 2014
Source  |  DeltaMetrics 2014 (trade data), Bloomberg (currency data)

 

Europe runs a trade deficit with Russia because of the amount of oil and wheat it imports and Russia’s trade with Europe will have little effect on the value of the Rouble against the US Dollar as the correlation is zero. However, the effects of declining trade with Russia on the value of the Euro are quite clear to see: the correlation between the Euro’s value against the Dollar and Europe’s exports to Russia is 0.78 while the correlation between the Euro’s value against the Dollar and Europe’s imports from Russia is 0.76. Its correlations with the DAX are even stronger at 0.82 for both. A trade war with Russia may well hurt Europe’s markets far more than it hurts Russia itself.

The flashpoint of this economic conflict is of course, not just the sustained health of Europe. The real problem is oil. Oil is 94% correlated with trade and the unfortunate consequence of what we are witnessing in terms of sanctions is a more general feeling of uncertainty that is itself fuelling substantially slower trade growth than either the IMF or the WTO predicted, as shown in Figure 3.

 

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Figure 3  |  Value of world exports (USDbn) versus NYSE Arca oil spot, Last Price Monthly, June 20014-July 2014
Source  |  DeltaMetrics 2014 (trade data), Bloomberg (oil prices)

 

A positive correlation like this suggests that oil prices may start to fall towards the end of the year.

Yet if trade overall is dampening, this can only be explained in terms of new sources of oil entering the market: one unforeseen consequence of the current conflict in Iraq is the increased dominance of Iran in global oil markets. Iran is expected to export USD 28bn of oil to China this year alone and its exports are forecast to grow by over 9%. Its exports to India will grow by nearly 10% from a level of USD 18.2bn in 2014 and to Spain by nearly 5% from a base of nearly USD 4bn. In fact, we are expecting the Middle East’s exports to increase by 5.3% compared to 4.2% three months ago suggesting that it is the major beneficiary of Europe’s desire to become less dependent on Russia.

 

 

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Figure 4  |  Why oil supplies will not dry up as a result of trade sanctions
Source  |  DeltaMetrics 2014

 

The other new entrant to the market is of course the United States. Just as greater sanctions were imposed on Russia, it revoked its long-standing ban on crude oil exports. As a result its exports of mineral fuels generally are expected to grow by over 12% this year, of crude oil by nearly 6% and of shale gasses by 11.5%. Exports to the Netherlands will increase in 2014 by nearly 15% and to France by just over 15% with similar growth into 2015. Compared to a decline in oil exports from Russia of 0.63% since the start of sanctions in March, US exports have increased by nearly 5%.

 

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Figure 5  |  Value of Russian and US exports of mineral fuels, June 2001- Dec 2014 (USDm)
Source  |  DeltaMetrics 2014

 

Russia’s exports and the value of its currency will not suffer unduly from more widespread sanctions. Its exports of oil to China are forecast to grow by over 11% this year alone. The value of its currency is unrelated to its trade and punitive sanctions against it will have little additional impact on its already sluggish economy.

However, the impact on Europe could be severe because of the vulnerability of its economy to reduced energy supply. Similarly its currency is threatened by reduced exports generally and to Russia in particular. It is too early for politicians to claim that slower growth in Europe is because of the current crisis. But if our forecasts prove to be correct, then Europe and the world’s trade looks like it will really struggle to lift in the second half of this year and this will worsen into 2015 as the impact of sanctions do start to appear in the data. In formal terms, war may not be the right word to use to describe the imposition of sanctions. But what we have to hope is that any escalation does not lead to mutually-assured economic destruction.