How the ANZACs might handle the trade shock
This note discusses the key similarities and differences of the Australian and New Zealand economies with reference to how they might fare in this global trade shock.
Trade policy uncertainty is at extreme levels and could significantly impact the small open economies of Australia and New Zealand. Both countries could lose to some extent as global demand and the pattern of trade flows adjust. But beyond this common thread there are key differences that could determine how New Zealand and Australia will fare.
Trade and economic policy uncertainty has been very high for months now but really erupted this week. Financial markets swung wildly, especially in equity markets which ranged widely and where implied volatility levels have moved up towards the levels seen only during Covid, the 2012 European debt crisis and the 2008 global financial crisis.
There have been similar movements in the rules governing global trade flows. Tariff policies in the US and China especially have moved a lot – in some cases, in both directions. We are now in a transitional position of US tariffs of 10% tariffs on most countries and 145% tariff on China, while China has retaliated with 84% tariffs on US imports.
None of this is set in stone, as negotiations are ongoing, and US tariffs on non-Chinese imports are to be reviewed again in three months. And frankly, the US and China are not negotiating right now but are engaging in tit-for-tat retaliation. Hence uncertainty will remain very high.
There will be a lot of debate around the ultimate size of the change in global trade rules that the Australasian economies will need to adjust to. It’s hard to put a finger on the scale of that now. But it is interesting to reflect on the ways in which our economies might be both similarly and differently impacted as we go forward.
There are many common factors. Both countries are trade orientated; hence this global trade shock could have potentially profound implications for incomes and growth over both the short and longer term. We both have strong trade linkages with the US, China and South-east Asia. Hence weaker demand in those jurisdictions has the potential to impact our incomes – especially though lower export commodity prices.
We both have strong macroeconomic frameworks (including independent central banks) that should help us navigate any troubles to come. Our floating exchange rates will buffer us should very negative scenarios emerge. Our government debt loads are low and credit ratings top tier, providing resilience.
The bottom line in terms of the commonalities is that we are both exposed to the worsening global trade environment but have resilience factors which will help even as the global trade environment shifts to greater protectionism and balkanization of trade flows.
But there are also some key structural and cyclical differences that may matter. On the positive side of the ledger for Australia: its current account and fiscal position is unequivocally stronger than New Zealand’s and should imply more resilience to the global trade shock. Cyclically, Australian fiscal policy is easing from a position of strength, providing some support to consumption and growth. That will matter. Another key Australian strength is that it enters this period of uncertainty with stronger growth and output that is close to trend. Australian growth has been disappointing by historical standards, but the economy is not on the ropes already. The labour market in particular remains in decent shape, notwithstanding recent debates on whether the NAIRU is lower than previously appreciated and associated productivity questions.
On the New Zealand side of the ledger: a strength is that NZ is further through the monetary easing cycle than Australia – so there is more stimulus already in the pipeline. Both countries have room to ease if required, but Australian inflation may be a little higher than NZ inflation in core terms, reflecting the different positions in the cycle. New Zealand’s commodity prices have been strongly on the up in the last year as resilient demand has combined with constrained supply of agricultural export products.
New Zealand will be more resilient if global manufacturing weakens relative to consumption given its export focus on agricultural and food commodities compared to Australia’s industrial commodities and energy exports. Global industrial production could come off worse in the new tariff environment and supply chains may have further to adjust. People will still eat whereas global steel demand may or may not be resilient.
New Zealand’s main issue is that we go into this more uncertain environment with output significantly below trend, which is why policy has been easing. While the trade sector is well positioned to absorb a trade shock, it’s less the case for the domestic economy. A further issue is the New Zealand government is trying to tighten fiscal policy even though aggregate debt levels are low by global norms. The finance minister noted this week a determination to continue the consolidation process even in the face of a weaker global economy. That’s going to be a challenge.
The pattern of trade is quite interesting and could favour either country depending on how the global growth environment pans out. Australia’s trade is more heavily tilted towards China, North and South-east Asia. New Zealand is more reliant on trade with the US. Both countries have roughly the same sensitivity with respect to trade with developed countries. If US growth and consumption were to be hit relative to Asia, then New Zealand could be worse off. And of course, the opposite also applies.
The uncertainty around how the global economy will evolve means it’s hard to know whether there will be any ‘winners’ at the end of the day. Hopefully we both lose little in the end. But it’s important to consider the differences in the economies as we move forward into this mist of uncertainty.
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