Wide Angle Shot: Global trade and financing heading into rougher waters

• Geopolitical competition challenges free trade paradigm, structural imbalances across geopolitical divides a risk factor
• President Trump adds to already heightened uncertainty, putting EU in a difficult position to navigate
• US policy moves may add to great complexity of fast changing tariffs on individual countries/sectors and overall tariffs on a global level
• Trade volumes point to slowbalisation rather than deglobalisation
• Protectionism increased since 2020, mainly in form of subsidies; now additional measures on plate (tariffs, export controls, sanctions)
• CE/SEE countries are deeply imbedded in EU trade — limiting their policy space — and demonstrate a high overall trade openness
• While CE/SEE countries trade less with the US, German weakness and relocations to US could become a structural problem for CE/SEE region

Looking at the news flow 2024 should have been (another) difficult year for global trade. However, despite heightened global risks, a dampened economic performance, higher interest rates, increased sanctions and growing protectionism global trade volumes remained relatively stable. Aggregated trade volumes indicate slowbalisation rather than deglobalisation. Moreover, a large chunk of the more recent global trade slowdown can be possibly linked to subdued dynamism in the global industrial sector. From a long-term perspective taken by modern economic history, global trade (in goods and services) remains at a historically lofty level, having oscillated around the 60% mark of global output in recent years.

However, protectionism has been increasing since 2020, with a continued high level in 2024. Overall, the number of protective measures has trippled since 2019. We often encounter discussions about tariffs in the news, particularly due to President Trump's frequent statements on imposing them. But far more often, protectionism takes the form of subsidies, for example, for agriculture, key technologies or the green transition. These protective measures perfectly illustrate an economy's conflicting objectives: balancing sustainability, national interests, security considerations vs increased wealth and efficiency gains from free trade. Moreover, in the case of some of these subsidies, it is not entirely clear whether they are “only” about "mercantilist" industrial promotion, or also about the creation of (future) dependencies or even the global competition for technological leadership (here, primarily between China and the United States). In historical terms great power competition — if direct confrontation can be avoided — at least reflects itself in the areas of strive for leadership in technology, global trade relations and the international financial architecture. Additionally, financial sanctions (some of them with an extra-territorial reach) or export controls contribute to the rise of protectionist measures. If Trump were to resolve the Ukraine conflict, as he claims, there is the option that some Russia-related (US) sanctions could be lifted and somewhat mitigate protectionist tendencies. However, even if the US were to lift the sanctions against Russia, a divergence from its European counterparts could emerge. This could even add to the complexity of the Russian sanction regime and does not necessarily have to be seen as a relief. It is important to acknowledge that there are also already reciprocal non-negligible sanctions and/or export restrictions between the US and China targeting strategic sectors. Moreover, the overall threat of US tariffs and countermeasures undermine the potential for near-term relief on the protectionist front. Consequently, protectionism remains a significant issue going forward, with a renewed emphasis on tariffs or export controls, substantially increasing uncertainty and complexity. This holds especially true as US trade policy moves may add to great complexity of fast changing tariffs on individual countries/sectors and overall tariffs on a global level for imports to the US market.

In terms of the current protectionism debate, a broader view of the subject is clearly needed that goes beyond the person of US President Trump. In the US, large parts of the political establishment and the general public are critical of free trade. The same holds true for certain parts of the expert community. This position has been built up over the last decade and is based on a wide range of considerations. Firstly, free trade and structural dependencies that result from it can be viewed much more critically in a geopolitically and geoeconomically divided world than in the rather geopolitically uncomplicated 1990s and early 2000s. This is especially true for a geo-strategic actor like the US. Free trade and chronic imbalances between (geo)politically close countries (e.g. within a political and/or currency union) must be evaluated differently than between explicit geopolitical rivals. Russia has vividly demonstrated that it wanted to exploit Europe's energy dependencies in a manipulative way in the run-up to and in the context of the war in Ukraine. Secondly, long-term trade imbalances can also create complex financial interdependencies (e.g. Chinese assets in the US or US Treasury bonds), which may also need to be assessed differently in times of geo-strategic rivalry. Not to speak of the fact that regulators are increasingly focusing on geopolitical vulnerabilities in the global banking and financial system. In light of the two previous arguments, it should also be noted that, in terms of economic history, great power competition is precisely about regulatory and financial reach. Thirdly, free trade only makes sense in political-economic terms if the losers of free trade are compensated. This does not appear to happen in a comprehensive way in the US, given the widespread skepticism towards free trade in society.

Looking at the foreign-held US public debt in more detail, China's share has declined because the total amount has increased, and China's appetite for US Treasuries has diminished. Nevertheless, China is still the second-largest holder of external debt. In December 2010, China held 26% of US external debt, decreasing to 10% by the end of 2023. However, some market observers still consider this too excessive. They see a risk that China could sell off US debt in an erratic move (e.g. in case of political frictions) or Chinese Treasury selling could add to an already more fragile US-Treasury market. However, the overall share of non-residents in overall US public debt remains at moderate 25%, while a strong domestic financial sector or possibly the Fed are likely to support the market in case of need.

In general, Russia's experience with frozen assets (sovereign bond holdings) and sanctions has already influenced some countries' investment strategies (as reflected in the substantive gold buying activity of Emerging Market central banks) and will possibly shape financial flows along geopolitical lines. Therefore, China is critical of the US dollar's dominance, especially in recent years, and fears that having too many assets in the US or Europe would make it more vulnerable to sanctions. These shifts could involve foreign exchange reserves or the use of alternative currencies for trade, with the ultimate goal to decrease risks for Emerging Markets related to dollar dominance. However, as long as there is no alternative currency with superior property rights to the US or the EU it will be unlikely that we will see a sweeping reallocation of global reserve assets. Nevertheless, the usage of the CNY in global trade may gradually increase in the coming years.

Moreover, in case of Russia, China has demonstrated that the country is able and willing to keep a country afloat economically and financially that is deeply sanctioned by the Western World. We think that this experience may somehow boost the willingness to increase the ties to the Chinese financial sector in certain parts of the world economy. Moreover, we think that China will actively use in power on global energy/commodity markets to settle certain flows in CNY on a bilateral level, while offering CNY swap lines to relevant economic and trading partners. However, for the time being we see the international CNY usage mostly centered around trade with China (some 25% of Chinese foreign trade is currently already settled in CNY). However, the usage of CNY in international trade remains moderate at 4-7% of global foreign trade settlement. In terms of reserve assets the CNY is accounting for some 2-3% of (officially disclosed) global reserve assets (55-57% USD, ~20% EUR).

According to the IMF, fragmentation increased. A study that divided the world into a U.S. leaning bloc, a China leaning bloc, and a bloc of nonaligned countries showed that trade within blocs decreased less than trade between blocs.

The impact of geopolitics on foreign trade and the emergence of geopolitical blocs is evident in the context of the EU, Russia and China trade dynamics triangle. EU exports to Russia have declined significantly, with sanctions evasion continuing to be a hot topic. In contrast, China's exports to Russia surged 46% from 2022 to 2023. The United States has generally played a lesser role and is now virtually absent in this context. For Russia, this shift signifies a risky dependence on China. It is also more or less obvious that China is de facto widely undermining Western sanctions against Russia. After all, the majority of Chinese exports to Russia consist of electronics, machinery and technical equipment. Moreover, the question arises — in addition to the delivery of purely Chinese products — whether Western sanctions are circumvented.

A closer look at the relationship between China and the US shows that US imports from China (as % of total) decreased by roughly 8 pp from 21.8% to 13.9% since 2017. Nevertheless, China remains one of the most important import partners for the US, ranking second place after Mexico in 2023. At the same time China is a key trading partner for Mexico. In this respect, pragmatic strategies for bypassing direct trade and/or investment links are clearly evident. China's attempts to compensate for some restrictions in the US and reroute trade flows to the EU has led to a slightly increasing trading share with the EU. However, this development was controversial for the EU, ultimately leading to punitive tariffs on Chinese e-cars. As a strongly export-oriented economy, China is dependent on its foreign trade. Despite years of government pledges to prioritise domestic demand, it remains insufficiently low. Additional tariffs from the US on Chinese products present an economic challenge for China and, on top of that, prompt calls for similar measures in the EU. The new US administration could explicitly oppose the still considerable economic ties between the EU and China. Moreover, if China were to aggressively try to target the EU as a substitute market, there would be possibly a need for action among European politicians and an increased likelihood that the EU would also impose tariffs in China's direction. In this respect, it may also be up to China and Europe to position themselves as responsible global trading powers. However, it is also true that a more critical view of Sino-European trade is emerging in some parts of Europe, where views converge with those in Washington D.C.

But Trump is not only threatening China with tariffs, but also the EU and the rest of the world. Consequently, the world's fragmentation would reach a new level of complexity. For the EU, this means that it cannot rely on old alliances. In this respect, the EU needs to form smart and pragmatic alliances, possibly not only with more like-minded players such as Japan, Australia or South Korea, but also with players that do not fully support all of its political and/or ambitious environmentally-friendly values. A pragmatic approach is also indicated because the USA under President Trump is more likely to enter into pragmatic trade and economic agreements with states that do may not have democratic and liberal foundations.

In a rather realistic adverse case, erratic tariffs and retaliation in response may create a lose-lose situation, posing a significant threat to the global trade outlook. Such developments would also have an impact on the global inflation outlook, which could complicate monetary policymaking. Fewer interest rate cuts by leading global central banks than currently expected should be in the cards in such a scenario, unless we see some extreme scenario like in the 1930s. However, we still think that central banks would act more pragmatically today than in the 1930s. Furthermore, in addition to direct tariff retaliation, questions of currency manipulation and/or competitive devaluation could come to the fore. This aspect also argues for a less confrontational approach in the event of a desired reorganization of global trade relations.

The current geopolitical fragmentation suggests increased vigilance with regard to global trade networks and dependencies. This concerns dependencies between individual countries and/or trade blocs. Regarding the latter aspect, it can be clearly concluded that, from a global perspective, the BRICS group of countries and/or Emerging Markets are significantly more dependent on foreign trade with the Western world and/or the EU and the US (given lowish Intra-BRICS trade volumes). By contrast, Western countries are less dependent on trade with Emerging Markets and the BRICS countries, respectively, due to a higher share of intra-EU or intra-NAFTA trade. However, in our opinion there will remain substantial real economic and financial ties between the two groups of countries (i.e. developed economies and Emerging Markets or BRICS countries). In light of the outlined dependencies, some (important) Emerging Markets and BRICS countries may well want to and will position themselves as geopolitically “neutral” or non-aligned players. It is important to remember that BRICS countries, despite the shared vision of an enhanced role for the Global South in world affairs, this group is heterogeneous and often comprises different or even competing interests. In this respect, such geographies could continue to be important exchange points for world trade — despite increasing protectionism at the bilateral level, for example between the US and China. But of course such geographies also allow sanction circumvention, with risks for directly and indirectly involved actors and financial service providers.

All CE/SEE countries, even large ones like Poland, are very open economies, making trade an important factor for their economic performance. Trade openness is especially pronounced in the CE countries, where trade as a percentage of GDP often reaches values well above 100%. Romania and Albania come last, with trade-to-GDP ratios as high as 80%, which is still respectable.

EU integration plays an important role in the region as a member or as a result of economic cooperation and bilateral agreements. Except for Kosovo, more than half of the trade occurs with EU partners, showing a strong connection on the European continent. Intra-EU trade for Western Balkan countries exhibits similar values to those of EU countries, indicating that these nations are already well integrated into the single market from an economic perspective. Germany is a major partner for most of these countries, posing risks due to the current weakness in German industry and the outlook regarding US tariffs.

In light of the elevated dependencies on EU trade relations in CE/SEE we see clear limits to how far small open economies such as Serbia or Hungary can really position themselves as neutral, multi-vectorial or even China/Russia-leaning economies.

While most CE/SEE countries have limited direct exposure to the US and primarily trade with the EU or other European partners, Germany could be a weak spot for the region. We are already witnessing economic spillovers from sluggish German demand, particularly affecting Czechia and Slovakia. Additionally, dampened European growth has the potential to strain the up-to-now rather self-sustaining economic development in CE/SEE economies. According to an analysis by the Austrian Central Bank, Trump tariffs may have a noticeable effect on CE/SEE countries via indirect channels, with CE countries obviously being especially vulnerable. Furthermore, depending on the design of the tariffs and other location-promoting measures, relocating European production to the US to avoid them might add to this issue. Such re-locations might even undermine CE/SEE countries' economic policy ambitions not to end up in a so-called middle-income trap. Moreover, it remains to be seen to what extent Chinese goods — that can no longer be exported to the US — are being directed towards European and CE/SEE markets. On aggregate the CE/SEE markets are running huge trade deficits with China. Hence, these markets could even experience slight deflationary effects resulting from such strategies.

To sum up: We are heading for uncertain times with an as yet unknown impact on global trade. An erratic US administration will make it even more difficult to navigate this environment. Small and open emerging market economies are especially vulnerable to rising global uncertainty and/or more limited access to international (cross-border) financing. Lastly, it is important to remember that economists often base their arguments (at least to a certain degree) on economic rationality, which politicians may not always adhere to, as evidenced by Russia's invasion of Ukraine.