Will this Trade War have any Teeth?

Here is what we are seeing and what it could really mean for global trade.  

The speed and scale of China’s retaliation to the proposed US tariffs represents a significant escalation of tensions, though there is still plenty of time for a deal to be struck before tariffs come into effect. The risk is that President Donald Trump raises the stakes further, possibly by labelling China a currency manipulator later this month. 

But what does all this really mean? 

Following Trump’s announcement of tariffs on $50bn of Chinese goods last month, the US Trade Representative published a list of 1,333 products that would face a 25% tariff. As expected, it focused on a wide range of high-tech goods. The big surprise, however, was how rapidly the Chinese responded with equivalent 25% tariffs covering $50bn worth of imports from the US, including on soybeans, motor vehicles and aircraft. In contrast to their response to the steel and aluminum tariffs, which came weeks after the US announcement and was half the size of the US action, this was a strong signal that China will not back down easily. 

So, let’s assume that full trade sanctions are implemented – what will it mean?

If implemented in full, the macro impact of both sets of tariffs would be small. The US proposals cover 2% of total imports, so a 25% tariff would raise import prices by 0.5% or so, boosting domestic inflation by less than 0.1% point. It would, in effect, be a tax on US consumers, offsetting some of the boosts to real disposable incomes from the income tax cuts. The reality is that China is the dominant global supplier for many of these goods, so it would be hard to find alternatives. 

China’s $50bn of retaliation covers more than 40% of US goods exports to China but accounts for only 2.1% of total exports and a trivial 0.3% of US GDP. Nevertheless, the tariffs would fall disproportionately hard on vehicle and aircraft manufacturers and soybean farmers. The latter will be protected for two reasons, however. The next US crop won’t be harvested until this October, giving farmers some breathing room. Moreover, soybeans are a commodity that is close to market balance globally. If China buys more from Brazil this summer, the US will sell more to other countries. Pigs have to eat. :)

Trump likes to make Deals and so do the Chinese. Current wagers are that there is likely a deal in the future on this trade battle and if we are lucky another Tweet or two… 
 

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