US-China Trade War Update
On May 30th, New York Magazine published a chat between business writer Josh Barro and Benjamin Hart1. In discussing recession questions and trade wars Barro argued, with respect to President Trump that:
“He’s also right that China has more to lose in a trade war than we do, so that’s a reason for him to think his negotiating position is strong and if he fights, he’ll get concessions he wants. So I think those are reasons for him to fight harder and endure more pain than he usually would.
I also think a sign he’s hunkering down is something I wrote about two weeks ago: He has backed off some of his other global trade disputes in a way that suggests to me he realizes the fight with China is going to be harder than he thought and he needs to keep some powder dry. He took off metal tariffs on Canada and Mexico he’d been reluctant to lift. And he delayed, for now, global tariffs that he clearly wants to impose on auto imports. That suggests to me he’s gearing up for a prolonged dispute with China and trying to reduce both the political and economic costs imposed by non-China protectionist moves.”
Alas, at about the same time that the chat transcript was published, President Trump tweeted2:
“On June 10th, the United States will impose a 5% Tariff on all goods coming into our Country from Mexico, until such time as illegal migrants coming through Mexico, and into our Country, STOP. The Tariff will gradually increase until the Illegal Immigration problem is remedied...”
Treasury Secretary Steven Mnuchin and US Trade Representative Robert Lighthizer reportedly opposed the Mexico tariffs3. Adding a second front to the trade war with China would appear to raise the difficulty bar considerably. Thankfully, the US quickly reached a settlement with Mexico and Trump declared victory, though he is still threatening to reimpose tariffs if Mexico’s legislature doesn’t sign off on the migration pact.
If all of this trade turmoil seems chaotic, it is. When we last updated US-China trade relations in December, it appeared that the US had stepped down the threats of a broader trade war. That trade truce has now collapsed, as President Trump has raised tariffs from 10% to 25% on $200 billion of Chinese exports across 5,700 categories of Chinese-made goods. In retaliation, China has imposed tariffs of up to 25% on $60 billion worth of US goods4. Markets have been wobbly since then, in part due to soft economic data, in part due to trade disputes with China, and in part due to the announced tariffs against Mexico.
It’s unclear what happens next. The US has legitimate grievances against China with respect to its trade practices over the past several decades, and a case can be made that a confrontation is long overdue5. The Trans-Pacific Partnership (TPP) was an Obama-administration attempt to use a carrot approach in dealing with China—if China wanted to join the TPP, it would need to open up its markets, and if it didn’t join, other Asian countries would still be less dependent upon Chinese trade. The Trump administration is trying the stick approach with tariffs.
China may capitulate in some fashion. It may offer some cosmetic changes to its industrial and trade policy so that Trump can declare victory. Or it may wait, using tariffs targeted at Trump constituencies, calculating that pressure on Trump will rise as the 2020 election approaches. In this respect, recent soft economic data, the yield curve inversion, stock market slippage, and an increased likelihood of recession mean that it will be difficult for Trump to maintain a hardline approach to China. Raising economic risk with tariffs against Mexico and threatening a tariff against European cars are also maneuvers that appear more baffling than strategic.
The economic impact of tariffs, while not enough to provoke a recession, is nonetheless sufficient to slow down GDP growth significantly. Bloomberg put out a set of scenario analyses in which the trade war cost to US GDP ranged from 0.2% to 0.7%, depending on the extent of any further escalation of tariffs6. Economist Ernie Tedeschi calculated domestic US-China trade war costs to be between 0.5% and 1.0% of GDP7.
We may know more after the G20 summit at the end of June. President Trump has threatened to impose 25% tariffs on $300 billion worth of Chinese consumer goods, which would represent virtually all of the remaining Chinese imports not currently covered by tariffs.
Unlike 6 months ago, when we were cautiously optimistic that the US and China would find it in their best interests to reach a settlement, we are highly uncertain as to what will happen next. US-China trade is still a small fraction of global GDP, so we believe the impact on markets would be modest, and that much of the impact is already priced into valuations. However, with the global and domestic economy showing signs of softer growth, it would be preferable for the two sides to remove this economic headwind by finding an amicable resolution to their trade disagreements.
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