Until early this year, markets cheered ‘good’ US President Donald Trump. Indeed, fiscal stimulus and deregulation have supported growth, though it is questionable whether the former is a sensible medium-term macro policy as it risks overheating the US economy and adds to the budget deficit.
But in recent months, the Trump administration’s protectionist agenda has become more apparent.
At first we saw tariffs on steel, aluminium, lumber, solar and washing machines based on tenuous national security grounds and other obscure trade laws.
The higher imported costs have probably done more damage to the users of these goods than the value of the jobs ‘saved’ in the protected industries, but the overall macroeconomic impact was negligible.
Then over the summer and in response to the investigation into China’s alleged theft of US intellectual property, the US imposed 25 per cent tariffs on $50bn (£38.5bn) of Chinese imports. This list mostly avoided consumer goods.
China retaliated proportionately, leading to Mr Trump firing the latest shot in his trade war: 10 per cent taxes on $200bn (£154bn) worth of Chinese imports. Furthermore, from January 1 2019, this figure could rise to 25 per cent — a delay intended to give US companies time to establish new supply chains.
In reaction, China’s response has been relatively measured, with variable tariff rates up to 10 per cent on $60bn (£46bn) of imports. True to form, Mr Trump has once again threatened to respond to any Chinese retaliation, with restrictions on a further $267bn (£205bn) of additional goods, covering nearly all of China’s imports to the US. This would raise prices on high-profile consumer goods such as TVs and mobile phones.
The tariffs so far will probably only make a minor dent in US GDP growth. But the danger of further escalation in trade tensions appears to be increasing.
For investors, the biggest uncertainty is the indirect effect: financial conditions and business sentiment could be shaken by changes to the global trade order.
Interestingly, the market reaction so far has been relatively muted. This may be because what began as a multilateral melee, with the US facing off against Mexico, Europe, Canada and China, has become a bilateral bust-up between Washington and Beijing. Market participants, moreover, may expect the recent US fiscal stimulus and Chinese currency weakness to mitigate any short-term negative impact of the fracas on the world’s two largest economies.
Yet this does not mean we can be at all certain as to how the situation might unfold.
Can Trump win a trade war?
China cannot match Mr Trump’s tariff threat dollar for dollar as it only imports less than $150bn (£115bn) of US goods (see chart). However, the trade deficit vanishes when one considers US subsidiaries’ sales in China.
China can retaliate by putting pressure on US companies operating in China. Customs delays, tax audits and increased regulatory scrutiny are possible, with Hollywood and US pharmaceutical companies easy targets.