The latest developments suggest that trade tensions between the US and China will be more protracted than previously expected. The US recently announced it is raising tariffs on $200 billion of imports from China to 25% from 10%, and China has responded by increasing tariffs on $60 billion of imports from the US.
The US had warned Beijing not to respond to the tariff increase whilst threatening to extend tariffs to the remaining $325 billion of imports from China. China’s decision to press ahead suggests that it sees little prospect of a favourable outcome from the talks in the near term.
In terms of the impact on GDP, we would expect both countries will be worse off, with US and Chinese GDP lower by 2020 compared to a baseline of no tariffs. However, the impact will be greater on China given its higher dependence on trade. Japan and Europe will also experience declines in GDP.
Trump may be reluctant to escalate tensions further
Although the prospects do not look good at present, we still believe that President Trump will be reluctant to escalate trade tensions further with a blanket 25% tariff. An extension of tariffs would mean pushing up prices on a wide range of consumer goods which will feed through into inflation. While Trump has said that “China will pay” for the tariffs, the evidence suggests that it is the US consumer who is paying as companies pass on the higher costs.
When tariffs are imposed on Chinese goods, US importers have to pay higher costs which they can either absorb into their margins or pass on to consumers. Consumer price index (CPI) inflation in the US has remained relatively low since the tariffs were imposed. This has given the impression that companies have absorbed the tariffs into their profit margins.
However, this is difficult to prove as the tariffs mainly hit intermediate goods used in production processes and capital goods. Only about 25% are on consumer goods. Although US imports from China have fallen, it has been difficult for US importers to find alternatives in many cases as most of the imports are highly specialised products.
US companies raising prices as tariffs weaken China’s competitiveness
US companies have been complaining about higher costs. For example, the CEO of automaker Ford said that steel tariffs would add an additional $1 billion in costs. This has occurred despite the company buying much of its metal supply from domestic producers.
What seems to have happened is that domestic companies have raised their prices as the tariffs have weakened the competitiveness of Chinese suppliers. The latter have not been cutting their prices. Generally, companies are passing these costs on to the consumer.
If the US were to put tariffs on the remaining $325 billion of imports from China then households would be hit further, especially as consumer goods account for a larger part of this tranche of imports. With presidential elections fast approaching in 2020, Trump will wish to avoid hitting consumers with tariffs.
Consequently we anticipate a deal at the end of the year and a reversal of some of the recent tariff hikes. Inflation will be higher in the near term and growth slightly weaker. The danger is that the trade tension and volatility will be ratcheted up before a deal is agreed, hitting growth and inflation further.
Author: Keith Wade, Chief Economist & Strategist and Grace Canavan, Head of Intermediary Business Development, Ireland. Website www.Schroders.com and contact number +353 (0) 85 254 9839.
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