Just when it looked like the U.S. and China might be close to hammering out a trade deal, it appears that China backed off some previous concessions and the U.S. escalated the tariff war it started about a year ago by imposing 25% tax on a new list of $250B worth of Chinese goods. Beijing was quick to respond by raising tariffs on $60B of U.S. goods. This could be just the beginning as President Trump, confident that the U.S. will “win” a trade war, also said he was considering additional tariffs on nearly every imported product from China.
For the record, I’d like to clear up some misconceptions about who will be paying the price if the two sides cannot come to agreement.
How we got here: Throughout his Make America Great Again campaign for the presidency, Trump promised to bring manufacturing and jobs back to the U.S. from China. Separately, for years before this, the international community has tried and failed to get China to play fair and open up its markets, which is what it agreed to when it became a member of the World Trade Organization. It seems the best way to achieve both objectives, at least in President Trump’s view, is by taxing Chinese goods coming into the U.S.
As per @realDonaldTrump: “I am a Tariff Man. It will always be the best way to max out our economic power. We are right now taking in $billions in Tariffs. MAKE AMERICA RICH AGAIN.”
Historic low unemployment in the U.S.
Really? Isn’t America already rich. Yes, a lot of manufacturing has moved to China, but unemployment is at historic lows in the U.S. sitting at only 3.6% in April 2019. U.S. companies cannot find enough people to fill jobs. Maybe we should be talking about all the jobs that have been created in the U.S. because U.S. companies are producing in countries such as China where they can keep costs down so that retailers such as Walmart and Amazon can bring goods back into the country and sell them at affordable prices. Low-cost manufacturing in China is the reason inflation in the U.S. has been kept to a minimum which is why the Federal Reserve has not needed to raise interest rates which is why the bull market continues its historic run.
That the U.S.--and the world--wants a more level playing field with respect to trade with China is understandable. However, let’s be honest, even with the restrictions China has put in place, Starbucks, Apple and many other U.S. companies doing business there are flourishing. They are navigating around the restrictions and doing great. Let them continue. How will “leveling the playing field” increase employment in the U.S. when it’s already almost at full capacity?
Who’s actually paying the U.S. tariffs on China?
Another big misconception being advanced by the President: the U.S. is cashing in on all the tariffs its collecting and will win a trade war with China. In reality, both countries will be hurt. Even though the U.S. imports much more than China and has more room to impose tariffs, China is not paying for the tariffs. U.S. companies are and if they manage to survive an all-out tariff war then the added cost will be borne by U.S. consumers. Even White House economic adviser Larry Kudlow admitted as much--something he took heat for from the President. While U.S. GDP is currently at a healthy 3.2%, for every month the tariffs are in place, growth will slow.
China has options other than tariffs for retaliation
How bad could this get? It could get to a point where both countries stop speaking to each other, which means very little trade. China could ban U.S. companies and U.S. products. It is also the largest holder of U.S. debt and could sell off U.S. Treasury bonds, potentially triggering a huge rise in interest rates, seriously hurting the U.S. economy. The U.S. could issue an ultimatum to other trading partners: Stop doing business with China or we’ll stop doing business with you. Thankfully, at this stage, the likelihood of any of these scenarios playing out is low.
The world is interconnected. Supply chains are all intertwined thanks to globalization. Investors know this, which is why the markets have not been impacted as much as they might have been. Maybe we were naive to think a deal between two of the world’s largest economies would be straightforward. What is clear is that it’s in both sides best interest to arrive at a deal. Nobody wins in a tariff war.
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