THE latest developments in the unfolding trade war saga suggest that trade tensions between the United States and China will be more protracted than previously expected, says Schroders chief economist and strategist Keith Wade.
Two weeks ago, the United States announced raising tariffs on US$200bil of imports from China to 25% from 10%, and China responded by increasing tariffs on US$60bil imports from the United States.
The United States had warned Beijing not to respond to the tariff increase while threatening to extend tariffs to the remaining US$325bil 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 gross domestic product (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,” said Wade.
He is of the opinion that 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,” said Wade.
This is because 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, Wade said that 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,” adds Wade.
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 US$1bil in costs. This has occurred despite the company buying much of its metal supply from domestic producers.
“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,” says Wade.
If the United States were to put tariffs on the remaining US$325bil 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 election 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,” concludes Wade.