On Friday, May 10th, the Trump administration followed through on its threat to raise import tariffs on $200 billion worth of Chinese goods from 10% to 25%. Beijing retaliated three days later with tariff hikes on $60 billion of US goods.
Supporters applauded the move saying that this was a necessary step to alter the trade imbalance between the U.S. and China. However, it was pretty clear that the markets weren’t happy with the move. The major market indices fell immediately: The Dow Jones Industrial Average fell more than 550 points, the S&P 500 dropped more than 2%, and the Nasdaq Composite fell around 3%.
The President claims that trade wars are “easy to win”. The reality is not that simple and the global impact of trade wars is actually very difficult for everyone involved.
To help us understand what is going on and why, I wanted to offer a brief primer on the issues surrounding tariffs, trade wars, and the implication on the economy and to us individually.
What is a Tariff?
A tariff is a tax imposed on a product made outside of one’s own country like the United States.
In theory taxing items coming into the U.S. means people are less likely to buy them as they become more expensive. The intention is that they buy cheaper local products instead - boosting your country's economy.
What is a Trade War?
A trade war is when one nation imposes tariffs or quotas on imports on another. The other country retaliates with similar forms of tariffs. As it escalates, a trade war results and the impact is an overall reduction in international trade.
What is going on now and why?
The goal of the Trump Administration is to reduce the $621 billion total U.S. trade deficit and create more jobs in this country. The largest U.S. trade deficit by country is with China. In 2018, that deficit was $420 billion. The U.S imported $540 billion, primarily in computer electronics, machinery, and clothing. However, U.S. companies exported only $120 billion worth of goods to China with most of this being commercial aircraft, soybeans, and cars.
Interestingly, much of the goods imported from China are actually made by U.S. companies Why? Because China can produce consumer goods for much lower costs than other countries can. China has a lower standard of living and can therefore pay lower wages. Unfortunately, because it is challenging for most U.S. manufacturers to compete with China's lower labor costs, they have shifted the cost of labor to China. While most would agree that “Made in America” would be preferred, in reality American consumers are not willing to pay more.
In addition to reducing the trade deficit, the Trump Administration wants to limit U.S. technology shared with Chinese companies. China requires foreign companies who want to sell products in China to share their trade secrets. The administration has asked China to stop subsidizing the 10 industries prioritized in its "Made in China 2025" plan. These include robotics, aerospace, and software. Because China’s goal is to be the world's primary artificial intelligence center by 2030, China is unlikely to agree to these U.S. Demands.
The US launched an investigation into Chinese trade policies in 2017 and as a result, imposed a 10% tariff on billions of dollars in Chinese products in 2018. The Trump Administration justified it’s actions by relying partly on Section 301 of the Trade Act of 1974 to prevent what it calls unfair trade practices and theft of intellectual property. This gives the president the authority to unilaterally impose fines or other penalties on a trading partner if it is deemed to be unfairly harming U.S. business interests, especially if it violated international trade agreements.
China argues it has strengthened intellectual property right protections and that the U.S. has ignored the effort. China opposed the action taken by the U.S. saying they represent unilateralism and protectionism. Therefore, China then retaliated in kind.
After months of tension between the two countries, they both agreed to halt new trade tariffs in December to allow for talks.
The trade talks unfortunately broke down and the additional Tariffs were imposed on Chinese goods on May 10th.
Larry Kudlow, Senior Economic Advisor to Trump, justified the strategy on a recent interview, “it is worth bearing the short-term pain of a trade war to force China to open up its vast economy to American firms on a fairer basis”.
Is the pain of a trade war worth it?
Initially, it may work but in the long run, a trade war actually costs jobs because it depresses economic growth for all countries involved. Trade wars can also trigger inflation because they end up increasing the prices of consumer goods imported from that foreign country.
Economic experts say that the Trump Administration’s attempts at trade protectionism will hurt the U.S. economy as it will lead to an increase in the price of goods like cars, computer chips, and heavy equipment. Companies will have to cut jobs because the cost of production using local materials will be too high to be profitable. U.S. exporters of things like agricultural products and auto parts will suffer as foreign markets for their goods shrink under retaliatory tariffs.
China’s tariffs on U.S. goods exported and sold in China will make them more expensive. U.S. exporters may have to cut costs and lay off workers to remain competitively priced. If they fail, they may cut costs further or even go out of business.
In the long term, a trade war with China will slow economic growth. They create more layoffs, not fewer, as foreign countries like China retaliate.
Over time, trade wars by its nature weaken the protected domestic industry. Because without foreign competition, companies within the protected industry lose the incentive to innovate. Eventually, the locally made product would decline in quality compared to foreign-made goods.
How does a trade war impact the consumer?
Here’s how the current tariffs on goods coming into the US from China work: taxes are applied on goods coming in, and American importers are the ones responsible for paying them. Some absorb the cost; most pass them onto the consumer.
"If the U.S. imposes a tariff on Chinese televisions, the duty is paid to U.S. Customs and Border Protection at the border by a U.S. broker representing a U.S. importer — say, Costco," Howard Gleckman, a senior fellow at the Urban Institute-Brookings Institution Tax Policy Center, wrote in September. "The Chinese government pays nothing."
"When tariffs are levied at 10 percent, many firms choose to absorb the cost in their margins," said Monica de Bolle, a senior fellow at the Peterson Institute for International Economics. This can be done by settling for lower profit margins or cutting costs in some fashion.
"However, with tariffs now scaled up to 25 percent, firms will inevitably pass on some or all of the increase to U.S. consumers," de Bolle said. "That means that U.S. consumers could in some cases pay 25 percent more for a given good than they did before."
“Our results imply that the tariff revenue the U.S. is now collecting is insufficient to compensate the losses being born by the consumers of imports,” a study published in March by economists from the Federal Reserve Bank of New York, Princeton University and Columbia University concluded.
In summary, economic experts agree that trade wars are not “easy to win” and in fact they are difficult and costly for all countries involved and their citizens. There are no winners only losers in a trade war. The markets understand this so expect a period of increased volatility until the trade dispute between the United States and China is resolved.
This content is developed from sources believed to be providing accurate information, and provided by Attune Financial Planning. Please consult your financial, legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information only.