The trade wars have moved from political rhetoric to actual law, affecting global trade flows between the world’s largest economies. For the US, the biggest burden may be a rise in inflation, potentially forcing the US Federal Reserve (Fed) to quicken its pace for further interest rate hikes.
Trump’s aggressive stance on trade has put the Fed in an awkward situation, where it is forced to raise interest rates to match increasing consumer inflation. We project two more interest rate hikes in 2018 and three in 2019, but the additional tariffs may increase the number of hikes in 2019. Besides consumers, higher interest rates and rising input costs may also induce US companies to deleverage and reduce their capital expenditures.
Should the announced US tariffs be matched by all the affected countries, the new tariffs could reach US$1.377 trillion, or roughly 1.71% of global GDP and 8.78% of global trade. However, only US$109 billion of US tariffs are already implemented or likely to be implemented this year.
Tariffs on Chinese products have been met by retaliatory tariffs on US products. The US tariff list has targeted high-value-added products, effectively mirroring China’s Manufacturing 2025 list of development priorities. The Chinese list has focused on US agriculture, energy, chemical and medical products.
Products affected by US-Chinese tariffs
| First tranche of USD34bn US tariffs: Engines and Motors Construction Machinery Inorganic chemicals, metals, radioactive elements Telecommunication Devices and Parts Machinery, boilers, nuclear reactors Electrical Equipment Agricultural Machinery Transportation Equipment (land, water, air, space) Medical Equipment and Precision Instruments | First tranche of USD34bn China tariffs: Meat Products Aquatic Products Vegetables & Fruits Soybean Other Agriculture Products Processed Food Beverages & Tobacco Passenger Cars |
| Second tranche of USD16bn US tariffs: Petroleum Products Lubricating Oils Chemical Materials and Products Metal Construction Materials Agricultural Machinery Semiconductors Transportation Equipment | Second tranche of USD16bn China tariffs: Coal Petroleum Products Chemicals Medical Equipment |
Macro impact
For the US, the tariffs may not achieve Trump’s stated goal of narrowing the country’s trade deficit, as the combination of a stronger dollar and retaliatory tariffs may dampen exports.
China’s GDP may be harder hit than the US, however, as its economy is still heavily dependent on exports. If Trump implements all announced tariffs, the drag on China’s GDP growth could reach as high as 0.36%. US GDP growth is only estimated to reduce by 0.11% from the 2.8% projection for 2018, as reported in the Fed’s June FOMC minutes.
For the Chinese government, the easy answer would be to devalue the currency, but they will try to avoid a significant collapse in the value of the yuan, given Beijing’s recent experience trying to stem capital outflows after the last major devaluation in 2015. The Chinese government is more likely to strengthen the economy on the margins, as seen in the lowering of reserve requirement ratios for banks, which encourages domestic lending. If Trump increases tariffs beyond the amount that China actually imports from the US, China will not have an equal amount of US imported goods to punish with retaliatory tariffs. This may lead Beijing to consider fiscal stimulus.
Inflating risk
The biggest challenge to the US remains increasing inflation on the supply side.
Assuming US consumer prices increase as tariff are passed through to end consumers, the current tariffs, combined with the US$50 billion in tariffs on China may increase the US consumer inflation by about 15bps. If all the announced tariffs are implemented, the rise in core inflation, which excludes crude oil, may be as large as 78bps by the time the full extent of the price increases reaches end consumers. However, prices are sticky, meaning it will take more than a year for US businesses to pass their price increases on to consumers.
As prices increase for businesses and then consumers, the burden of tariffs will also affect labor markets in both the US and China, however, Chinese workers will suffer more than their US counterparts. FinEX Asia research estimates tariff-related job losses in the US at 690,000 if all announced tariffs are implemented. For Chinese workers, our estimation is 1,550,000 jobs will be affected if all tariffs announced implemented.
The growing trade war appears to still be in its early stages, but the ramifications are already taking shape. As Trump does battle with leaders across the globe, including the EU and neighbors Canada and Mexico, the impact may be felt much closer to home.
