Just How Bad Could the U.S./China Tariff War Get?
As more and more shots get fired in the trade war between the U.S. and China, many are now wondering just how bad this might become if things just keep getting worse.
The stakes just keep getting bigger and bigger in the trade war between the United States and China. The goal presumably is to reach an agreement at some point, and we have been waiting for quite some time for the two sides to put their pens to paper and shake hands, but things don’t look all that great right now whether or not new talks are held soon.
President Trump announced on Monday that the Chinese had called Washington and are eager to resume the talks, even though the Chinese deny this. Stock markets are so desperate for good news that they ended up taking this and running with it to the tune of a more than 1% gain Monday.
This might seem to be premature and presumptive, and it actually may very likely be, but the point of this rally isn’t so much that the Chinese are willing to talk as Trump is, and after Trump’s remarks last Friday, this is indeed a step in the right direction.
Trump not only used words to attack China on Friday, he also raised the bet 5% across the board, where the former 10% tariff has now become 15% and the new 25% one has grown to 30%.
This was all in response to China announcing further tariffs on $75 billion worth of U.S. imports on Friday, which was in response to Trump’s new 25% tariffs beginning September 1. With Trump raising his bet, we may reasonably expect China to raise theirs again, which will certainly cause President Trump to at least want to raise his again, and so on.
We may rightfully wonder where this will all end, and while a truce would do it, we seem to be getting further and further away from this as time goes on, not closer. As the tariffs rise on both sides, the impact of them will as well.
Thus far, the impact of this war has been fairly minor, but as the stakes keep getting raised, this all becomes at least a theoretical threat and one that may be significant enough to need to be reckoned with.
This has caused some people who were already concerned with the possibility or even the probability of a recession coming even more anxious and worried, and whether or not these worries are merited, we do need to vet them to at least have a better idea of what the threats are here so that we may adequately prepare if needed.
It’s the Americans that Need to be Careful Here
The political repercussions on the Chinese side are likely pretty minimal, as while people do take to the streets over there in protest, this isn’t an issue that is all that big on the radar on that front. The party in China doesn’t have to worry about being voted out like the American side does, and they are also well prepared to deal with whatever unrest emerges, by force if necessary, as we have seen in the past.
The Chinese response has been more measured though, and they generally have been escalating the battle in a much more token way than the Americans have, more to make a statement than anything. They slap the table while Trump pounds it with both fists and keeps his fists ready to do it again, and doesn’t always require provocation either.
We did see Trump wisely back off on some of these new tariffs, ones that are more likely to incite the public, and demonstrations in the U.S. are mostly performed at the ballot box. Just about anyone but Trump sees all this as bad for his political survival, but even he seems to know that there is a line out there that crossing would be an even worse idea.
The word is out that a lot of things will cost Americans more if changes weren’t made, and this takes the issue beyond the realm of boasting and exposes the sharp teeth of the battle, and these teeth cannot bite Americans too hard or they will turn on their president even more. This cannot be Trump’s goal.
Edward Moya of OANDA sees the upper limit of U.S. tariffs on China as 40-48%. Moya does believe that this is unlikely but possible, and sees this causing a recession in the U.S. if we end up going that far and also needing to wait for a new president to see this all resolved.
It isn’t made clear how even tariffs this high could cause a recession, and a lot of talk about recessions do not really involve much of an examination of how this is all supposed to happen. The fact that so many people are worried about one now when it’s hard to imagine our being anywhere close to one now perhaps forms the baseline for this, but the baseline has to be accurate for us to add things like this to it and come up with adequate conclusions.
We do know that tariffs do constrict the economy because they take money out of the system, in other words they constrict our money supply. This can be compensated for to some degree by central banks though, as they can and will use expansionary tactics such as rate cuts or even buying treasuries to keep us well away from the kind of contraction that will drive growth so low to cause a recession or anything even close to that.
We do need to realize that the economy is performing marvelously by any meaningful measure, which does not include nonsense such as worries about rate inversions and the like. We are a very long way from a recession if we actually look at the numbers and not just rely on superstition or fear to guide us.
We also know that a 25% tariff across the board won’t have a meaningful impact upon the U.S. economy, even without the Fed counterbalancing this, because the numbers here are just too small to matter very much. Doubling this would double the impact but it would be doubling a number not really that worthy of concern, leaving one that is of more concern but not anywhere near as much as it would need to be to cause a recession.
The reason why we know this is if we take the impact upon GDP of even huge tariffs like this and subtract it from current GDP growth, we still are well above water. Even if we went from 2% to 1%, which isn’t even a foreseeable outcome of this battle, we’re still way ahead of zero.
The side that is not worried is the one that has looked at the numbers and have come away not very concerned, while the bigger camp that is worried seem to be relying on fear alone, or they at least haven’t managed to justify them properly.
Moya, for instance, tells us that if the situation escalates to his upper limit, “the risks go up tremendously and a recession would be likely.” How this would make a recession likely or even possible isn’t shared though, and we’re left with one man’s opinion without anything to really support it.
We Need to Consider How Much This Will Really Impact the Economy
Morgan Stanley chief economist Chetan Ahya has even stronger views, and believes that “if the U.S. raises tariffs on all imports to China to 25% and China makes a matching response, with these measures staying in place for four to six months, we believe the global economy will be in a recession in 6 to 9 months.”
That’s even a lower threshold perhaps then Moya has set, and we’re not really that far away from this on the U.S. side, although China hasn’t been keeping up. If Ahya is right about this, just foretelling this without attempting to convince us just isn’t very convincing.
We know that this would mean that all imports from China would cost 25% more, and this would lead to a lot of money indeed being taken off the table, from the pockets of Americans into the U.S. treasury. This is a big tax indeed, and we know what economic harm taxes can have, so should we be worried?
This does put downward pressure on growth of course because the extra 25% that was spent on these imports could have been spent on something else. It is not unreasonable to assume that almost all of it would be given these funds are earmarked for discretionary spending.
We can add money back in to cushion the blow, for instance by lowering rates and having us borrow more and spend more that way, and the main worry with all of this is this impeding expansionary action by the Fed due to the tariffs being inflationary. This is especially true given that the Fed has now set inflation as the benchmark for further cuts.
It’s been too low if anything in the aftermath of all the tariffs we’ve had already, and people simply do not spend that much money on Chinese goods for this to send inflation too much higher. There will be an increase though, but even at 25% across the board, it will be fairly modest.
As far as the Chinese side goes, just like we do not want to ever assume that these tariffs will stop people from buying Chinese goods, we don’t want to assume Chinese tariffs will stop their people from buying American goods.
There always is some of that, but this is not a matter of seeing sales to China drop 25% or anything close to that. Just like China has found their niche by selling cheap goods to China, the U.S. has their own niche with the advanced goods that they sell in China.
The net effect of this is more a matter of governments padding their coffers than anything, with the U.S. treasury skimming a percentage of sales of imports and the Chinese government doing the same.
Make no mistake, these things are bad for the economy overall. Just how bad they are is the matter at hand, and while in isolation they sure look like they are big monsters, but when you get close enough you can see that it is the way the light shines on them from afar that has them looking so large.
We’re probably getting close to the threshold now, as there is only so much pain you can inflict upon your own people and this is exactly what the bottom line is here on both sides. This is not unlike two parties being bloodthirsty and then just watching each other cut themselves.
We’ve already seen the blade sharpened a little bit too much on the American side, where it got dulled a bit before it was used, and the Chinese are even less willing to sharpen theirs too much, using lower numbers overall. Even a 25% across the board tariff is very unlikely because we already have seen the U.S. pull back on this idea, and the Chinese aren’t even close to this.
Given that the tariffs so far haven’t really touched us very much, especially with regard of this taking us toward a recession, even if they do end up going up quite a bit, there is still no convincing or even good reason to think that this will do us in, unless of course you already see us teetering on the edge.
We’re right in the middle of the table though and these things will push us a bit but there’s plenty of room to use.
You can bet though that a 25% tariff on all Chinese goods would do something, not a recession but a big tax that is bound to be transparent enough to really rile the people, and this is where the real limits of this tariff war lie.
Editor, MarketReview.com
Eric has a deep understanding of what moves prices and how we can predict them to take advantage. He also understands why so many traders fail and how they may help themselves.
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