Markets have been roiled by President Trump’s threat to impose tariffs on Chinese imports. The announcement was heavily flagged in the media leading up to the announcement, and we have also highlighted the risks of such a move (see here, here and here). However, while the risks of an escalating ‘tit for tat’ trade war have increased, we would caution against viewing this as a base case scenario, for the following reasons.180323-Global-Trade-Watch.pdf (214 KB)
First, the imposition of tariffs remains by no means certain. The US Trade Representative (USTR) has been instructed to propose a list of products with any intended tariff increases within fifteen days (see the official presidential memorandum here). Then, there is an undefined ‘period of notice and comment’ and ‘consultation with appropriate agencies and committees’ before tariffs are actually implemented. USTR has been instructed to update the President on any progress made within sixty days. This provides ample wiggle room for China to offer concessions to placate the US and potentially to avoid an imposition of tariffs altogether, or at least a mitigated version.
Second, the threat of tariffs looks much more like a negotiating tactic to get China to open its economy to US products, services and investment, rather than a serious attempt at protecting US industry from competition. President Trump has suggested that China come up with proposals to reduce its trade deficit with the US by USD100bn. We know that Chinese trade representatives have been engaged in talks in Washington for a while, and likely have a number of ‘carrots’ they can offer the US to prevent tariffs. In their economic plans for 2018, China had already offered the opening of certain strategic sectors (such as financial services) to foreign firms, following talks between Trump and Xi Jinping in Florida and Beijing last year. The watering down of steel and aluminium tariffs – which now exclude the biggest exporters of steel to the US – corroborate the idea that the threat of tariffs is more a negotiating tactic for the US.
Third, the US administration is likely not as protectionist as it appears. While the departure of Gary Cohn as Director of the President’s National Economic Council was viewed by markets as a significant setback for the pro-free trade camp in the administration, we note that the President’s replacement for Cohn – Larry Kudlow – is also an outspoken advocate of free trade. While he has towed the President’s combative line on China, just a week before being appointed Director of the NEC on 15 March, he wrote a column for CNBC arguing vociferously against the use of tariffs, calling them tax hikes on consumers (see here). We know, then, that instinctively Kudlow is against the use of tariffs, and we suspect his influence may be stronger on the President than that of Cohn’s was, given his longstanding support prior to the election (Kudlow was an economic advisor to the Trump campaign).
Finally, in our view China would act to reduce the risk of a trade war occurring. It has reacted in a targeted and moderate way so far, by proposing reciprocal tariffs on around USD3bn of US imports (128 products including pork, fruit, wine and recycled aluminum). We expect China to do its utmost to prevent a real escalation, by remaining contained in retaliation and offering sweeteners to the US in return. For instance, by offering improved access for US firms to strategic sectors and measures helping to reduce the politically sensitive large bilateral deficit of the US with China.
Conclusion: Experience suggests the bark can be worse than the bite. As the experience with the steel and aluminium tariffs has shown, what is initially annound or threatened is not necessarily the policy that is implemented. The initial response by the US’s trade partners to those tariffs was a mixture of alarm and consternation, with the EU in particular proposing its own extensive list of counter tariffs. The administration has now exempted the biggest exporters of steel and aluminium to the US, including the NAFTA countries, the EU, South Korea, and other major global exporters. While the risks of an escalating trade war with China are real, we continue to think the more likely outcome will be one where the US and China come to a negotiated settlement.