Wall Street Journal: Why the U.S. Could Suffer Deeper Economic Shock Than China in a Trade War

Doug Sachtleben - February 15th, 2017

From the Wall Street Journal, 2/13/2017

 

Retaliation could cause inflation to surge and cut demand for U.S. goods

A lot of economists aren’t factoring a U.S.-China trade war into their central forecast scenarios, counting on the Trump administration to curb its sharpest protectionist tendencies.

But what if it doesn’t?

“Bad for the world, worse for the U.S.,” says Nicholas Fawcett, a senior global economist with Goldman Sachs. “Trade is not a zero-sum game; by curbing imports, the U.S. could lose out in the long run.”

Mr. Fawcett figures a 45% tariff on Chinese imports and 35% fees on goods from Mexico translate into an effective tariff rate of around 11%, given their share of total U.S. trade.  Assuming Beijing and Mexico City retaliate with equivalent tariffs, he estimates it could depress U.S. gross domestic product by 0.7 percentage point by 2019. That’s more than twice the hit on China’s growth, at 0.3 percentage point. Roughly 21% of the value of U.S. imports are from China, more than double that of China’s imports from the U.S.

The most immediate impact would be a surge in prices for American consumers, given that around 10% of the basket of prices that comprise the inflation index is imported. The U.S. imports roughly three-quarters of its toys, shoes, computers and telecoms equipment from China and other Asian emerging markets.

The higher costs for U.S. goods abroad would also sink demand for American exports.

“In fact, tariffs would likely hit U.S. GDP so sharply that the Federal Reserve would be prompted to reduce interest rates to cushion the blow—despite an increase in inflation,” Mr. Fawcett says in a Goldman Sachs research report.

Ian Tomb, a macro strategist with Goldman, says either a surge in input costs for U.S. production or falling demand “could prompt globally connected firms to reduce wages and cut workers.”

That’s why among the losers will be some of his most ardent supporters: blue-collar workers who helped sweep him to election victory.

The fallout would spread to other countries, including Europe and Japan, as U.S. demand for international goods slumped. U.S. allies with strong trade relationships with China such as Korea would get hit from both sides of the shock. And with the Fed cutting rates and the dollar subsequently weakening, the yen and the euro would appreciate, adding to their woes.

The potential danger of a trade war is why the International Monetary Fund and others aren’t including a tit-for-tat tariff brawl in their projections. (Here’s why the IMF is worried about rising protectionism globally.)

But, warns the Institute of International Finance, “The likelihood of harsher trade initiatives should not be underestimated.”