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Jun 4, 201912:39 PMOpen Mic

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Trade war or Game of Thrones?

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If you aren't a GoT fan, then skip to the next paragraph. If you are, then you can appreciate how the current trade situation between China and the U.S. has all the drama of GoT. It’s a bit like Daenerys Targaryen and Cersei Lannister trying to out-scheme one another, with the prize being the Iron Throne of the Seven Kingdoms. The Trump administration’s chief negotiators, Treasury Secretary Steve Mnuchin and trade negotiator Robert Lighthizer, resemble Tyrion Lannister and Lord Varys. Despite playing for the same team, they seem to want different outcomes.

Trade situation

Over the last two years, the Trump administration has targeted China’s trade deficit as one of its major foreign policy initiatives. And why not? China makes up more than two thirds of the U.S. trade deficit. (For those who’ve forgotten their Econ 101 class, a deficit detracts from economic growth). In 2018, the U.S. trade deficit for goods and services was $621 billion, up almost 13 percent over the prior year; $419.2 billion of that was a result of the imbalance in Chinese trade. The policy of levying tariffs on goods that are imported from China raises the cost of Chinese goods by the amount of the tariff. The thought goes that because those goods affected by tariffs are more expensive, U.S. consumers will buy less and thereby reduce the deficit. Alternatively, the administration seems to hope that some of those goods made in China will be made in the U.S., and that, too, would reduce the deficit.

This, however, belies the idea that we live in a world with a global supply chain and companies are most interested in making things closest to their customers. We already see some manufacturing returning to the U.S., and much of this is a result of the need to reduce time between steps in the supply chain.

In addition to wanting to reduce the deficit, the administration admirably wants to open the Chinese market further to U.S. companies and also reduce the amount of intellectual property taken from U.S. companies whose goods are copied in China without remuneration.

Tariffs

As trade negotiations appeared to be faltering a couple weeks ago, the administration announced an increase in tariffs on $200 billion in goods and services with the potential to add tariffs to another $360 billion. This was seen as a sign by investors that negotiations weren’t likely to produce a favorable result any time soon. As a result, stock prices have declined by over 5 percent from their recent all-time highs. (We must keep in mind that this decline in stock prices follows a rally of more than 16 percent since the beginning of 2019.)

Tariffs detract from economic growth. As you can see from the chart below, as the U.S. government levies tariffs, they will have a negative impact, albeit relatively benign.

 

For their part, the Chinese responded with an increase in tariffs on $60 billion in goods and services. You might wonder why such a relatively small response? Well, that’s the inherent problem the Chinese have: Because their deficit with the U.S. is so large, the implication is that they don’t import much from us, leaving them little room for similar retaliatory methods. However, both countries have other tools in the trade dispute toolbox.

(Continued)

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