United States: Risks of a trade war heighten as White House escalates rhetoric against China, while main trading partners retaliate on tariffs
The Trump administration’s imposition of tariffs, including on political allies, has led the global trade environment to rapidly deteriorate in recent weeks. While the first retaliatory measures from key trading partners, such as Mexico and the EU, took effect in June, more are yet to come, with levies on Chinese imports and retaliation from China and Canada coming into force in early July. Although these measures are expected to have too modest of an impact to derail the otherwise stellar U.S. outlook for now, downside risks materially increased when President Trump dramatically ramped up tensions with China in the past few weeks. While reciprocal tariffs against the EU, Japan and NAFTA partners do not look set to escalate at this stage—despite talks of restrictions on imports of cars and parts— the dispute with China could rapidly ramp up to a full-blown trade war.
On 19 June, President Trump announced he directed the United States Trade Representative (USTR) to identify another USD 200 billion of goods to be targeted with 10% duties, which could take effect unless China backs down from retaliating to the initial US tariffs on USD 50 billion of imports. The president added that, were the Chinese tempted to retaliate to this second round, there would be a third wave of measures equal to the preceding one, affecting in total USD 450 billion, or close to 90% of China’s U.S. exports in 2017 (USD 505 billion). Finally, the U.S. administration is set to unveil a new set of measures aimed at curbing Chinese investments in industrially significant American technology on 30 June.
U.S. tariffs on steel and aluminum took effect for most countries, including China and Japan, on 23 March, while they started applying to Canada, Mexico and the EU on 1 June. The Trump administration also targeted USD 50 billion of Chinese imports to be taxed at 25% in response to what it described as unfair trade practices and intellectual property theft from China. Tariffs on USD 34 billion will be enforced as of 6 July, with the remainder taking effect at a later date. Trade partners have retaliated with WTO complaints as well as tariffs of their own. Mexico imposed duties on USD 3 billion of imports on 6 June, followed by 25% tariffs from the EU on EUR 2.8 billion (USD 3.3 billion) on 22 June. Nevertheless, the brunt of the payback is yet to come: Canada’s duties on USD 12.8 billion will take effect on 1 July, while China will respond tit-for-tat and enforce 25% tariffs on USD 34 billion of imports starting 6 July.
Technology has long been a key point of tension in the U.S.-China trade dispute. As noted by ING analysts, “the US trade disagreement with China not only reflects a desire to reduce the trade deficit, but also concerns about the rise of China and the perceived threat its ‘Made in China 2025’ policy could spell for the U.S. high-tech industry”. Furthermore, concerns over industrial policy overlap with national security imperatives, as the U.S. aims to prevent China from accessing technologies critical to American military hegemony.
While China has been swift to retaliate so far, it only imported USD 130 billion of U.S. goods in 2017, meaning it will not be able to pursue its tit-for-tat strategy if President Trump’s new threats become reality. However, China still has plenty of options it could use to counterattack. It could notably target U.S. firms and their investments in China, prop up competitors or intentionally disrupt U.S. supply chains. For instance, slowing administrative processes or the movements of goods entering Chinese ports could be an effective tactic, as could be calls for consumer boycotts of American products.
Nevertheless, China’s ongoing growth slowdown, which appears to have worsened in Q2, could prove to be a boon to Trump, as Xi Jinping will likely be concerned about provoking a hard landing if he escalates tensions too far. Furthermore, Xi’s posturing as a champion of free trade means he is more likely to keep China’s response proportionate. According to the Council on Foreign Relations’ Edward Alden, “China still has an interest in trying to be seen here as playing by the rules. Proportional responses make it easier for you to argue that you have been operating within the spirit of World Trade Organization rules.”
Regarding Western partners, retaliatory tariffs have been specifically targeting “Trump country” exports such as bourbon and soybeans to maximize political pressure on congressional Republicans. The strategy could prove useful to Mexico and Canada during NAFTA renegotiations; however, these discussions are likely to be on hold for several months due to the upcoming Mexican elections in July and the U.S. midterms in November. A “NoFTA” scenario now also appears more likely. Economists at JPMorgan believe that “withdrawal risk on the part of the U.S. has materially increased given retaliation by Mexico and Canada on the U.S. steel and aluminum tariffs. Mexico and Canada remain committed to the trilateral NAFTA framework, but U.S. negotiators have hinted at bilateral negotiations”.
All in all, the economic impact stemming from the current round of tariffs should be modest. Goldman Sachs analysts estimated it could shave off up to 0.15 points of U.S. GDP growth this year, while economists at Nomura concluded the effect on inflation would be negligible. However, the most pressing risk is a potential spiraling of tensions with China. The simple prospect of an all-out trade war between the world’s two biggest economies could impact business confidence and investments more forcefully than the tariffs enacted so far and will most likely be a driver of equity markets volatility in coming months. An escalation could also dampen the pace of the policy rate hikes, as the Fed in June seemed more concerned with downside risks to growth stemming from trade tensions rather than higher inflation.