Has President Trump just started a global trade war?

Principal Economist’s View

 

Economists often disagree. But one thing that is almost universally accepted is that trade protectionism is harmful. President Trump, however, clearly takes the opposite view. His decision this week to impose a 25% tariff on steel imports and a 10% tariff on aluminium imports runs counter to the shift towards free-trade underway since the mid-20th century. The ramifications of Trump’s decision, while still uncertain, have the potential to dramatically shift the economic landscape.

 

Around the US election in 2016, we highlighted our concerns around the economic damage that could result if President Trump imposed protectionist policies. Our assessment of his campaign proposals to slug a 45% tariff on imports from China and a 35% tariff on imports from Mexico were dire; a hit to US real GDP of around 2 percentage points. While the protectionist threat receded in 2017 as Trump backed away from his campaign proposals, we remained concerned of a shift towards protectionism that was operating under the radar (see here for our comments from a speech delivered to the Conexus Fixed Income, Cash and Currency Forum in July 2017).

The reasons to be concerned are simple. First, Trump has decided to protect the steel and aluminium industries due to national security concerns. This is in stark contrast to the usual process where companies, industry associations or workers petition the government to determine whether a tariff or quota should be applied due to the existence of foreign subsidies or dumping (i.e. where goods are sold in the US below their fair-value).  Initiating the investigations himself and appealing to national security grounds, particularly when so little of the goods are used for defence, undermines the existing rules-based system. This section has only been enforced twice since 1980, with the last in 1986. Foreign countries are likely to seek to appeal at the WTO and retaliate with their own protectionist policies. The EU have already suggested 25% tariffs on about $3.5b worth of US imports, including on bourbon, Harley Davidsons, Levi jeans, cosmetics and agricultural products.

 

Although the move by Trump is alarming, he seems to have backed down slightly after pressure from Republican leaders and the resignation of the White House National Economic Council head Gary Cohn. Trump agreed to exclude Canada and Mexico from being subject to the tariffs, given their position as regional allies and to not to derail the NAFTA renegotiations currently underway. This has opened the door for other US allies, including Australia, to lobby the US to also be excluded. However, time is short for any deal to be reached, with the tariffs scheduled to come into force in 15 days.       

 

In our view, the direct damage from the tariffs currently announced is likely to be modest from a macroeconomic perspective. President Bush imposed steel tariffs of 8%-30% in 2002 and the various studies on these policies suggested a hit to real GDP of between $30 million to $1.4 billion, or between 0 to 0.1%. These figures are very similar to simulations that we have run in a global trade model GTAP, which suggests that the steel and aluminium tariffs imposed by Trump would wipe off approximately 0.1% of US GDP and raise consumer prices by around 0.1%.

 

However, just looking at these aggregate numbers masks some of the likely damage. For instance, the tariffs lead to a significant increase in domestic steel and aluminium prices, hurting domestic US metal consumers, such as auto manufacturers. If these metal-consuming industries start to come under pressure, will Trump consider further protection for the manufacturing and auto sectors? You’d think so given some of his rhetoric. Furthermore, the tariffs are expected to have little impact on China given that existing measures have already curtailed imports of steel from China in recent years. With China less impacted, will Trump consider further tariffs to target China?

 

To be clear, our concern around Trump’s protectionism stance is not the economic impact of the tariffs announced this week. Rather, our concern is that Trump’s decision opens a can of worms that potentially leads to a downward spiral and an eventual global trade war. In our portfolio modelling, we frequently stress-test alternative scenarios. One such scenario, is where this protectionist tit-for-tat plays out and leads to 10% tariffs across the board from the US, with retaliation by its trading partners. Under this scenario, the US would fall into recession and the level of real GDP would be around 6% below our baseline forecast by the end of 2020. In other words, real GDP growth would average just under 1% over the next four years, rather than our baseline view of 2.3%. Inflation would surge in the US, reaching 4% in 2019, as the higher import prices feed through the economy. Despite the weaker longer-term outlook, the US Federal Reserve would be forced to raise interest rates more quickly to keep inflation expectations anchored and bond yields would rise by around 25bps. In such a world, equities would fall sharply, dropping by at least 20%.

 

No one stands to benefit from a global trade war. For the sake of the global outlook, let’s hope that President Trump listens to the economics profession. Otherwise, the stock market that Trump likes to benchmark his performance on is likely to fall below the level that existed when he entered the White House.     

 

Table 1: Financial market movements, 1 – 8 March 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,739.0

2.3%

US

2.86%

4.9 bps

US Dollar Index (DXY)

90.18

-0.2%

Nikkei 225

21,368.1

-1.6%

Japan

0.05%

1.1 bps

USD-JPY

106.23

0.0%

FTSE 100

7,203.2

0.4%

UK

1.47%

0.7 bps

GBP-USD

1.381

0.3%

DAX

12,355.6

1.4%

Germany

0.63%

-1.6 bps

EUR-USD

1.231

0.4%

S&P/ASX 200

5,942.9

-0.5%

Australia

2.81%

5.4 bps

AUD-USD

0.779

0.4%

Source: Bloomberg

 

To read the full report, including the Economic update by region, click here. 

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