U.S. President Donald Trump claims trade wars are easy to win. As the United States ratchets tariffs higher on the largest economies in the world, we are about to find out if he is right. History reveals that trade wars don’t end well, especially the tariff escalation that preceded the Great Depression in the early 1930s. There are so many moving parts and unintended consequences that it is virtually impossible to predict how things will unfold.
Already, though we are in the early stages of this particular fight, there have been some unexpected developments that could offset the President’s goal of lowering U.S. trade deficits. At the industry level, the effect of tariffs depends on a host of different factors including price sensitivity, productive capacity, and the amount of time it takes to ramp up production. Some industries will lose, but others could come out ahead, just as some countries will do well while others lose out.
The first development that could throw a wrench into President Trump’s plan is the U.S. dollar, which has been on a rocky road since the beginning of 2018. From early February until about the middle of March, the greenback slumped as tighter monetary conditions in the EU and elsewhere took some of the shine off the dollar. However, toward the middle of March it reversed course, and the weighted exchange value of the dollar appreciated by more than 6 per cent between early March and late June. While there are several factors behind that appreciation, including higher inflation and interest rates, investors frequently flock to the safety of the greenback during periods of uncertainty. This is somewhat ironic given that the United States is driving the escalation in tariffs.
Trade-war proponents believe tariffs will increase import prices and encourage consumers to purchase domestic products, which could lower the U.S. trade deficit and potentially create new American jobs. But an appreciating U.S. dollar lowers the cost of imports and threatens to offset the impact of higher tariffs on those imports, depending on how high the dollar rises.
Our view is that the dollar will eventually level off over the near term, as investors come to grips with the return of trillion-dollar fiscal deficits, but if trade tensions continue to rise, and investors ramp up their purchases of greenbacks, the increase in import prices linked to tariffs could be dampened even more.
It isn’t only currencies that have adjusted to higher tariffs. Canadian soybean farmers initially thought there could be opportunities in China, after Beijing implemented retaliatory tariffs on U.S. agriculture exports, including soybeans. The higher cost of American soybeans in China due to the tariffs could make Canadian soybean exports more competitive and potentially boost sales. This makes economic sense, but other developments could easily derail these plans. Since the Chinese government announced the tariff on U.S. soybeans in early June, the price of soybean futures has tumbled by 16 per cent to hit two-year lows, so the revenue for Canadian soybean farmers from increased sales in China could be offset by far lower prices.
At the industry level, the New York Times notes that the effect of tariffs gets even more complicated. Flat-screen TVs manufactured in China managed to evade the first round of U.S. tariffs, but likely won’t avoid them altogether as trade tensions escalate. Final assembly of these popular TVs takes place all over the world, including in China and Mexico. Some of the largest manufacturers of flat-screen TVs, like Sony and Samsung, may take steps to avoid the Chinese tariff by shifting some of their production to Mexico. This strategy could help manufacturers avoid the punitive tariff and spare American consumers from paying higher prices. However, such a strategy can only succeed if NAFTA remains in place to ensure that U.S. imports from Mexico remain duty-free.
This highlights the risks of the Trump administration’s strategy of battling trade partners on multiple fronts: When only one trading partner faces higher tariffs, firms can shift production to reduce the damage to their bottom lines. But with the U.S. raising tariffs on the world’s largest economies at the same time, corporations have less room to manoeuvre. In this case, American households could pay the price.
The Times also points out that some recreational-boat manufacturers in the U.S. will find it increasingly difficult to stay in business, due to the tariffs placed on Chinese imports. Many of the powerheads (electric motors that turn boat propellers) come from China, and it is difficult and costly to change suppliers because substitutes aren’t readily available. Profit margins in this industry are already paper-thin: Most manufacturers can’t absorb the 25 per cent tariff and must charge higher prices, but the demand for recreational motorboats is highly responsive to price changes. Consequently, a price hike could lead to tumbling sales and declining production.
The above examples illustrate that trade wars are incredibly complex and their outcomes difficult to predict. President Trump may win this war, because the United States is less reliant on trade compared with many of its trade partners. But it won’t be easy: There will be many losers, and at the end of the day the large U.S. trade deficit, which is at the heart of this dispute, will likely not change much.
Canadian Outlook with the Chief Economist: Unfair Trade
The Conference Board of Canada, August 15, 2018, at 2:00 p.m. EDT
Neil Irwin, Alexandra Stevenson, and Claire Ballentine, “Opportunities and Big Risks in Trade Clash,” The New York Times, June 24, 2018.