Top Trumps

Six months have now passed since President Donald Trump launched his first salvo in an attempt to reduce America’s growing trade deficit as illustrated in the chart below. We know that each new tariff announcement is designed to up the ante. By design it is part of a much larger plan to tackle what Trump perceives as the unfair competition US firms face abroad.

Trade Deficit

Source: Bloomberg, data as of July 2018

Thus far, there have been ‘tit-for-tat’ exchanges between the US and China, and more recently between the US and Europe. This is a typical, disruptive tactic in Trump’s mission to achieve more favourable terms for America.

This week, US Trade Representatives announced further tariffs of 10% on $200bn of Chinese products. How China will respond is not yet known. The obvious retaliation would be to implement further tariffs on goods imported from the US (they matched duties on $34bn of goods imposed by the US last week). However, China will struggle to match the new increased tariffs slapped on it this week. Its imports from the US last year only amounted to $154Bn! This is deliberately provocative.

What tactics can China play?

A blanket tariff on all goods imported from the US; this would be a bold move as they cannot source some of the goods elsewhere.

Non-tariffs retaliation:

• Make it more difficult for US companies to do business in China
• Currency management, targeting a weaker Renminbi to make Chinese exports cheaper
• Foreign Exchange reserve mix – hold fewer US Dollars
• Use alternative currencies such as Euros and Sterling to trade at the expense of US Dollars

Predicting the next strategic steps of this trade tariff debacle is not easy. We know further escalation will begin to have greater ramifications both economically and politically. Meanwhile, the trade tariffs have failed to materially disrupt economies, but if Trump puts forward another $500bn of tariffs, as he has alluded to, this could be problematic for economies. It may begin to weigh even more heavily on stock market performance and consumer sentiment.

The lessons from history around imposing high tariffs is that while they lower the incentive for imports (a benefit for the US domestic economy given its net-import status) they also push up costs. If this pushes down on growth we end up with an economic scenario referred to as stagflation.

Many say that if further tariffs end up wiping out the benefits the US is enjoying from the recent fiscal stimulus then Trump’s tactics will have failed. However, the US economy does at least have this stimulus effect to cushion them. It appears that no one really knows if the tax cuts occurring along-side the decision to start a trade war is inspired genius or just coincidental. Whatever the real intent it is certainly helpful to Trump to have a stimulus effect in place right now as these negotiations continue.

Whilst Trump has primarily been targeting China, America’s largest trading partner, he has also had one eye on Europe. After tariffs were placed on imports of European steel and aluminium into the US, Europe’s strategic response was not only to place tariffs on US consumer goods but to target those which have a strong symbolic, political impact.

Tariffs were placed on Harley-Davidson motorcycles and cranberries which are produced in Wisconsin (the state of Paul Ryan, speaker of the House of Representatives) and on Bourbon whiskey produced in Kentucky, home of the Senate Majority leader Mitch McConnell. This targeting of specific goods produced in politically sensitive constituencies is a tactic that may also appeal to China. It is a particularly smart political counter move as the US begins its run-up to mid-term elections in November. With international trade secretaries taking a very strategic approach to negotiations, the current “tit for tat” exchanges are beginning to resemble less a game of Top Trumps, than one of Grandmaster chess.

One thing is sure, we should expect more headlines as Trump struts the international stage culminating in a meeting with Russian President Vladimir Putin on Monday.