Trade wars are messy and not easy

J.P. Szafranski, BridgeTower Media Newswires

“When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good and easy to win.”
– President Donald J. Trump, March 2, 2018

At the time of President Trump’s memorable tweet, we collectively wondered whether we were actually headed for a trade war. Four and a half months later, the answer is an unequivocal “yes.” How big of a deal might this be?

Let’s parse the president’s above point of view on trade. Interestingly, when we compare the trade deficit of the United States to the total size of its economy, the trade deficit has fallen nearly in half from a peak of 5.4 percent in 2006 to just 2.8 percent in 2017, according to data from the Census Bureau and St. Louis Fed. While the deficit is in fact “many billions” it is not at a truly worrisome level relative to a roughly $20 trillion economy.

Are trade wars “good”? It is undoubtedly in the interest of the United States to increase its exports relative to imports. Lower trade deficits equate to higher national economic output (by definition) and lesser accumulation of debt, both obvious positives. We also subscribe to the commonly held belief that China’s government industrial and trade policies are mercantilist and predatory to its trading partners. To the extent the current administration ultimately negotiates better terms with China and others, we would welcome it.

Are trade wars “easy to win”? If only it were as easy as saying because our country buys more stuff from your country than the other way around, we can unilaterally demand better trade terms overnight and receive them. In reality, in order to achieve Trump’s strategic objective of lower trade deficits, the administration’s tactic of choice, implementing new tariffs on trading partners who we view as unfair traders inevitably incites retaliatory tariffs in response.

For example, with the July 6 implementation of U.S. tariffs on $34 billion in Chinese imports, China immediately responded with tariffs on U.S. goods in the same amount. An additional $16 billion in U.S. tariffs on China goods are set to go into effect sometime this month. At that time, China will almost certainly reply in kind. It’s difficult to predict how and when this tit-for-tat cycle of trade aggression will ultimately subside.

While we wait and watch things play out, U.S. consumers and businesses face higher costs from our new tariffs and certain export-heavy domestic sectors, like agriculture, already face significant new stresses on profitability from China’s retaliation. Tariffs are a form of taxation. Commerce becomes less efficient and costlier.

We’ll be watching second order impacts that could ultimately be of a much greater magnitude upon financial markets than any first order contraction in global trade. For example, how will a trade war impact the Federal Reserve’s plan for monetary policy? Will tariff uncertainty cause a retrenchment in corporate investment? How will certain trade-dependent emerging market economies weather the storm?

Truly free and fair international trade improves everyone’s standard of living. Trade wars might be “good” if they ultimately result in freer and fairer trade, but are certainly not “easy to win.”

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J.P. Szafranski is CEO of Meliora Capital in Tulsa (www.melcapital.com).