- In this piece, we try to dive into US trade policy from different angles, what it means for the economy and what to expect from here.
- We do not expect the recent developments to evolve into a full-blown trade war but measures to be taken in fairly narrow areas (small part of global trade). Hence, we expect the impact on US growth and inflation to be fairly limited.
- There is a risk that we are too optimistic and that there will be a bigger trade war, which would be negative for the global economy and global risk sentiment and would lift inflation by more than we expect.
- Trump’s formal decision is likely to be postponed until next week but the White House is signalling he is not backing down. Gary Cohns’s resignation supports this view. Trading partners unlikely to retaliate until formal decision has been made. Next step for Trump is likely measures targeted at China.
- In our risk scenario, we expect a weaker USD due to slower US growth and US isolation to dominate traditional USD support from lower global risk sentiment.
Trump shifting focus to trade
US President Donald Trump’s announcement that he intends to put a 25% tariff on steel and 10% on aluminium has increased the fears of a global trade war although this was widely expected. Trump has tweeted intensively on trade recently, saying ‘trade wars are good and easy to win’ and that the US has a large trade deficit ‘because of our very stupid trade deals and policies’ and threatened the EU that he would impose tariffs on cars from Europe (see tweet).
After Trump’s success in passing the tax reform and budget deal (and the Republicans’ inability to reform health care), we are not surprised Trump is moving his attention to trade policy, as ‘America First’ and protection of the US were key pledges during his election campaign. This is also in line with what Commerce Secretary William Ross hinted at in the autumn when he said that the administration would shift focus to trade policy after the tax reform. The promotion of Peter Navarro to assistant to the president for trade policy is another sign that focus has shifted to trade.
So far the tariffs are mainly symbolic, as imports of steel and aluminium only account for 2% of total imports of goods in the US and it remains our base case that this is not going to evolve into a full-blown global trade war, as it would hurt everyone economically. The impact on US growth and inflation should be limited also if trading partners are countering US tariffs. While protectionism is bad for global risk sentiment (lower yields and equities), we think the market impact will be limited in our base case. We still think it is likely that Trump will go further, targeting China explicitly, as the US’s largest trade deficit is with China (see chart to the right) but these measures are likely to be small in the bigger picture as well.
Republicans are pushing back on protectionism
Especially within the Republican Party, the establishment is pushing back on the protectionist agenda; most notably House Speaker Paul Ryan. Trump’s economic advisor Gary Cohn was also against protectionist measures, which he considered business-unfriendly, but he resigned yesterday. Many Republican politicians think Trump should target China and not US allies, see Financial Times and the discussions mean the formal decision has been postponed until next week, see NYTimes. The White House is signalling that Trump is not backing down.
Trump can implement the tariffs on steel and aluminium without Congressional support through Section 232 of the 1962 Trade Act based on ‘national security’ concerns. The US Congress may try to prevent this by passing a bill, but Trump can just veto the bill unless it is passed by a two-thirds supermajority in both the House of Representatives and the Senate, which might prove difficult.
It is important to note that Trump’s tariffs are going to be fundamentally different from the ones George W. Bush implemented in 2002. George W. Bush used a clausal (Section 201 of the Trade Act of 1974) stating that the President can impose tariffs on imported goods if they are threatening domestic industries. Trading partners filled a WTO complaint and won the case but it is unclear what the WTO will do now Trump may use the ‘national security’ exemption. The fear is this this opens up a Pandora’s Box, as other countries could easily use the same reason for protectionist measures, which might result in ‘the Wild West’ in the global trade area.
Another concern is that Trump may choose to withdraw the US from the WTO. He mentioned this during the election campaign when he called the WTO ‘a disaster’, see Financial Times. Trump’s administration could also just decide to ignore WTO rulings, something which has been put on the table before, see Reuters. It is interesting that the Trump administration continues to block appointment of new WTO judges to the Appellate Body (‘supreme court of world trade’), which has slowed down handling of trade disputes, see Reuters.
Trump thinks trade is a zero sum game
Trump thinks trade is a zero sum game and this is a view that Trump has repeated since the 80s (see e.g. interview with Oprah Winfrey from 1988 here (YouTube)). If the US is running a trade deficit with country A, A is winning and the US is losing. This is also why Trump is lashing out at countries like China, Mexico and Germany, who have a large trade surplus with the US (see chart on front page). We consider trade a positive sum game from a macroeconomic perspective but acknowledge that there might be winners and losers from a microeconomic perspective. In US media there are stories about manufacturers praising Trump, as they think NAFTA and China are to blame for the decline in manufacturing employment, see e.g. CNN Money. Total manufacturing employment has declined from around 18m 20 years ago to 12m now, not least in the ‘Rust Belt’ with states like Ohio, Pennsylvania and Michigan, all three important swing states that Trump won. In reality, there are likely other forces at play (e.g. automatisation), as manufacturing output has risen 150% since 1980 despite manufacturing employment having fallen 34% during the same period.
Trump’s pledges to protect US companies (‘America First’) and implement protectionist measures help to explain his victory and with a low approval rating it makes sense for Trump to try win back popularity by acting on it before the US midterm election in November (the Republican leaders disagree with this strategy).
Our base case is that Trump will stick to symbolic measures, as it would satisfy his voter base without starting an actual trade war. If we are right, this would not slow GDP growth or lift US inflation significantly. For example, 900kg of steel is used per vehicle on average, according to the World Steel Association, which cost approximately 588 dollars to buy. Assuming the tariffs increase the steel price by 25% (unlikely as car producers are likely to buy domestic-produced steel instead), the price would be 735 dollars instead, an increase of around 147 dollars. The average selling price of a new vehicle was 34,450 dollars in 2016, so steel input only accounts for 1.7% of the total selling price. The price of an average car including 25% higher steel costs would be 34,596 dollars, an increase of 0.4%. As a new vehicle only accounts for 3.8% of total CPI, it would lift CPI inflation by only 0.02 percentage point. Of course there are other items being hit as well (the price increases will likely come with a lag, as prices only change infrequently) but this back-of-the-envelope calculation shows that the tariffs proposed so far are not a game changer for US inflation.
China will be cautious in its response
China will not be hurt much by a steel tariff, as the US imports very little steel from China. However, China could choose to come with some countermeasures and, for example, put tariffs on grain imports from the US and it could also pull back from part or all of the USD250bn of trade deals it offered Trump during his visit in November last year. However, we believe China will be cautious as it is not interested in a big trade war. At the same time, though, it will show the US that protectionist measures will come at a cost. Clearly, China would also be disappointed by the tariffs, as it has done a lot over the past two years to reduce the overcapacity in the steel industry (the big dumping of Chinese steel took place in 2014-15 when the Chinese construction sector was in a huge downturn). As a result, steel prices have more than doubled over the past two years to the highest level since 2012. China announced two years ago that it would aim to cut steel capacity by 140m tonnes from 2016-2020, corresponding to 15% of total capacity. By 2017 it had cut 115m tonnes and had met 80% of the target set for 2020 already. At the ongoing National People’s Congress, Li Keqiang announced in his Work Report that China aims to cut steel capacity by another 30m tonnes in 2018. If implemented, the total amount of capacity cuts would actually reach 145m tonnes and exceed the target of total cuts by 2020. Hence, China has clearly stepped up measures to deal with the overcapacity problem.
Should the trade war escalate, China could hurt the US in the areas of soybeans and aircraft, which are the two biggest US export groups to China (see table on page 6). It is quite easy to substitute Boeing airplanes with Airbus. Soybeans can also be bought from other countries. That said, the trade flows between the US and China are large and it would hurt both economies if the situation escalates. We have dived further into the US-China trading relationship in the appendix on page 6.
Another possibility is that China will slow down US treasury purchases, as was talked about in January, see Flash Comment: US-China relations on a concern path – part 2, 11 January 2018. Back then it was likely a warning that China has the tools to hit back at protectionist measures from the US and now that the US seems to be on a more protectionist path, the probability of this happening has increased, although it is not our base case. US Treasury yields moved higher on the story.
US is investigating theft of Intellectual Property Rights
In an interesting story, Bloomberg writes the next step for the Trump administration is to target China by imposing tariffs on Chinese imports and limiting Chinese investments in US businesses. It is not surprising that Trump wants to target China, as the US runs the largest trade deficit with China and with the ongoing investigation of Chinese theft of intellectual property rights (initiated in August 2017). Still, it is noteworthy that the story is more concrete than we have seen before. For instance in the most severe scenario, the US could impose tariffs on imports of for instance Chinese-produced clothing and electronics, according to the story. Both account for a large share of US imports from China (see appendix page 6). On the investment sides, the US may limit or prohibit Chinese mergers and acquisitions of US companies based on ‘national security concerns’, especially for sectors, where US companies cannot access the Chinese market. The investigation on China is expected in the coming weeks. As with tariffs on steel and aluminium, we expect any measures taken against China to be small in magnitude, meaning this is more about politics than economics. There is a risk we are being too optimistic and that we are heading for a full-blown global trade war.
Trump has also started to use the Taiwan card, which angers China. Trump has just signed a law aiming to encourage official visits between the US and Taiwan, which a Chinese Foreign Ministry spokesman said ‘severely violated the one-China principle’, see China Daily. The Taiwan issue could add to provoking China into retaliation. So far, though, China has kept calm but given how sensitive the Taiwan issue is in China, it may add to China’s wish to strike back at the US in the trade area.
EU ‘can also do stupid’ but retaliation is of small magnitude
EU has signalled clearly it will retaliate to US tariffs and EU Commission President Jean-Claude Juncker has said the EU ‘can also do stupid’. According to Bloomberg, the EU is considering to implement tit-for-tat tariffs of 25% to USD3.5bn of US goods (corresponding to 1.2% of the total US goods exports of USD384bn to EU). Tariffs on Harley Davidson motorcycles and Kentucky Bourbon, produced in home states of leading Republicans, have been mentioned, which was how the EU responded to George W. Bush’s tariffs on steel in 2002, when the EU also targeted specific products in order to punish specific politicians.
The retaliation measures are unlikely to do much damage to the US economy (something US Commerce Secretary Ross has also touched upon) and are also symbolic. That said, a harder stance on trade policy fits well with French President Emmanuel Macron’s view on trade, as he is actually quite protectionist himself. Macron has on several occasions pushed for a tougher trade policy strategy, see e.g. Financial Times.
There are divergent opinions among the EU member states and we think it is noteworthy that the Danish finance minister in a tweet warned about EU retaliation, as it would hurt the EU economy and EU citizens. While Denmark is obviously a small EU country, it supports our view that the EU is unlikely to implement very tough measures against the US, as there is a risk that Trump would counter the EU’s move by increasing tariffs on European cars, for instance. The European economy is strong and while the acceleration phase is likely over, we expect growth to remain strong and the symbolic US tariffs do not alter this view.
NAFTA discussions on a concern path
Trump’s decision to impose tariffs on aluminium and steel imports is also important for the ongoing NAFTA negotiations, as Canada is one of the main exporters of steel to the US. While NAFTA has a ‘national security exemption’, both Canada and Mexico think Trump’s tariffs are misusing the exemption. The tariffs are likely making it more difficult to reach a compromise and Trump has tweeted the US needs concessions in order to exempt Canada and Mexico from tariffs on steel and aluminium. Trump wants better access to the Canadian market for US farmers and wants Mexico to do more to stop drugs passing the US-Mexico border. In this sense, it seems like Trump is following the same strategy as when he made NATO countries spend more on defence: making big threats in order to get concessions (‘mad man’ strategy).
The seventh round of the NAFTA negotiations ended a couple of days ago and at the moment the three countries have not announced dates for the eighth and final round. Progress in the negotiation is slow as only six chapters of the NAFTA agreement have been closed and there are still 24-27 to go. In addition, campaigns for the Mexican federal election are expected to begin soon, which may slow talks further. The Mexican election takes place on 1 July 2018 and the Mexican government fears that it will lose to left-wing nationalists, making it difficult for them to compromise.
If Trump wants to pull out of NAFTA, Congress may be able to prevent a total withdrawal since it ratified and implemented the agreement through legislation. The Congress can also pass new laws that give it greater authority over trade agreements. If Trump vetoed those laws, it could lead to a rupture with the Republican Party. Besides, the Congress could possibly form a veto proof majority by a two-thirds supermajority of both houses. If the US withdraws from NAFTA, the US and Mexico would return to WTO standards, while the US and Canada may resuscitate the previous US-Canada FTA. The US may seek bilateral deals with both countries instead.
US protectionism is dollar negative
As discussed in Strategy: Push for a weaker USD supported by flows, Trump’s accelerating his protectionist agenda is easily reconcilable with his highly fiscal expansionary policies and the talk of the virtues of a weak dollar voiced by Treasury secretary Mnuchin early in the year. While the current mix of fiscal and monetary policy policy is set to remain USD negative, see Part 5: FX and inflation – US inflation outperformance + comfy Fed = weaker USD, we further note that the hegemony status of the USD – and hence possibly its safe-haven properties – have been up for revision for a while, and Trump’s trade rhetoric is accelerating that process. Currency-reserve flows take time to shift but a decline in the lure of US assets at a time when the US has to issue more bonds to finance the twin deficits could be critical. In an FX context, we deem that the associated upward pressure on yields will do little to outweigh the negative effects of the current US policies on the USD.
In our base case that the Trump administration introduces protectionist measures on a case-by-case basis, we believe the near-term USD weakness trend would abate somewhat, and EUR/USD should stay in the 1.21-1.26 range for now (but still edge higher as the ECB continues its path to ‘normalisation’).
In a risk scenario where an actual trade war breaks out, e.g. with the US leaving the WTO, global risk sentiment is likely to take a firm hit and it is less clear whether the traditional safe-haven status of the USD would still be in place and support the dollar. We think however that the associated hit to US growth will dominate any flight to US ‘safety’ in that case, and foresee a weaker USD in that outcome too.
Appendix. US trade with China
As there is a risk that we are heading for a global trade war, we have dug into the goods trade flow between the US and China. In 2017, the US exported goods to and imported goods from China for a total of USD130.4bn and USD505.6bn, respectively. The trade deficit was USD375bn or 2% of GDP. The large trade flows mean that a trade war between the two biggest economies in the world would be damaging for both sides and this is the main reason why we do not think it is going to happen. US consumers would experience higher prices (and smaller supply of goods) in case of tariffs or import quotes. China would be hurt, as the US is the most important export market for China (lower exports and lower employment).
The US main goods exports to China consist of the following.
- ‘Crude Materials Inedible except Fuels’ (mainly soybeans).
- ‘Chemicals and related products’ (pharmaceutical products).
- ‘Machinery and transport equipment’ (mainly motor vehicles and aircrafts).
The US mainly imports the following goods from China.
- ‘Manufactured goods classified chiefly by material’ (textile yarn and manufactures of metals).
- ‘Machinery and transport equipment’ (mainly electronics like computers, televisions, smartphones etc.).
- ‘Miscellaneous manufactured articles’ (toys, apparel and clothing and furniture).