The purpose of this article is to show that the impact of tariffs compared with overall trade flows is very small, but the downside for President Trump could be disproportionately larger.
Despite being very small, the trade war hogs headlines and makes President Trump look like he is making progress against foreigners who have "unfairly" stolen American manufacturing jobs.
Putting the Trade War in Perspective.
The chart below shows trade and tariffs between America's major trading partners.
The above information, plus China, is shown in the table below in terms of imports and exports between each land and the USA.
(Source: Trading Economics dot com plus author calculations for 2017)
The above information provides some perspective on the matter.
Except for China, the impact on US allies from the trade war is relatively minor at between one and five percent of total trade between the nations.
The actions against Canada, Mexico, and the EU are more bluff and bluster than a real threat to overall trade and prosperity. Though, no doubt catastrophic for specific companies and sectors of the economy. At the macro level, the trade war impact on these countries is a pinprick.
China is an exception in that the effect of the tariffs is potentially over 15% of total trade between the countries.
Foreign countries have taken the strategy of targetting some of their tariffs on products that come from parts of the USA where midterm elections are to take place this year. The purpose of this strategy is to damage Republican election chances and to weaken President Trump. The prospect of a hung Congress and Senate is a good way of dissuading the President from pursuing his damaging trade war strategy in the first instance. If the strategy is successful and the Republican power base is diminished with no majority in either the Congress or Senate, then it makes further trade war action harder to enact in the future.
President Trump's Trade War Strategy
President Trump is on record and repeats almost daily that the purpose of his trade war is to get a fairer deal for America from its trading partners. This is in view of the fact that America generally imports more than it exports and is running a current account deficit against the rest of the world as a result.
The US current account balance is shown in the chart below.
The numbers look large; however, when one compares the result as a percentage of GDP it again becomes a sideshow.
The rest of the world is content to exchange real goods and services for American dollar credits that are generally saved at the Federal Reserve in the form of Treasury deposits. As a monetary currency sovereign, America can create as many dollar credits out of thin air as it likes in return for real goods and services. The political problem is that the Federal Government does not use its sovereign currency creation privilege to make good the current account deficit with new Federal spending on the domestic economy.
The President's aim is to reduce the current account deficit and achieve a situation where trade with each country is more balanced.
The purpose of this strategy is to garner and maintain support from the poor, white, middle-aged, working-class Rust Belt voters who put the President in office at the last election.
To pander to this support base, the President now seeks to impose trade tariffs on foreign goods. This makes for big daily headlines, and the President is seen by his support base to be doing something for them.
The President must think that the political support he gains from his actions is of greater value than the damage that the trade war causes in real terms.
Actual Impact of President Trump's Trade War on His Support Base
While the President's trade war may be popular with his Rust Belt support base, it is making their situation worse.
The term “trade war” is used to describe a situation in which one country applies tariffs to imports from another country, and the other nation retaliates with tariffs of its own.
In some cases, there exists a situation where American goods face a more burdensome tariff than they get in return. Cars and trains are an example:
There is a case for such irregularities to be ironed out. Make this the focus. All tariffs are a form of income tax on the consumer and should be eliminated.
But, a “trade war” is different from a military war. In a military war, the enemy shoots at you, and you shoot at the enemy.
In a trade war, the enemy shoots at you and at itself, while you shoot at the enemy and at yourself.
With every nation shooting at other nations and at its own people, how do you “win” a trade war? You don’t. All trade wars are lost because the cost base is made higher. Each nation has higher internal nominal costs and receives less real benefits in the form of goods and services.
The hypothetical purpose of a tariff is to protect local businesses from foreign competition. But a tariff hurts the entire economy.
One example: Taxing imported cars would raise the price of all cars because domestic car manufacturers would feel less pressure to hold prices down.
The two results - both adverse - would be:
- The entire American public pays more money so that the relatively fewer American car makers can receive more money. The philosophy of tariffs is for many to pay more so the few can receive more.
- Tax dollars are taken from the economy and sent to the federal government, which being Monetarily Sovereign, and not needing to receive dollars, destroys them. Reducing the money supply is economically recessive.
The arguments for any tariff generally fall into two kinds of goals:
- To protect vital industries from extinction. Consider, for instance, steel. Steel is a vital defense product for tanks and battleships, and if there ever were a military war, the nation with a monopoly on steel manufacturing would have a distinct advantage.
- To protect domestic jobs. Every industry that is depleted by foreign competition loses jobs.
Both types of protection = protecting vital industries and job protection - are reasonable goals, but neither needs to be costly to the economy. It is not necessary, or even wise, to “shoot” our own people, in order to protect them from enemy “bullets.”
Both goals of protectionism can be accomplished by our Monetarily Sovereign government via:
- Federal government purchases from domestic suppliers, even at higher than import prices.
- Federal tax breaks for the selected industries
- Direct federal cash subsidies to the selected companies.
A Monetarily Sovereign government has the unlimited ability to create its sovereign currency.
It can easily fund any sort of protectionism without tariffs, which has the added value of stimulating the economy instead of depressing the economy, as tariffs do.
The table above shows that US consumers will pay an additional $86.9B when they purchase imported goods with a new tariff on them. This is $86.9B that cannot be spent on other goods and services and has increased the cost of existing goods and services and is therefore inflationary. $86.9B is almost 0.5% of GDP and might give the Federal Reserve cause to make a rate increase to stave off this inflationary effect. Then everyone pays more for credit as well.
This is where President Trump will be shooting his support base, the rest of America, and himself in the foot. $86.9B worth of financial damage per annum.
It will not take long for the poor, white, middle-aged, working-class Rust Belt voters to feel these additional costs, especially if the other nations are tailoring their reprisal tariffs to target this particular demographic.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.