Who Pays For U.S. Import Tariffs On China?

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by: Desmond Lachman
Summary

Import tariffs on China are a major threat to the US and global economic recoveries and they could involve the wiping out of literally trillions of US dollars in stock market value.

President Trump is certainly correct in thinking that a 20% tariff on China's $500 billion exports to the US would produce around US$100 billion a year in budget revenues.

As such, the US consumer would be unaffected by the import tariff in the price he would have to pay for Chinese goods.

With the Chinese decision to allow its currency to depreciate, President Trump could turn out to be correct in the narrow sense that it will be the Chinese rather than the US consumer who will bear the major burden in paying for those tariffs.

However, one has to hope that this does not blind the president to the broader and very much more important issue. Import tariffs on China are a major threat to the US and global economic recoveries and they could involve the wiping out of literally trillions of US dollars in stock market value. These costs would totally dwarf any budget revenues that the import tariffs might produce. And those costs would be borne importantly by the American public.

US President Donald Trump attends a bilateral meeting with China's President Xi Jinping during the G20 leaders summit in Osaka, Japan, June 29, 2019. REUTERS/Kevin Lamarque

President Trump is certainly correct in thinking that a 20% tariff on China's $500 billion exports to the US would produce around US$100 billion a year in budget revenues. He is also correct in thinking that if China depreciates its currency by a sufficient amount, it will be the Chinese rather than the US consumer who would bear the major cost of the import tariff.

In an extreme case, if China were to depreciate its currency by 10% in response to a 10% US import tariff, the price of Chinese goods to the US consumer in dollars would remain at the same level as it was before the tariff was imposed. As such, the US consumer would be unaffected by the import tariff in the price he would have to pay for Chinese goods.

However, to focus on the narrow issue of who bears the cost of the US import tariff on China would be to miss the bigger question of how damaging the trade war is to the global economy and how costly this might prove to be to US equity holders.

As the IMF reminds us, the US tariffs have already led to a marked economic slowing in China, the world's second-largest economy. That in turn has already moved the global economy from a situation of a synchronized economic recovery in 2018 to one of a synchronized economic slowdown today.

On this basis, and on the basis of the market's recent very negative reaction to Trump's new trade threat, there is every reason to think that an escalation in the US-China trade war will only further accentuate the global economic slowdown. It would do so by heightening global economic uncertainty. If that indeed were to lead to a global economic recession, it would be fanciful to think that the US economy would not be adversely affected.

The sharp global equity markets' reaction to the escalation in the US trade war should be a sobering reminder as to how costly US import tariffs on China might be for the US equity holder. In the space of a few days, US equity markets fell by more than 5% or over a staggering US$1.5 trillion. That is a large multiple of the US$100 billion a year Trump expects to collect in budget revenues from the tariffs.

While the markets could of course bounce back, there is ample reason to fear that if the US-China trade war were to tip the global economy into recession, there will be many more days of large losses in the US and global equity markets.

Judging by China's immediate retaliation to the US import tariff threat, it would appear that China has no intention of caving in to the United States' trade policy demands. It would seem that China knows the costs that a US-China trade war can inflict both on the US economy and on the US stock market. It also seems to know that there are political limits to how much economic pain the US can bear.

Sadly, it is far from clear that the Trump administration has a grasp as to how costly its China tariff might be for the US public. It is also not clear that it understands the dangers of the tariff fire with which it is playing. For which reason, I am not expecting any quick resolution to the US-China trade war.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.