It is now almost three years since the Trump administration’s opening tariff salvo in April 2017, targeting an estimated $5.6 billion of Canadian soft lumber. In retrospect 2017 was a watershed year not for tariffs—but for pitted, partisan battles over a leftover vacancy on the Supreme Court, the repeal of the Affordable Care Act, government deregulation and tax cuts—a tumultuous year by most measures.
It was really not until January 2018 that the Trump administration showed its hand on its novel approach to international trade, abandoning almost 80 years of constructing multilateral infrastructural solutions to trade disputes between nations in the post-WWII years. Candidate Trump was long-winded in his contempt for multilateralism, from the North American Free Trade Agreement (NAFTA) to the unratified Trans Pacific Pact (TPP) to the regulatory oversight of the World Trade Organization (WTO). Multilateral trade agreements and regulatory oversight would be duly replaced by a unilateral approach between the US and its trading partners. Tariffs, or the threat of tariffs, would offer up a blitzkrieg body punch, setting the tone for the negotiations that were to follow. Employing the rarely used Section 201 of the Trade Act of 1974, the US targeted washing machines and solar panels, moving quickly to steel and aluminum through the equally rarely used Section 232 of the Trade Expansion Act of 1962. This time, tariffs were justified under the guise of either national security or under Section 301 of the Trade Act (1974) against unfair trade practices that dealt with intellectual property and the forceable transfer of technology. About $370 billion in Chinese imports came under Section 301 and about $359 billion in vehicles and car parts from Canada, Mexico, the EU and Japan fell under the Section 232. It is a vivid rewrite of the post-WWII rules of engagement: Prioritizing narrowly defined interests while maximizing forward leverage.
In August, steel and aluminum tariffs were used against Turkey over the country’s detention of an American pastor. In March 2019, the Trump administration stripped both India and Turkey of preferential market access, effectively increasing duties on each country’s exports to US market. By October, Thailand was added to that list. In December, the Trump administration proposed $2.9 billion of tariffs on French wine, cheese, handbags and other goods for France’s digital services tax that purportedly targeted US technology companies. The month also saw tariffs proposed for Argentina and Brazil, with each country being accused of currency manipulation. In August, it was China who was officially tagged with the opprobrium under section 301 of the Omnibus Trade and Competitiveness Act (1988). The on-shore renminbi had broken the psychologically important Rmb7 threshold against the dollar, closing at Rmb7.0481 on the 5th of August. During the month, the renminbi faced the steepest selloff in a quarter century as the currency weakened to Rmb7.2 to the dollar. China’s 3rd quarter GDP growth fell to a three-decade low. By summer’s end $360 billion of US tariffs on Chinese goods was online. Through the end of September, the renminbi had fallen 4.5% against the dollar. The renminbi clawed back strength in the final quarter, down 1.2% against the dollar on the year. The renminbi’s rebound was further helped along in the New Year by the Rmb3.23 trillion loaned by Chinese banks in January to meet bonus schedules to workers before the Lunar New Year at the end of the month. By Friday’s market close, the renminbi had strengthened to Rmb6.9178 to the dollar. The US Treasury quietly removed the designation last week, days before the signing of phase one of the US-China trade deal.
China announced retaliatory tariffs on US exports in April of 2018, while the EU, Canada and Mexico followed suit in June and July. China targeted aluminum, pork and agricultural commodities such as soybeans and wheat while the EU, Mexico and Canada targeted steel and aluminum and other agricultural products.
There is no post-WWII example of an advanced economy erecting tariffs to the level of those put into place by the US in 2018-19. Complicating the matter, the impact of tariffs on global supply chains that international companies have spent billions of dollars setting into place over the past decade also holds no comparable post-war precedence. The International Monetary Fund has cut its global economic growth projection for 2020 to 3.3% for 2020, a modest increasing from the 2.9% growth in 2019 on increasing global trade volume in 2020 after falling to 1% YOY in 2019. Economic growth in 2020 could further be augmented by the 71 interest rate cuts enacted by 49 central banks for the most coordinated worldwide monetary policy response since the global financial crisis. The Federal Reserve accounted for three of that total. In addition, the Fed brought its balance sheet unwind that began in October 2017 to a screeching halt and is now buying $60 billion of Treasury bills of durations of less than 12-month in an attempt to place a floor beneath the repo market. US asset prices have responded favorably: Since the Fed’s 11 October announcement, the S&P 500 is up 13.31% through Friday’s market close (17 January). The yield on the 10-year Treasury note has risen 3.41% over the same period. The Fed’s actions and the possible lessening of tensions as a result of Wednesday’s phase one agreement on trade between the US and China have investors visibly taking on more market risk. Still, headwinds to growth shade to the downside as current growth projections remain highly tentative in scope and subdued in context, particularly when compared with the last decade.
There is a good deal of existing research documenting the negative impact of tariffs on the greater economy—higher input prices from supply chain disruptions, decline in capital investment due to economic uncertainty, declining market valuations of affected companies, lost jobs and, eventually, higher prices for the end users--consumers. For manufacturing, rising input costs and retaliatory tariffs from targeted countries place upward price pressures on intermediate and final goods pricing, undermining market share vis-à-vis non-tariffed competitors in global markets. Rising producer prices are a direct outgrowth of rising input costs, accentuated further by supply channel disruptions as companies scurry to circumvent tariff restrictions. Eroding market share comes at the cost of jobs and sundry cost-cutting measures by the tariffed firm to reclaim lost market share. Over time, economic growth suffers.
Curiously, the Trump tariffs were justified at least in part as a protective measure for US manufacturers against unfair trade practices of the country’s international trading partners, particularly China. Another overriding justification was to finally do something about the ever-ballooning US trade deficit, also targeting China who owned the biggest and most persistent trade surplus with the US. Just how are these justifications holding up to the costs of the administration’s tariff regimes?
Throughout much of 2017, durable manufacturing was on a tear. The mean capacity utilization for manufacturing for the year (2012 = 100) was 76.46%. New orders started the year at $223 billion, on their way to $262 billion by September 2018. A year later, new orders have contracted for the fifth straight month to a reading of 46.8 through the end of December. Factory capacity utilization for 2018 rose to 78.79%. By the end of 2019, capacity utilization had fallen back to 77.77%. Manufacturing employment expanded in sync, bulking up from 12.4 million in January to 12.7 million over the same period. Since July, manufacturing employment has been in a steady decline, posting a reading of 45.1 in December—its fifth consecutive monthly decline. In 2018, manufacturing added 264,000 jobs. Through the end of 2019 that total as dropped to 46,000 jobs created. December’s manufacturing count dropped by 10,000 jobs. Real output in the US manufacturing sector through the end of the 1st quarter of 2017 grew by 1.5% YOY, 2.8% YOY in the 2nd quarter, 1.9% YOY in the 3rd quarter and 2.7% YOY in the 4th quarter. Real output grew by 2.4% in the 1st quarter of 2019, 2.2% YOY in the 2nd quarter, 3.6% in the 3rd quarter and 2.5% YOY in the 4th quarter. By the 3rd quarter of 2019, real output had fallen to -0.5% YOY. Real output had fallen 86% from the 3rd quarter 2018 to the 3rd quarter 2019. Manufacturing PMI has fallen from a reading of 56.6 in January 2019 to a reading of 47.2 logged in December, a 16.6% drop in 12 months.
The producer price index (PPI)for US durable consumer goods (2015 = 100) for January 2017 came to 101.43. By December, the PPI index was up to 102.77 for an annualized growth rate of 0.11% for the period. In January 2018, the PPI was 102.71, rising to 104.44 for an annualized growth rate of 0.14% for the period—up just over 27%. Out of the gate, US tariffs focused almost exclusively on machinery and capital goods purchased by businesses, in effect shielding consumers from increased costs due to tariffs. These tariffs were paid by US importers. The impact on PPI comes from intermediate good manufacturers with a large share of imported inputs. Higher input costs due to tariff duties give manufacturing firms several options: Reduce finished good markups, absorb higher costs via lower margins or pass higher costs to the end user. Survey results conducted by the Federal Reserve Bank of New York revealed that 79% of manufacturers and, surprisingly, 60% of service firms stated that tariffs had increased their input costs. Of that number, 14% of manufacturers and 12% of service firms stated that their input costs had increased significantly over the past year.
Meanwhile, the average annualized industrial capacity for durable goods increased in the 2017-2019 period from 136.62 to 141.13 (2012 = 100). The measure for capacity utilization for the period was more mixed, increasing from 76.46% (2017) to 78.74% (2018) only to drop in 2019 to 77.77%. In 1997, capacity utilization was 83.04%. Capacity utilization has been falling at an annualized rate of -.3% for the period. The slowdown spilled directly into the transportation sector, hitting railroads dependent on the transport of agricultural commodities, industrial equipment, durable goods like cars, petroleum and its byproducts as well as coal for both domestic use and export. Freight volumes fell 7.9% in December YOY for the largest drop since October 2009. The entirety of freight volumes were negative YOY in 2019. As a result, warehouse and transportation employment weakened significantly, shedding 10,000 jobs in December alone. The industry added about 57,000 jobs throughout the course of 2019, about a quarter of the 216,000 jobs added in 2018. A similar picture emerges in manufacturing, losing 12,000 jobs in December while creating just 46,000 for the entire year against 264,000 created in 2018. The cumulative hit to gross output due to the administration’s tariff regime over the past two years is difficult to project. At the same time, the share of the workforce in labor unions fell to 10.3%, down from 20.1% in 1983. Private sector union workers number 6.2% of the labor force through the end of 2019.
There are simply too many unknowns regarding precisely how economic growth would otherwise have shaped up had the tariffs not been in place. Some of those unknowns for 2020 include the November elections and possible US tariffs on foreign car imports from Europe, Japan and South Korea. Britain, France and Italy are proposing digital taxes that could invite US retaliatory response. Unlike China, Europe is less vulnerable to US duties as US exports to Europe are three times the volume currently bound for China. This offers up plenty of targetable goods for EU retaliatory duties. With 2020 being an election year, new trade deals or tariffs placements present enormous challenges from a variety of fronts. In 2003, George W. Bush instated tariffs on European steel. The EU struck back with retaliatory duties on Florida orange juice. Bush finally relented. Florida is an important electoral swing state. Current estimates on GDP hits abound for the tariffs already in place. The Congressional Budget Office estimated GDP at -0.3 percent smaller through the end of 2020. The Tax Foundation hazards the hit to long-term GDP growth at -0.55%, adding the loss to wages at -0.37%. A recent study from the University of California, Los Angeles puts the long-term GDP hit at $51 billion or -0.27%. And from the World Economic Forum in Davos, Switzerland, the IMF posits that US-China trade tensions accounted for about an -0.5% hit to global GDP, down from -0.8% in October.
Through the end of 2016, the US trade deficit in goods and services came to $504.8 billion. A year later, that deficit came to $550.1 billion. By the end of 2018, the US trade deficit was $627.7 billion for a 7.53% annualized growth rate over the period. Using the same reporting period, China’s share of the US trade deficit came to $347 billion through the end of 2016. That total increased to $375.6 billion through the end of 2017. By the end of 2018, China’s share of the US deficit for the year came to $382.7 billion for an annualized growth rate of 3.32%. Through the end of the 3rd quarter 2019, the US goods deficit with China contracted to $319.8 billion, down from $381.1 billion YOY, as both countries cut back on imports and exports as tariff regimes went live. However, the US deficit with the rest of the world rose by $49 billion, offsetting completely the deficit decline with China. The 4th quarter tabulations scheduled to be released on the 28th of February.
Economic uncertainty continues to weigh heavily not only on capital investment, but market performance. Foreign direct investment (FDI) to acquire, establish or expand US business came to $296.4 billion (preliminary) in 2018. This represented an 8.7% increase over 2017 but fell well short of the average of $338.1 billion for the period 2014-2017. Acquisitions accounted for $287.3 billion of the total for 2018, about 97% of the total FDI coming into the US during the year. International companies in general are more reluctant to invest in the US because of the continuing trade tensions. This reluctance to invest is potentially debilitating to forward growth given that international companies employ about 26% of US manufacturing workforce and produce about 25% of all US exports.
The impact of tariffs on the consumer is more nuanced and dependent on the types of goods being exported by the respective countries. China provides US markets with large volumes of specialized finished goods such as laptops, tablets, e-readers, smartphones, flat screen televisions, smart watches and voice activated assistants from Apple, Microsoft, Samsung, Google and Amazon. Substitutes for such goods are difficult to re-source quickly, if at all, given existing global supply chain mechanics. Accordingly, US distributors continue to find a good deal of difficulty in passing on the added costs of tariffs without absorbing the significant fixed costs of reconfiguring existing supply chains as companies redirect investment and sourcing to avoid current tariff regimes. This means importers likely pay the added costs of tariffs in the form of either margins or reduced volumes of high-demand import goods. An alternative option for retailers was to increase the price of non-tariffed goods such as clothes dryers which are usually purchased in tandem. Prices of South Korean-made LG and Samsung washer/dryer combinations rose quickly in response to the 20% to 50% tariffs placed on the components after January 2018. In this manner, margins were allowed to remain largely the same with US consumers shouldering the added costs of the tariff regime. Another option for retailers was to front-load purchases of both washing machines and solar panels before tariff regimes went online. This is one reason why price inflation in the greater US economy remains muted with personal consumption expenditures (PCE) inflation at 1.5% through the end of the 3rd quarter.
In contrast, US exports to China are largely undifferentiated agricultural products like soybeans, wheat, corn and pork. For soybeans, China swapped out US production for that of Brazil as US purchases dropped 89% in the October 2018-March 2019 period YOY. Current global soybean inventory is estimated at 96.4 million metric tons (MMT) through December with an anticipated global demand set at 95.23 MMT. US farmers and grain operators will continue to pay the cost for agricultural tariffs either directly due to lost sales or indirectly due to lost market share. US tariffs presents the country as an unreliable trading partner, making the regaining of market share all the more difficult moving forward.
US-China trade tensions are now on something of a hiatus, at least temporarily. Phase one of the agreement was inked on the 15th of January. The US will now cancel new tariffs on roughly $156 billion in Chinese imports that were set to go online the 15 of December. The Trump administration also agreed to half the duty on approximately $120 billion of Chinese goods that was imposed on the 1st of September to 7.5%. While details remain scarce, the agreement covers at least five areas of contention: Future purchases of US goods, intellectual property protection, the further liberalization of China’s financial to foreign competition, enforcement provisions and foreign exchange policy. What phase one doesn’t cover is likely more important than what the two countries have agreed to thus far. Underscoring the entirety of the US-Chinese relationship is the fate of China’s ongoing industrial policy—Made in China 2025—including governmental subsidies for homegrown competitors in semiconductors, commercial aircraft, EVs and other high-tech industries. Commercial cyber theft, supply chains, access to advanced technology, not to mention all the unresolved issues around Huawei await future “phase” agreements. Xi Jinping goes back and forth between industrial autarchy and giving valedictory speeches on globalization. The Trump administration furthers the muddle with a curious mix of mercantilist pursuits to lower the US-China trade deficit to a shareholder-based drive for profits from US owned Chinese subsidiaries to a geopolitical program to thwart Chinese expansionism come-what-may. Are the two biggest economies in the world economically coupling with, or de-coupling from, one another? Can the US and China cooperate with each other’s mutual benefit while constructively managing their differences? Or will more than two decades of increased economic integration between the two countries simply unravel? Phase one is more of a truce, and likely a temporary truce at that. And how long the truce lasts is highly uncertain; the completion of phase two, three and so-on is even more so.
With Trump’s eye on the November elections, China is more than happy to bide its time. China has agreed to buy more US agricultural commodities and will continue to talk about allowing US financial companies to market their payment products in China, the same tactics Beijing has pursued for the better part of a year to date. China will also increase their purchase of US energy products, particularly oil and liquid natural gas imports. Beijing has promised to provide greater intellectual property protection. China has even committed to buy a fixed amount of US goods and services worth $200 billion by 2021 (something of a dollar for dollar bid to lower the US-China trade deficit) and is expected, but not obligated, to ease some of its retaliatory tariffs on US products during the period. Many of these US demands are already in place. Beijing dropped the joint venture requirement for foreign companies in the spring of 2018. Allowing US financial services to market their wares in mainland markets is slowly coming to fruition. And on currency manipulation, both countries have pledged not to competitively devalue their respective currencies. Interestingly, the US has for years asked Beijing to let its currency be determined by market forces. Now, both countries appear to be allowing their respective currencies to do just that—to be determined by market forces. The onshore renminbi “floats” within a determined range which is set by the People’s Bank of China (PBOC) on a daily basis. There is no stipulation to change the practice in phase one. What happens if the market pushed the renminbi down in value is highly sensitive for the PBOC. The agreement offers little or no details on the matter. In many respects, however, the agreement appears to be pushing on a half-opened door.
Leaving an estimated $360 billion of US tariffs, about 65% of China’s exports to the US in place, however, clearly invites suspicions that something big remains amiss. The Trump administration is counting on tariffs as an offset as a strong incentive program not just to manage future Chinese trade behavior, but as a strong financial incentive to coax US internationals to reconsider supply chains that continue to rely on China. This explains the lethargy of the S&P 500 on the agreement, up about 0.2%. Tellingly, the Philadelphia Semiconductor Index fell more than 1%. In anticipation of this interregnum period, bank stocks, drug companies and energy companies will likely do well. So will beef, poultry, hog and soybean futures.
Without doubt, US farmers took a direct hit, first from lost agricultural commodity sales to China and then from record rains that turned fields into duck ponds. During the October to March 2017-2018 growing season, the US supplied 24.4 million metric tons (MMT) of soybeans to China while Brazil supplied 14.23 MMT, filling 83% of China’s needs. After the July tariff on US soybeans, US exports fell to 2.7 MMT in the October to March 2018-2019 season—a drop of 21.7 MMT. Brazil’s export total jumped to 25.7 MMT for an increase of 11.5 MMT for the period. Brazil was supplying just under 80% of China’s soybean needs in the 2018-2019 season while US exports plummeted to about 4%. Similar scenarios played out for pork, poultry and corn. The Trump administration turned quickly to the Commodity Credit Corporation (CCC), a depression-era agency of the US Department of Agriculture. The CCC funneled $10.2 billion in aid to farmers in all fifty states through the end of November. Combined with other USDA farm assistance program and insurance claims, farm income in 2019 was at its highest level since 2014. While most farmers benefited from the government largess, funds were distributed based on acreage rather than actual need. Accordingly, almost half of the CCC funds went to the largest 10% of farming operations. China’s purchases are scheduled to resume this year with a goal of $40 billion to $50 billion/year in agricultural commodities over the next two years. In 2017, US agricultural exports were worth $23.8 billion or about 17% of total US agricultural exports for the year. Of the 85 million tons of soybeans imported by China last year, 57 million came from Brazil. Under the best of circumstances, reaching the agreement’s two-year target will be an outsized challenge—and most certainly will come at the expense of existing contracts with countries that were tapped to fill in the gaps of tariffed US agricultural exports. Chinese purchases beyond that date remain largely undefined.
The agreement to date is a significant departure from the free trade agreements the US has entered in the post WWII period. Rather than lowering tariffs as the building block of the agreement in the promotion of the free-flow of goods and services across national borders, phase one goes in the opposite direction—and leaves tariffs in place. Further, China is being forced to buy an estimated $200 billion of US exports over the next two years, irrespective of market demand or constraints. Managed trade flies in the face of the free-flow, market driven flow of goods and services. Rather than exposing Chinese markets to market driven trade, phase one conveniently embraces the top-down, command-driven Chinese economic model long the bane of US policy makers of old to meet current agreement objectives. On a similar topic, enforcement of the agreement will not depend on arbitration boards or the WTO dispute body, the latter having been systematically crippled by the failure of the US administration to recommend judicial appointments to the body to fill attrition vacancies of the past several years. Instead, disputes under the agreement will be handled by ongoing rounds of negotiations between the two sides, which highlights the agreement’s allowance of maintaining US tariffs on about 65% of Chinese exports. The US Trade Representative (USTR) has labeled arbitration boards as violations of US sovereignty. Both the redo of the NAFTA agreement and phase one do away with such boards, supporting the administration’s move away from multilateral to unilateral solutions to international regulation and enforcement of trade agreements. Disputes will be decided by the parties involved. And since most of the concessions appear to be made by China in phase one, disputes appear destined to be decided by the USTR and the president. Both USCMA and phase one represent a stick in the eye of the WTO.
Economists have long argued the premise that protectionism leads to real income losses for businesses and households, buyers and sellers. Free and voluntary trade across national and international borders benefits both buyer and seller. Tariffs on commerce usually distorts the free flow of goods and services, generally leaving buyers and sellers worst off. The lesson derives from the mistakes made during the Great Depression. We now have renewed talk of tariffs crossing the Pond—and back again—over ballooning trade deficits and the inability of US trade policy to reduce their impact. Targeting imported automobiles and their parts and protecting domestic producers presents a highly visible target. Tariffs and retaliatory tariffs are also circling over digital taxes being proposed by Britain, France and Italy. The aggressive use of tariffs to advance unilateral US trade initiatives appear on the rise rather on the wane.
James B. Allen in his book “The Great Protectionist,” describes Senator Reed Smoot, Republican from Utah, Chairman of the Senate finance committee, co-author of the Smoot-Hawley Act (1930) as infinitely self-confident, a person that wasn’t one to admit he was wrong about anything. There is no evidence that any apparent fact, any argument, any introspection even faintly disturbed him. Reed Smith lost his seat in the Democratic deluge of 1932, a witness to 16 consecutive quarters of plunging GDP growth. Until his dying day, the only problem he would ever admit to with his tariff regime was that they might not have been set quite high enough.
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