The next phase of the trade war begins next week, when a 25 per cent tariff on $50bn-worth of Chinese exports to the US comes into effect. This poses the question: will US tariffs have the effect that Donald Trump intends?
He regards international trade as a zero-sum game in which countries with surpluses are winners while those with deficits are losers. He has complained that the US’s trade deficit means it is making “losses on trade” and claims that “massive trade deficits subtract directly from our gross domestic product”.
To understand whether higher tariffs would change this, remember a basic accounting fact. In developed economies such as the US, the trade balance is the biggest part of the current account balance on the balance of payments. This current account balance is by definition equal to the gap between domestic investment and domestic savings. Countries with trade and current account surpluses, such as Germany and China, are saving more than they are investing domestically. And countries with deficits, such as the US and UK, are investing more than they are saving domestically.
This fact means that tariffs will reduce the US’s trade deficit if, and only if, they cause increased domestic savings or lower investment.
Which they could do. Tariffs on steel, aluminium and Chinese electronic goods will raise the prices of some capital goods, which might depress capital spending. Uncertainty about the size and direction of future rises in tariffs – or about how other companies will respond to the trade wars – might also reduce investment. What’s more, workers in industries that buy lots of steel and aluminium might save more for fear of losing their jobs: we know from the experience of 2002 that steel tariffs are a net destroyer of jobs.
In these ways, it’s possible that tariffs will have their intended effect. In cutting investment and raising saving, they might shrink the current account and trade deficits.
But of course, they’ll do so at a price. Less investment and more saving will reduce aggregate demand and hence economic activity.
You might think there’d be an offsetting effect here. More saving and lower investment should mean lower interest rates which would eventually stimulate capital spending.
Not so. Remember another basic accounting fact – that the overall balance of payments must, well, balance. The counterpart of the US’s deficit on goods and services has been that for years trade surplus countries such as China have been buyers of US bonds. If they no longer run big trade surpluses, their demand for bonds will fall. This will tend to raise bond yields. Yes, this might be offset by increased domestic buying. This is probably why bond yields have been stable in recent weeks in the face of the rising threat of a trade war.
We mustn’t, however, overstate all this. So far, tariffs have been imposed only upon a small fraction of US imports. President Trump has administered a poison, but only in a tiny dose – which is why some economists think there’ll be no overall damage. There is, though, a danger here – that if Mr Trump sees little impact on the trade balance of these measures he might take much hasher ones. It is this possibility, more than the actual tariffs that have been imposed so far, that should worry equity investors.
