Liberation Day

President Trump’s love of tariffs isn’t news.  Since the 1980s Trump has talked of tariffs as the way to attack countries which in his view were taking advantage of the United States.  Back in the 80s it was Japan he wanted to target as American political and business elites feared that the rise of corporate Japan would overwhelm American businesses.  Forty years later it is the entire world which Trump is battling against, but the primary villain is now China.

Since early in his second term he had made it clear that tariffs were coming but they would be fair and broad ranging.  He delighted in explaining his reciprocal tariffs, it sounded as if he had just learnt the word reciprocal.  Whatever rate each country charged America, that would be the rate which America charged back to that country.  It does sound fair but there was no indication of how his administration would actually calculate the different rates.  All was to be unveiled on Liberation Day, April 2, the day of liberation from the decades of unfair trade practices which America had suffered so said Trump.

Although Trump had continually emphasized tariffs as his go to policy tool the markets were simply not prepared for what was announced.  Proposed tariffs rates were well beyond anything which had been expected and the promised rates for each country did not align in anyway with what could be considered reciprocal rates.  Wall Street elites who had assumed that Trump was one of their own, or at least business friendly abruptly discovered they had completely misread the man.  What followed in US and global stock and bond markets will continue to be written about for decades to come.  But the impact was not limited to financial markets.  Trump’s tariffs effectively torn up the existing global trade order and it is probably fair to say that his announcement affected nearly everyone on the planet involved in some sort of economic activity.  For those holding stocks and bonds the impact was clear, but no factory anywhere in the world would be spared.  Every part of the global integrated supply chain was being put on notice.  Not only business models of companies were being affected but entire countries which had built their future prosperity on a low-cost export model were thrown into disarray.

The reciprocal tariff rates were calculated not on any detailed understanding of each country’s tariff or trade policy but instead solely driven by the US calculated trade balance and deficit with the US.  As such it offered no remedial steps which could be taken to reduce the tariffs.  The entirely (false) premise of the rates was that for any country to run a trade surplus (in goods) with America was a bad thing for America and which needed to be eliminated.  No consideration at all was given to the large trade surplus which America runs in services with much of the world.

Given the methodology of the tariffs it is no surprise that Asia was significantly impacted.  Cambodia, Vietnam and Sri Lanka all saw tariff rates over 40%.  Many other Asian countries were hit with rates over 30% and even Asian US allies of Japan and South Korea suffered mid-20% rates.  It is no surprise then that global financial markets went into freefall with corporate leaders and factory bosses at a loss as to how to respond.  With the needless exceptions of Russia and North Korea which weren’t even mentioned in the trade announcement no country escaped as a default 10% tariff rate became the norm across the board.

China pushes back

China, which had only been hit with a 34% tariff, albeit on top of an existing 20% tariff which Trump had imposed early in his second term decided to fight back.  For most countries retaliation was out of the question, they were neither big enough economies nor did they understand what they could do to actually make an impact.  Only the EU and China were big enough trader partners to push back aggressively.  China responded by imposing a 34% rate on US goods which Trump responded to again by upping the Chinese rate and as tit followed tat the measure escalated until the current rates are 145% US tariffs on China, and 125% Chinese tariffs on the US.  In addition to tariff rates the US has now eliminated the $800 de minimis threshold for small parcels into the US from China.  That destroys the business model of companies like Shein and Temu who exploited this threshold so send super cheap clothes and other items direct to consumers in the US.  The gloves were off in the trade war.

But Trump blinked first.  By mid-April the US treasury bond market was reeling, instead of investors rushing to US bonds in times of panic bond prices were falling, driving interest rates higher.  Trump responded by announcing a 90 day pause on tariffs which he pitched as allowing time for deal negotiation with dozens of countries who were allegedly eager to strike deals with Trump.  All countries except China would trade at a 10% rate.

For the Trump administration they take the view that China is bound to suffer more than the States.  Since China sells more to America than American sells to China an increase in prices means that China will thereby sell less to America but that is too simplistic an assumption.  Firstly, every American buys Chinese made stuff and the so the increased costs will be felt very broadly in America and very quickly.  That means lots of angry voters calling their elected officials complaining about the tariffs and how prices are going up not falling as Donald Trump promised.  Conversely the average Chinese doesn’t buy that much from America and what they do buy, such as agricultural products can be bought elsewhere like Brazil.  For things China does buy from America, like Boeing jets, that is a luxury not a daily essential and airlines flying older jets does not have an immediate impact.  In a great piece of political theatre Reuters reported that Xiamen Airlines had recently returned a Boeing as the tariffs bite.

Trump claims every country is ripping America off and has been abusing it.  That is his rallying call amongst his base and lies at the heart of his politics of vengeance but it is clear that he views China as a real threat.  He may say he admires Xi Jinping and knows him well, but the current levels of tariffs effectively mean an economic decoupling between the two countries.  Further to that the White House recently changed a prominent government website on Covid-19 to explicit state that by far the most likely explanation for the epidemic was the lab leak theory in Wuhan.  No new evidence was presented but the White House chose now to take such a definitive position no doubt to try and pressure China further as the two sides face off.

There can no doubt about this being a trade with between America and the world, but most especially with China it begs some very fundamental questions.  What does Trump hope to achieve? Is there a long-term strategy for what is being done?  What constitutes a “win”?  By what metrics can success be measured?  And over what timeframe is change expected?  President Trump doesn’t seem to have good answers to any of these questions.  Instead he has slogans such as Make America Great Again or promises of high paying jobs for American workers.  What is sorely lacking is clear policies to change economic activity within America.

A good example of the half-baked nature of the Trump position relates to a recent announcement to impose tariffs or fees on Chinese built ships that dock in the US.  The complaint is that too many ships are built in China and Trump wants to develop US shipbuilding.  That is a laudable goal and indeed one which needs urgent attention especially when it comes to naval ship construction, but nothing was announced by way of industrial policy to actually encourage businesses to make ships in America.  While economics is always a driver of activity simply raising the prices on Chinese build ships will not directly lead to more ship building in America.  Are there shipyards even ready to re-open in America?  Does America have the skilled workers required for building ships?  What about the steel and associated industries which are required?  The loss of shipbuilding or indeed many other manufacturing industries from America isn’t simply a case of cheaper workers overseas.  That has clearly been a driver historically and still remains a factor but China doesn’t just attract manufacturing based on cheap workers, it also benefits from a entire ecosystem of ancillary and support businesses which produce the complete supply chain often within one town or area.  Making cheap clothes isn’t just about wages but about design, fabric supply, cutting, buttons, zips etc.  All these things sit together within Chinese towns yet in America they produce very little of such things.  American manufacturing long ago moved to higher value-added specialized products.

Moving towards a new normal

What is clear, and little is given the almost daily flips and flops from the White House, is that the current situation cannot last.  Not only are the Trump tariffs on a 90 day hold but with US-China tariffs being at such an unworkably high level it is inevitable that some sort of climb down is engineered.  Even if the tariffs were just magically cancelled then the old status quo will not hold.  If nothing else America has lost the trust of many, or perhaps, all of its trading partners.  It is very likely that Trump will be able to strike some deals with some countries, particular high deficit countries like Vietnam in the coming weeks but even if Vietnam reduces its tariff barriers to American goods all those factories making consumer goods aren’t moving across to America.  America’s future prosperity doesn’t rest on assembling Nike sneakers.  The same holds true for many other South East Asian countries.  But a deal with Trump won’t rebuild the trust that America is a reliable partner.  As Trump has been trashing his allies and partners China has presented itself as a reliable partner keen to engage in trade but it hasn’t just been the developed countries which are targeted by Chinese overproduction and its export behemoth.  Vietnam is a great example of a country which looked to develop better ties with America to balance the pressure of its northern neighbour.  Instead Trump has wasted this opportunity to build a network of countries concerned by Xi’s assertive leadership.

Even if the trade war “settles” down with American tariffs at 10% that is a level not seen for a century and will affect a slow but steady grinding down of American growth, and by extension of global growth, without any indication that inequality will be addressed.  But let it not be forgotten that Trump is still in power for years to come, it has only been 3 months since his inauguration, and it would seem unlikely that he will just shut up and sit out quietly the remaining time as President.  If the economic consequences of his tariffs are hard enough to fathom it cannot be forgotten that his administration is also causing chaos across the federal government.  Those impacts don’t get the same coverage as some of the economic policies and the impacts aren’t as dramatically illustrated by the stockmarket but the long-term consequences will be deep and damaging.

But it would be too early to assume that China will benefit from the America mistakes.  China’s economy is already weak, four years of property woes remain, and its debt burden continues to grow.  The Trump tariffs are having an impact on Chinese factories and while some of its US exports can be redirected elsewhere there will be many countries wary of Chinese dumping into their markets.  It is a cliché to say there are no winners in a trade war and that is especially true when the goals are not well understood.  For all countries building economic resilience both economically and military would seem the only option available to them.  A new normal will be found but it could take a long time on a highly disruptive path before it becomes clear.