Tariffs and Trade Wars

Abstract

Trade tensions between the U.S. and China have been making headlines recently. The Trump administration recently rolled out plans to place 25% tariffs on $50 billion of Chinese imports, to which China responded in kind. In the near-term, tensions may continue to escalate, but ultimately a negotiated settlement is in the best interests of both countries. From a cash investor’s perspective, some flattening of the yield curve seems likely but credit quality most likely will not be materially impacted.

Introduction

Protectionism is not a new concept for President Trump. Back in 2015, his fervent Make America Great Again campaign catapulted him from an afterthought to the Republican front runner. His calls for protectionist policies intensified during the run-up to the election, as he called for 45% tariffs on Chinese imports, blamed NAFTA for hollowing out the rust belt, and labeled the Trans-Pacific Partnership (TPP) a potential “death blow for American manufacturing.”
While the rhetoric continued after his move to the White House, President Trump largely eschewed overtly protectionist policies in his first year in office, focusing instead on regulatory rollbacks and tax reform. Now, in the second year of the administration, protectionism has come back to the forefront. With the resignation of Gary Cohn as the Director of the National Economic Council (NEC) and the effective demotion of Jared Kushner amidst concerns over his business dealings, Trump lost his two biggest supporters of existing trade policy. At the same time, the promotion of advisor Peter Navarro and re-emergence of Commerce Secretary Wilbur Ross have placed two trade skeptics at the head of the economic leadership team within the White House.
Perhaps it’s no surprise, then, that the President’s first openly hostile actions towards foreign trade partners came in just the past few weeks. First was the announcement of a 25% tariff on steel along with a 10% tariff on imported aluminum. Second, the President invoked Section 301 of the U.S. Trade Act of 1974 to announce 25% tariffs on an estimated $50 billion of Chinese goods, along with potential restrictions on Chinese investments in U.S. tech firms. The administration also filed a complaint with the World Trade Organization (WTO) alleging, amongst other things, that China uses restrictions on foreign ownership to force companies to transfer their intellectual property to Chinese firms. China, in turn, responded to these actions by issuing reciprocal 25% tariffs on $50 billion worth of U.S. goods.
Given the ongoing nature of this dispute, it’s difficult to say exactly what the outcome will be. However, we’ll try to parse out some of the possibilities and their implications for short-term cash investors below.

Thoughts on the Actions

The most important thing to emphasize at this point is that nothing is finalized (save the steel and aluminum measures). The administration just wrapped up a two-week process by releasing a list of approximately 1,300 different products it wants to target, centered around high value-added areas such as tech and aerospace. China followed suit, announcing tariffs on 106 products (most notably soybeans and commercial aircraft) only hours later. Such a move highlights the tit-for-tat nature of these proceedings.
Neither side has taken concrete steps to move on the announcements. The White House is allowing for an extended period of public comment on its list of products, until May 22nd. Additionally, a public hearing is scheduled on Capitol Hill for May 15th. Given the backlash from a wide array of industries, it seems likely that the White House will face significant pressure to pare down the list. Furthermore, it could delay action on the finalized version for as long as 180-days under Section 301 procedures. China didn’t announce a timeframe for implementation, saying it was dependent on when the U.S. acts.
This time frame leaves open the possibility for reconciliation, a process which may already be under way. Only days after their initial announcement, it was reported that the Trump administration was in ongoing talks with China to expand access to Chinese markets. This would be consistent with the President’s negotiation style, in which he often stakes out aggressive positions publicly before ultimately compromising. For example, he initially issued across-the-board steel and aluminum tariffs before exempting all but a few countries (China being a notable exception).
Of course, there’s always the possibility that the negotiations will go sideways or backwards. Both Trump and China’s President Xi Jinping are strong-headed leaders who will not want to be seen as giving in to the other side. President Trump has already called for consideration of an additional $100 billion in tariffs as retaliation for China’s actions. Should he move ahead with them, it seems likely that Xi’s government would respond in kind.
Furthermore, some of the U.S.’s requests heading into negotiations, namely that China reduce its bilateral trade surplus by $100 billion, are unrealistic to say the least. Nevertheless, it remains in both countries’ best interests to come to some sort of deal. A trade war is a negative sum game, which could put economic pressure on Xi at a time of transition and heap political pressure onto Trump heading into the midterm elections.
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