US imposes more tariffs; is a global trade war now underway?
20 June 2018 | Markets and Economy
Note: This article was originally published on 15 June and has been updated to reflect recent developments.
The recent announcement by US President Donald Trump of duties on imports from Europe, China, Canada and Mexico has escalated the rhetoric and increased the likelihood of a trade war – with implications for the global economy.
How concerned should UK investors be?
Tariffs' effect varies by country
The impact of the steel and aluminum tariffs on US trading partners is mixed but remains small.
European steel and aluminum exports, for example, are not heavily exposed to the United States. Among the UK and other large European Union economies, less than 5% of total steel exports are sent to the US, representing less than 0.1% of those economies' GDPs.
For Canada and Mexico, on the other hand, the United States is the destination for more than 80% of aluminum and steel exports, leaving domestic industries more vulnerable. Even so, these exports represent only about 0.8% of Canadian GDP and about 0.3% of Mexico's. And currency fluctuations will have already absorbed much of the difference in relative prices. So the latest tariffs are not expected to alter Vanguard's baseline economic outlook for either country, although additional escalation – such as a US withdrawal from the North American Free Trade Agreement (NAFTA) – certainly remains a risk.
Few observers expect NAFTA renegotiation to be complete before 2019 or 2020. In the interim, investors can likely expect occasional market volatility resulting from intemperate political rhetoric, but we believe all three countries will remain focused on creating a solid, ratifiable trade pact in the end.
Where China is concerned, we see the road to a bilateral trade agreement as a bumpy one, unlikely to be smoothed out until 2019 at the earliest. Even so, most estimates indicate the Trump administration's newly announced duties on Chinese products should only affect a small percentage of total commerce between the world's two largest economies.
As with the 2002 steel tariffs imposed by then-President George W. Bush, we expect the latest tariffs' direct impact on the economy to be fairly minor. Instead, their real importance lies in the broader and longer-term implications for global trade policy.
To better understand what escalation might look like, it's helpful to consider trade in a historical and global context.
US ranks low in protectionism
US trade duties have been falling since the 1930s and have been under 5% for more than four decades, as shown below. According to the World Trade Organisation's latest report on trade, the current average US tariff is 3.5%, the second-lowest in the G20.
Note: Data shown are annual from 1900 to 2015. Source: US International Trade Commission.
Although the United States has in place non-tariff trade measures such as anti-dumping and national security safeguards, it remains one of the world's least protectionist countries, alongside the members of the EU.
Some market observers extrapolate the policy tilt of the new tariffs as marking the onset of a trade war, similar to the vicious cycle sparked by the American government's infamous Smoot-Hawley Tariff Act in 1930, which dramatically reduced trade flows and economic growth in the early years of the Great Depression.
Given the history of lowering trade barriers and realising the benefits of economic integration, we are led to believe it is unlikely that the current US administration will risk disrupting domestic growth by dramatically shifting trade policy.
Benefits of a slight rise in tariffs fast diminish
Vanguard's 2017 Global Macro Matters research paper Trade status: It's complicated estimated the impact of varying escalations in trade tensions. We found that a slight increase in tariffs, in the absence of retaliation, has a short-term marginal benefit to the US economy.
These benefits quickly diminish, however, and can be offset by retaliatory tariffs and market volatility. The end result would be higher consumer prices and reduced trade activity resulting in lower economic growth – a lose-lose scenario.
At present, Vanguard sees the odds of a true global trade war as having risen to about 1 in 3, up from 1 in 10 a few weeks ago. We estimate that a trade-war environment could reduce US GDP by 1.7 percentage points and increase inflation by 0.4 percentage point annually. In this case, the impact would be significant enough to force the US Federal Reserve to pause its interest rate tightening cycle and choose between bolstering growth and suppressing inflation.
Tariff fallout could put US in lagging position
Outside of these estimates of the direct impact on the global economy, reduced cooperation on trade over the next few years could hurt cross-border investment flows and place the United States in a lagging rather than a leading position in future economic and political partnerships.
Investors can reasonably assume that trade rhetoric will remain a source of volatility throughout 2018 as the Trump administration tries to set a new course on trade policy without triggering retaliation from its international partners. However, experience shows that most US and global investors are able to place trade disputes in proper context, generally ranking them behind currency valuation and central-bank policy in overall importance to the global economy.
Ultimately, we believe a full-scale trade war is still unlikely, but we believe it is worthwhile to closely monitor US policy decisions – and the responses from London, Beijing and other capitals – for signs of escalation.
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