Even before President Trump’s inauguration, we at PIMCO had identified trade policy as a potential spoiler to the otherwise pro-growth nature of the president’s economic agenda. And the unfolding of this “summer of discontent” has only affirmed our view heading into 2018 that trade policy remains one of the biggest policy risks for markets and the economy this year.
In addition to tariffs on steel, aluminum, washing machines and solar panels imposed earlier this year, the Trump administration recently imposed a 25% tariff on $34 billion of Chinese products, with tariffs on an additional $16 billion of goods expected in the weeks ahead. The administration is also considering the possibility of imposing up to 25% tariffs on an additional $200 billion of Chinese products – ranging from refrigerators to electrical components to seafood – as early as September, with threats of more tariffs should China continue to retaliate.
What’s coming for trade policy?
Given that no high-level negotiations are underway with China, we maintain that trade relations with China are likely to get worse before they get better. A compromise to avert tit-for-tat tariffs remains elusive, since the U.S. will likely require more than just a commitment from China to buy additional U.S. goods; indeed, we believe a deal would need to include concessions in the areas of market access and forced technology transfer, which China is unlikely to agree to given that access to advanced technologies is key to the country’s Made in China 2025 industrial policy.
We also believe that despite the recent détente (and hug!) between President Trump and European Commission President Jean-Claude Juncker, it is still possible that we see the administration proceed with tariffs on autos and auto parts, including those from Europe. Why? For one, the administration is still proceeding with the auto and auto parts investigation, a process that is likely to conclude later this month and would allow the administration the option to impose tariffs. Two, we see several potential pitfalls for the negotiations with the EU, including the already-simmering fight over agriculture, a perennial sticking point for both parties, and the fact that Juncker has limited power when it comes to actually forcing the 28 countries within the EU to agree to the terms of a negotiation (for instance, while Juncker promised President Trump that the EU would buy more soybeans, he actually does not have any real power to enforce that outcome).
While the form and scope of potential auto and auto parts tariffs – and any potential country exemptions – remain unknown should they proceed, we nevertheless think their economic impact could be significant.
China tariffs’ long-term impact is tough to gauge
The direct economic impact of the proposed 25% tariffs on $200 billion of additional Chinese imports, on top of the already announced 25% tariffs on $50 billion of Chinese products, could add about 0.3 to 0.4 percentage points to U.S. headline Consumer Price Index (CPI) inflation and subtract a bit more from real GDP growth over the next year, in our view.
Assessing the economic impact beyond the direct effects is complicated by uncertainty about potential retaliation. Because the U.S. exports only about $130 billion annualized to China, Chinese officials would be forced to retaliate with higher tariff rates or non-tariff measures (e.g., investment restrictions, sales of U.S. assets or currency devaluation) if they are to continue to respond in kind. Since April, the Chinese yuan has depreciated against the dollar by roughly 9%, making U.S. goods less competitive and, to some extent, offsetting the impact of the tariffs on both the U.S. and China’s economy.
Auto tariffs would drive inflation, have no clear winners
Looking out over the next year, we estimate that the direct effect of the 25% tariffs on all vehicles and vehicle parts, if enacted, could contribute 0.3 to 0.5 percentage points to headline CPI inflation while shaving off a similar amount of real GDP. And this estimate doesn’t consider the potential economic drag from trading partner retaliation.
Usually, we can think of trade policies creating winners (the domestic makers of products targeted for higher import duties) and losers (households or businesses that must pay higher prices); in this case, however, it’s tough to see who wins. Because domestic auto manufacturers, which should benefit from rising prices, tend to source a meaningful portion of parts abroad, higher input prices would likely offset any profit gains.
Rising uncertainty is a negative for the economy
The ultimate economic impact of the administration’s trade policies will also hinge on how forward-looking global businesses and markets respond. For example, rising uncertainty, like we’ve seen recently (shown by the Baker, Bloom and Davis Global Economic Policy Uncertainty Index), has historically coincided with slowing business investment and higher risk aversion in financial markets. Higher-frequency surveys of U.S. business confidence and purchasing manager views on the near-term outlook have also shown some deterioration lately. And any slowdown in global growth could also affect the U.S. economy.
Overall, we believe the administration’s recent trade policies and proposals pose a negative risk to our U.S. economic outlook over the cyclical (six- to 12-month) horizon, while the longer-term impact is less certain. If these tactics ultimately result in freer and fairer trade, that would augur well for longer-term growth prospects. However, we view a strategy of raising import tariffs – and tolerating some potential near-term economic disruption – to secure longer-term economic gain as inherently risky. Over the past 20 years, corporate supply chains have become more globally integrated, greatly increasing the strength and complexity of global economic links and the potential economic shock if these supply chains were disrupted.
For more of our insights into the investment implications of public policy, see related content on the PIMCO Blog.
Libby Cantrill is PIMCO’s head of public policy, and Tiffany Wilding is a PIMCO economist focusing on the U.S. Both are regular contributors to the PIMCO Blog.