President Donald Trump laid out his grand vision early Friday of why a full-scale China trade war will lift the U.S. economy. On cue, the Dow Jones immediately took another leg down, as Wall Street braced for an Infinity War without an Endgame.
Just about everyone else understands that the Trump trade war will be bad for U.S. investors, consumers, retailers and manufacturers. The trade war will hit consumer spending and could freeze business investment in the U.S. It will damage American business prospects in the world’s second largest economy. It will hurt global growth and pressure global financial markets.
The longer this takes to sink in, the greater the damage to the U.S. economy. That’s why Trump’s Friday tweetstorm should raise alarm.
“Tariffs will bring in FAR MORE wealth to our Country than even a phenomenal deal of the traditional kind,” Trump wrote.
This view explains why Trump essentially blew up the China trade talks. It also explains why Wall Street has totally misjudged the risk that China trade talks could end in utter failure. Wall Street knew that Trump saw tariffs as an effective weapon to leverage concessions. But almost no one thought Trump believed he could break up the world’s most important economic relationship without hurting the U.S. economy.
Dow Jones Slides As China Trade Deal Hopes Dim
One would have thought that Trump got the message as the Dow Jones had a brush with a bear market late last year. Yet Trump evidently blamed the stock market’s tumble almost entirely on the Fed.
Now that he has escalated the trade war after a five-month cease fire, Trump will have no one else to blame for the results. The Dow Jones ;has lost more than 600 points since Trump blew up the China trade talks with 2 tweets on Sunday.
In Friday’s stock market trading, the Dow Jones sold off sharply in the morning but then roared back to turn slightly positive by the close. Wall Street is clinging to the hope that Trump and Chinese President Xi Jinping will swallow their pride and reach a China trade deal.
But there’s no guarantee that will happen. For now, Trump is moving ahead with plans to further escalate the trade war. Just after midnight on Friday, tariffs on $200 billion in Chinese imports jumped from 10% to 25%. Later, Trump confirmed via tweet that his administration has begun taking steps to extend 25% tariffs to an additional $325 billion in imports that remain untaxed.
Beijing, meanwhile, has said it will retaliate. Trump is right that China can do less damage to the U.S. via import tariffs, since it only imported $120 billions in U.S.-made goods in 2018. Yet the U.S. also runs a $40 billion trade surplus in services with China. And Beijing also has nontariff weapons at its disposal that could undercut American businesses in China.
Trump’s 4-Part Plan To Win China Trade War
Trump plans to pull out all the stops to shield farmers from the trade war’s fallout. He tweeted that the U.S. will use a portion of $100 billion in tariffs collected per year to “buy agricultural products from our Great Farmers, in larger amounts than China ever did, and ship it to poor & starving countries in the form of humanitarian assistance.”
That would still leave, he says, $85 billion in tariffs to invest in U.S. infrastructure, health care or other areas. “China would greatly slow down, and we would automatically speed up!”
Trump added that the U.S. will exempt some imports from tariffs to minimize the hit to businesses. (No word yet if the Apple iPhone and other Apple (AAPL) products will get exemptions. However, Apple stock fell 1.8% on Friday, closing below a recent buy point, even as the Dow Jones turned positive.)
The Endgame, in his view, is simple: more U.S. manufacturing. “Build your products in the United States and there are NO TARIFFS!”
What Trump Is Missing
Trump has repeated again and again that China pays the tariffs he imposes on Chinese imports. On May 5, he clarified that a bit: “The Tariffs paid to the USA have had little impact on product cost, mostly borne by China.”
Tariffs, in fact, are paid by the U.S. companies that import the products. To some extent, these firms can push their Chinese suppliers to lower prices. Yet so far the evidence suggests American consumers have borne the cost. A study by economists from the New York Fed, Princeton and Columbia found that the full incidence of Trump tariffs imposed in 2018 fell on American consumers, “with a reduction in U.S. real income of $1.4 billion per month by the end of 2018.” Even worse, the estimated income loss built in an assumption that the U.S. spend all tariff revenue to improve social welfare.
In other words, the economic harm exceeds the cost of the tariffs — and the assumed tariff collections are likely overstated. Consider that the 25% tariff on $200 billion in imports covers about $40 billion in consumer goods. That means the U.S. could raise $10 billion, in theory. But the 25% tariffs could turn profitable sales into breakeven or unprofitable transactions. A broad range of consumer goods produced in China, from leather furniture to bicycles, would face price increases. That would dampen sales when retailers already face intense competition and the highest wage inflation in a decade.
Trade War Impact On U.S. Economy, Stock Market
If Trump extends 25% tariffs to all Chinese imports, “expect faster closure rates for soft-line and hard-line retail outlets,” wrote UBS chief U.S. economist Seth Carpenter. UBS expects soft-line retail stocks like Kohl’s, Macy’s and Ross Stores to fall 40%.
Likewise, manufacturers relying on inputs from China would have to find new suppliers or shift their manufacturing outside of the U.S. But small manufacturers may not have the financial flexibility to make the transition.
Meanwhile, as companies hold their breath in hope that Trump won’t apply tariffs on the rest of Chinese imports, businesses will hit the brakes on new investment.
Extending tariffs to all Chinese imports would cut U.S. GDP by 0.95% to 1.35% over the coming year, UBS estimates.
The Dow Jones and broader stock market also would price in a weaker Chinese consumer, a hit to U.S. consumer confidence and spending, a flight to safety from emerging markets, and more trouble for struggling European economies.
While Trump wants companies to shift manufacturing to the U.S., and some may, that would entail higher costs. Meanwhile, companies exporting to China may shift overseas to avoid retaliatory tariffs. More likely, most companies will seek neutral countries, ones out of the tariff crossfire. Bottom line: U.S. companies will face disruption and higher costs, yet the U.S. may get little from it.
Bad Timing For A Full-Scale China Trade War
Amid fading tax-cut stimulus and rising wage pressures from a tight labor market, the U.S. economy was already headed for something of a slowdown. Businesses were already eyeing the possibility of recession in 2020 or 2021. Now an escalation of the China trade war and a rocky time for the stock market rally will further sap the economy and business confidence.
Trump has said over and over that he wants to be judged on GDP growth and the level of the Dow Jones. If a wider China trade war sandbags the economy and stock market, Trump re-election odds will slump also.
Businesses and investors might begin to worry that Trump’s corporate tax cuts would be repealed by the next occupant of the White House. That could further rein in stock market valuations and business confidence.
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