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China tariffs could boost Fed rate cut case

Escalation of the U.S.-China trade war seems unavoidable whoever wins the White House in November, but the equally inevitable inflationary pressures that brings won’t automatically steer the Federal Reserve toward a more hawkish policy stance.

If the blows to employment and economic growth from rising tariffs land harder than the hit to import prices, a new phase of the Sino-U.S. trade war will put policymakers in a bind, and under pressure to cut interest rates just as much as raise them.

After keeping former President Donald Trump’s 2018-19 levies on over $300 billion worth of Chinese imports in place for years, President Joe Biden’s administration this week slapped fresh tariffs on a further $18 billion of imports.

China is bound to respond in kind, stoking fears of an inflationary spiral. But research shows that tariffs also damage the economy, labor market and Wall Street – so much so that the Fed’s reaction could be to ease policy.

A 2021 working paper, “Trade Protectionism and US Manufacturing Employment” by Chunding Li, Jing Wang and John Whalley, found that protectionist measures, contrary to what their proponents claim to be aiming for, reduce manufacturing employment.

Unsurprisingly, these declines deepen if America’s trade partners take retaliatory measures. The economists’ models showed that in a scenario of unilateral U.S. action against Chinese imports, tariff rates of 30%, 45% and 60% would reduce U.S. manufacturing employment by 1.3%, 1.8% and 2.15%, respectively.

In a bilateral tariff war scenario with China, tariffs of 30%, 45% and 60% would reduce U.S. manufacturing jobs by 2.6%, 3.3% and 3.8%, respectively.

In hard numbers, that today would translate into between approximately 300,000 to 850,000 jobs lost.

“This suggests that the US wanting to save manufacturing employment through trade protection measures may be unachievable,” the paper concluded.

‘HEAVY COST’

The Trump administration’s tariffs on China in 2018-19 had no positive impact on U.S. manufacturing employment and, according to Moody’s Analytics, the trade war that ensued cost 300,000 U.S. jobs overall.

Ryan Hass at the Brookings Institution think tank wrote last month that the trade war with China “came at a heavy cost to the American economy:” the job losses, a “regressive tax” on consumers from higher import costs, and a sizable hit to U.S. stock markets.

He cites research from the New York Fed and Columbia University in 2020 that found the U.S.-China trade war during Trump’s four-year term depressed equity prices by 6%, or $1.7 trillion.

A 6% fall in U.S. stocks from here would wipe around $2.65 trillion of market value off the S&P 500 .SPX, and with current valuations already stretched and notably higher than 2018-19, the market may be more vulnerable to a deeper correction.

“The 2018-2019 experience suggests that there would likely also be negative indirect effects, including a tightening of financial conditions, a hit to business sentiment, and an increase in trade policy uncertainty,” Goldman Sachs economists also wrote last month.

They estimate that every 1 percentage point increase in the effective tariff rate will lower GDP by 0.13% in a scenario without retaliation from China, and by 0.15% if Beijing responds with tariffs of its own.

On inflation, they reckon every 1-point increase in the effective tariff rate would increase core consumer prices by just over 0.1%, although this boost to the price level would raise inflation for one year but then drop out of year-on-year calculations.

IMPORTS FROM CHINA SLUMP

A new Reuters/Ipsos poll shows Biden and Trump neck and neck in the race to win the election. Trump has taken a far more belligerent stance than Biden on tariffs, floating taxes of 60% on all Chinese goods and even more on certain products.

Trump said on Tuesday the new tariffs should be widened out to other products “because China’s eating our lunch right now.”

But that lunch is smaller than when Trump fired his tariff salvo more than five years ago. Barclays economists note that for the first 11 months of 2023, goods imported from China accounted for 13.9% of total U.S. imports, down significantly from 21% in 2017.

Mexico is now the United States’ largest import partner, accounting for 15% of total goods, and the slack left by China’s diminishing presence has been taken up by other countries like South Korea and Vietnam.

The United States is less reliant on China for imports, buys more from other countries, and is building a domestic manufacturing base in key sectors. Policymakers will be crossing their fingers that an escalation in trade tensions with China won’t be as damaging this time around.
Source: Reuters (Reporting by Jamie McGeever; editing by Jonathan Oatis)

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