Echoing his claims that Mexico is paying for the wall, President TrumpDonald TrumpFormer defense secretary Esper sues Pentagon in memoir dispute Biden celebrates start of Hanukkah Fauci says lies, threats are 'noise' MORE keeps repeating that it is the Chinese who will be paying for the U.S. import tariffs on their goods.
Never mind that the escalation in the U.S. trade war has sent U.S. and global equity markets reeling. Never mind too that the U.S. bond market is now strongly signaling that the U.S. is headed for an economic recession.
To be sure, with China’s decision to depreciate its currency in response to U.S. import tariff threats, President Trump could turn out to be correct in the narrowest of senses. It will be the Chinese exporters rather than the U.S. consumer who will bear the major burden in paying for those tariffs.
But one has to hope that this does not blind Trump to the broader and very much more important issue. Import tariffs on China are a major threat to the U.S. and global economic recoveries and they could involve the wiping out of literally trillions of U.S. dollars in stock market value. These costs would totally dwarf any increase in budget revenues that the tariffs might produce. And those costs would be borne importantly by the American public.
Trump is certainly correct in thinking that a 20 percent tariff on China’s $500 billion exports to the U.S. would produce around $100 billion a year in extra revenues to the U.S. budget. He is also correct in thinking that if China depreciates its currency by a sufficient amount, it will be the Chinese exporter rather than the U.S. consumer who would bear the major cost of the import tariff.
In an extreme case, if China were to depreciate its currency by 20 percent in response to a 20 percent U.S. import tariff, the price to the U.S. consumer in dollars of Chinese goods would remain at the same level as it was before the tariff was imposed. As such the U.S. consumer would be unaffected by the import tariff.
But to focus on the narrow issue of who bears the cost of the U.S. import tariff on China would be to miss the bigger question of how damaging the trade war is to the global and U.S. economies as well as to how costly this will prove to global and U.S. equity holders.
As the International Monetary Fund reminds us, the U.S. tariffs have already led to a marked economic slowing in China, the world’s second largest economy. That in turn has already moved the global economy from a situation of a synchronized global economic recovery in 2018 to one of a synchronized global economic slowdown today.
On this basis, there is every reason to think that an escalation in the U.S.-China trade war will only further accentuate the global economic slowdown. It would do so by heightening global economic uncertainty. If that indeed were to lead to a global economic recession, it would be fanciful to think that the U.S. economy would not be adversely affected.
The sharp adverse global equity market reaction to the escalation in the U.S.-trade war should be a sobering reminder as to how costly U.S. import tariffs on China can be for the U.S. equity holder. In the space of a few days, U.S. equity markets have fallen by more than 5 percent, thereby wiping out over $1.5 trillion in U.S. equity wealth.
While the markets could of course bounce back, there is ample reason to fear that if the U.S.–China trade war were to tip the global economy into recession, there will be many more days of large losses in the U.S. and global equity markets. In the event of a recession, companies would not be able to generate the earnings needed to justify today’s lofty equity price valuations.
Judging by China’s immediate retaliation to the U.S. import tariff threat, it would appear that China has no intention of caving in to United States trade policy demands. It would seem that China knows the costs that a US-China trade war can inflict on both the U.S. economy and the U.S. stock market, and it also knows that there are political limits to how much pain the U.S. can bear.
Sadly, it is far from clear that the Trump administration has a grasp on how costly to the U.S. public its China tariffs might be. It is also not clear that it understands the dangers of the tariff fire with which it is playing.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.