Trade wars step up, more to come

As the trade wars escalate, no sign of agreement between the US and China can be seen. Keith Wade, Chief Economist & Strategist at Schroders, assesses the macro impact.

The US has announced tariffs on another $200 billion of imports from China, citing ongoing concerns over the theft of technology and forced transfer of intellectual property. The tariffs take effect next week and are initially set at 10% rising to 25% from 1 January next year. China has yet to respond, but the White House has warned that any retaliation will lead to tariffs on a further $267 billion of additional imports. China may bide its time, however, Keith Wade expects they will follow with tariffs on a further $60 billion of imports from the US.

Ideological barriers shrink room for negotiations
For some time Wade's assumption has been that we will eventually see tariffs on all the goods traded between China and the US. "The red lines on each side are too ideological and entrenched to allow much room for manoeuvre," he states. China sees its trade policies as an essential part of the growth strategy that will allow the economy to hurdle the middle-income trap, in line with its "Made in China 2025" policy. Meanwhile, President Trump came to power promising to put "America first" and he has assembled a team that believes China is a root cause of the decline in parts of the US economy.

"Against such a backdrop, we have the makings of a chronic dispute that will go well beyond the mid-term elections in November," claims Wade. Whilst China has less scope to match the scale of goods covered by US tariffs it has plenty of opportunity to apply non-tariff barriers, apply restrictions and make life difficult for US companies operating in China.

Stagflationary effect the probable outcome
According to Wade, in terms of macro impact, the latest tariffs will slow Chinese export growth to the US. The extent of the impact will depend on the price sensitivity of the goods involved and whether alternative sources of supply can be found. Movements in the exchange rate can also offset tariffs, even though Wade does not expect China to devalue the renminbi in response. Model simulations suggest China's export growth will be 2-5% weaker. Global growth would also be weaker as international trade slows. However, these effects will take time to come through. In the near term, Wade predicts an actual boost to China's exports as US companies accelerate imports ahead of further tariffs. This will complicate interpretation of the impact and frustrate the Trump administration's desire for a smaller bi-lateral deficit. "Ultimately though, the effect will be stagflationary, as tariffs slow trade and uncertainty drags on capital investment, whilst the extra cost of imports adds to inflation," closes Wade.