United States

One step closer to a global trade war

U.S. trade spat with allies intensifies

THE REAL ECONOMY  | 

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What a difference a month makes! Effective June 1, four weeks after declaring trade spats on hold, the Trump administration slapped tariffs of 25 percent on steel and 15 percent on aluminum for Canada, France, Germany, Italy, Japan and the United Kingdom—key U.S. trading partners—and promised to slap an additional $50 billion worth of tariffs on China beginning June 15. In our estimation, if fully implemented, these tariffs, in aggregate, will shave 0.2 percent from potential growth and put more than 2 million jobs at risk. This estimate may actually understate the true nature of the tariff impact due to uncertainty around likely retaliation by China, Canada and other G-7 trading partners.

The steel and aluminum industries support some 10,000 U.S. jobs. RSM estimates that the U.S. tariff structure amounts to a cost of approximately $915,000 per job to protect those industries. Similar to attempts by the Bush and Obama administrations to engage in protective trade activity, the current plan will also likely prove untenable and cause adverse outcomes for auto and aerospace businesses, as well as introduce higher costs for American consumers.

In fact, near-term substitution effects by downstream producers are already causing demand for domestically produced steel to decline, the very opposite of the outcome that the policy shift sought.

MIDDLE MARKET INSIGHT: The uncertainty imposed on U.S. industry due to the intensification of trade spats will likely cause middle market businesses that have export exposure to China, or are consumers of steel and aluminum, to absorb higher prices in advance of full implementation. As a result, middle market businesses will likely need to adjust to narrower profit margins and net revenues as they explore passing price increases on to customers.

U.S. trade and prospective tariff targets in perspective

The U.S. imports $2.4 trillion of goods and services each year that it otherwise does not produce in sufficient quantity or quality to meet the preferences of domestic consumers. Potential import targets based on the administration’s threats include autos (equal to about $176 billion, or 8 percent of total trade), aluminum (around $13 billion) and steel (roughly $30 billion). Together these industries account for slightly less than 2 percent of trade, and just 0.21 percent of total gross domestic product (GDP).

The administration has also threatened to place tariffs on China of about $50 billion in the near-term, and a total of $150 billion overall. (The U.S. imports about $136 billion in goods from the targeted China industries, which include the transportation, agricultural and chemicals industries, among others.)The latest moves imply that an intensified trade spat could easily turn into a tit-for-tat retaliatory trade war. That would almost certainly spill over into broader consumer imports and translate into higher consumer prices in the near-term, with the largest impact on the two lowest quintiles of income earners.

At this time, widespread reports of non-tariff barriers being imposed by China on U.S. agricultural and auto products are wreaking havoc among businesses attempting to estimate demand and production schedules for the second half of 2018.

Risks

There are two broader risks associated with the intensification of the trade spat. The first is linked to the disruption of the North American supply and value chains that have been constructed over the past quarter century.

Based on recent visits with our Canadian and Mexican trade partners who have taken the risk of a breakdown in NAFTA much more seriously than their American counterparts, middle market businesses based in those economies are already well along the way toward identifying and arranging for alternative sources of inputs in earlier stages of production and intermediate goods necessary to meet demand.

The second risk is the “uncertainty tax” linked to a general disruption of the global rules-based trading system for middle market businesses with exposure to the global economy. In our estimation, any disruption associated with the imposition of tariffs, quotas and an array of non-tariff barriers will distort patterns of gross private investment in general, and capital expenditures in particular.

MIDDLE MARKET INSIGHT: The most exposed middle market businesses are those downstream in the manufacturing, agricultural, construction and industrial products ecosystems. If the trade spat intensifies and begins to include consumer products, the broader retail, footwear and apparel industrial ecosystems will be hardest hit in the near- to medium term.

While the respective trade spats are still in early stages, investors have already moved to drive prices higher. One needs to look at the price of Canadian soft lumber (one of every three pieces of wood used to construct U.S. homes is imported from Canada), which have faced a tariff since early 2017, and have increased 20 percent this year. In the United States, this has caused the price of homes to appreciate by more than 1 percent, an increase directly linked to the tariff. Similarly, aluminum prices are up more than 25 percent this year, and steel prices are up nearly 30 percent.

These tariffs may support some steel producers, but come at the cost of harming all downstream businesses that use steel and, of course, consumers who are in the process of absorbing the pass-through costs of rising prices caused by the policy.

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