After a hiatus of nearly five years, a new round of the trade conflict with China is underway.
Last week, President Biden announced the White House has decided to raise tariffs on imports of goods from China that total $18 billion. The actions apply to some of the fastest growing exports from China. The biggest increase quadruples the tariff rate on Chinese-made EVs from 25% to 100%, while the rates on lithium batteries will increase from 7.5% to 25% and those on solar panels will rise from 25% to 50%.
A New York Times report by Keith Bradsher documents steps China’s government has pursued to spur industrial development since it launched its Made in China 2025 program almost a decade ago. One way the government subsidizes exports is through the state-controlled banking system that directs loans to key sectors at low interest rates. According to the Kiel Institute in Germany, nearly all publicly-listed companies in China received government subsidies in 2022.
China’s automotive sector has recently surpassed both Japan and Germany to become the world’s largest car exporter. It has done so by ramping up production of EVs, and China’s companies now produce the majority of the world’s electric car batteries. European auto companies are feeling threatened, and the EU is considering raising duties on Chinese cars to 55%. The Biden administration is promoting production of US-made EVs and wants to protect it at this stage of its development.
Previously, Biden had kept most of the tariffs the Trump administration imposed on China in place, but did not add new items. With the presidential election less than six months away and Trump making international trade one of the center-pieces of his campaign, Biden wants to demonstrate he is taking a tough stance on China.
Steve Rattner criticized Biden’s move in an op-ed for the New York TimesNew York Times
and believes it could backfire if Biden is perceived as aligning himself with Trump’s trade policies. However, based on how well the U.S. stock market is performing now, investors see considerable differences in Biden’s and Trump’s trade policies.
When Trump launched the trade war in early 2018, investors were wary that that it would prompt China to retaliate and threaten the global economy. After rising steadily in 2017 in anticipation of Trump’s tax cuts, the S&P 500 experienced a pullback of about 15% when the trade conflict escalated in 2018 (see chart below).
S&P 500 index, January 2017 to January 2020
The stock market did not surpass its prior peak until mid-2019, when the U.S. and China worked out an agreement whereby China would expand purchases of U.S. goods and services by $200 billion for a two-year period. However, China did not honor its commitment, which may be why Trump is doubling down on pressuring China now.
The stock market has not reacted to Biden’s announcement because the duties he will impose on China are more targeted than what Trump is contemplating. During the current campaign, Trump has called for boosting tariffs on China by 60% while raising tariffs by at least 10% on all $3 trillion worth of U.S. imports. He has also recently called for duties of 200% on vehicles produced in Mexico by Chinese companies.
A report by the Peterson Institute for International Economics (PIIE) contends that Trump’s unprecedented trade proposals would inflict “significant collateral damage on the U.S. economy.” It estimates they would cost American consumers at least $500 billion per year and would boost costs for middle-income families by at least $1,700 a year. The actions would also likely invite retaliation from trading partners including Europe, Canada, Mexico, as well as China, which would add to the costs.
Mark Zandi of Moody’s is also highly critical of Trump’s trade proposals. He estimates that even if Trump cushioned the blow from tariff increases with tax cuts, they would cost the U.S. economy 675,000 jobs, worsen inflation and shrink GDP by O.6 percentage points. When the likelihood of retaliation is factored in, he believes the U.S. economy would plunge into a recession.
So, how should investors respond to this prospect?
My take is at they should not over-react, because it is a close call whether Trump will be elected president and, if so, whether his actions will match his rhetoric. That said, one lesson from Trump’s presidency is they should not dismiss his stance on international trade: He has been a steadfast critic of free trade for the past four decades.
When Trump assumed office in 2017, one of his most important decisions was to appoint Robert Lighthizer as U.S. Trade Representative. He had previously served as Deputy Trade Representative for Ronald Reagan in 1985, when the U.S. dollar was very strong and the U.S. ran record trade deficits with Japan. He was involved in the negotiations over limiting Japanese auto exports to the U.S. then.
In Lighthizer’s capacity as Trump’s trade envoy, the administration’s over-arching goal was to restore jobs that were lost in manufacturing. The main target was China, which many observers believe benefited unfairly when it was admitted to the World Trade Organization in 2001 and U.S. manufacturing jobs declined by about six million during the decade. The Trump administration, however, fell short of its goal as manufacturing jobs increased only marginally.
The key difference today is that Lighthizer’s goal is much broader than before. In a book published last year, he called for trade imbalances to be eliminated altogether and for the U.S. government to depreciate the dollar to improve U.S. international competitiveness.
It remains to be seen whether Trump would adopt Lighthizer’s recommendations. If they were pursued, they would pose a much greater risk to the international financial system and global markets than what occurred during Trump’s presidency.
