Let’s stop pretending. An import tariff is nothing but a tax on consumers and businesses. Not in the exporting country, but the importing one. So the 10% tariff on $200bn of Chinese imports that President Trump has just imposed is in reality a new tax on Americans. And it will hurt America much more than China.
On September 18th, 2018, in an increasingly bitter trade dispute between the world's two biggest economies, President Donald Trump imposed a 10% tariff on $200 billion of dollars worth of Chinese goods, rising to 25% in January 2019 if China does not agree to a deal. China has said it will retaliate. (JOHANNES EISELE/AFP/Getty Images)
It is at present unclear exactly how this tax will bite, but we can expect it to have three broad effects on the U.S. economy.
The tax will raise input prices for American businesses, increasing their operational costs and putting pressure on profit margins.This is likely to feed through into weaker wage and employment growth, leading to poorer retail sales and declining economic growth. The Trump boom is already fading: this tax seems likely to hasten its end.
The tax will raise headline CPI inflation. How much inflation will rise depends on the extent to which producers are able and willing to absorb higher costs rather than passing them on to customers.The Fed might respond to rising cost-push inflation by increasing the pace of interest rate rises. This would dampen consumer demand at a time when it was already under pressure because of the wage and employment effects of the tax. Fed interest rate policy has previously accelerated consumer demand slumps, most recently in 2006-7, when the Fed continued to raise interest rates despite rising unemployment, falling house prices and weakening consumer demand. I suppose we might hope that the Fed would act more responsibly this time, but the “mood music” from the Fed these days is increasingly hawkish. I am therefore doubtful that this time would be different.
The tax will strengthen the U.S. dollar’s exchange rate. At the time of writing, the U.S. dollar was already up 10% versus the (offshore) Chinese renminbi. If China allows the onshore renminbi to depreciate, this would largely negate the impact of the tax on Chinese exporters while making life more difficult for U.S. exporters
Of course, although the tax falls primarily on American consumers and businesses, there will be a knock-on effect to Chinese producers through reduced exports. But in their snap response to the tariff announcement, CLSA (via FT Alphaville) estimated that the impact on China’s exporters might amount to little more than a flea bite:
