BRACING FOR TRADE WARS

Samantha Amerasinghe analyses the potential impact of US tariffs on imports

A new age of protectionism and trade wars between the US and its three largest trading partners has begun. US President Donald Trump has long declared that he is a “tariff man” who is willing to impose sweeping levies on imports from countries that have hurt the United States.

He has threatened to hit Canada, Mexico and China with steep tariffs of up to 25 percent on goods imported from trading partners. And if he does, the implications will be severe. According to the Director-General of the World Trade Organization (WTO) Ngozi Okonjo-Iweala, there is a high probability of double digit global GDP losses.

Uncertainty prevailed at the time of going to print, as Trump halted sweeping tariffs on Mexico and Canada hours before they were due to come into force, pulling North America from the brink of a damaging trade war.

A trade war may still unravel but it was delayed for another month as both Canada and Mexico agreed to implement border security measures to stop migrants and drugs crossing into the US. This buys time to see whether or not a final economic deal with Canada could be structured.

Trump claims that lax security at the borders with Mexico and Canada justifies his use of tariffs, arguing that both coun­tries along with China have failed to do enough to stem the flow of deadly opioids into the United States.

He has also cited the US’ trade deficit with Canada, Mexico and China as justification for the tariffs.

These tariffs will be far-reaching and deliver an immediate shock to the economies of North America and the world, if implemented. They will jeopardise decades of progress towards economic integration that has boosted global prosperity and the US economy.

Trump plans to apply additional tariffs of 25 percent on all imports from Canada and Mexico, with the exception of Canadian oil and energy products, which would face a 10 percent tariff over and above existing US tariffs.

Canada is by far the largest foreign oil supplier to the United States and accounts for about 60 percent of its crude imports. Should he follow through with his tariff aggression, it would deal a severe blow to Mexico and Canada, as it’s been less than six years since they signed the United States-Mexico-Canada Agreement (USMCA) with Trump, in the hope of stabilising relations with the US.

Mexico and Canada will be hardest hit globally, given their heavy reliance on the US economy, with both facing outright recessions if Trump goes ahead with his planned 25 percent tariffs in the future.

It’s ironic that the two countries that struck the biggest trade deal with Trump in his first term may be the first two to be hit by tariffs. Officials are considering imposing universal tariffs on all imports – including plans to levy tariffs on EU imports too.

The unravelling of North American free trade and supply chains built up over decades will deal a severe blow to both US consumers and corporate America – especially oil refining, automobile production, pharmaceuticals and agriculture. The tariffs seem nonsensical and unnecessary as they will impact over 40 percent of US imports – and that will result in a significant supply shock to the US economy itself.

If countries are hit by Trump’s tariffs, they will very likely retaliate.

A swift response came from Canadian Prime Minister Justin Trudeau when he announced 25 percent tariffs on US goods worth US$ 107 billion including alcohol, clothing, household appliances and lumber. This will put American jobs at risk, and potentially shut down US vehicle assembly plants and other manufacturing facilities.

Mexico and China have also said they will announce retaliatory tariffs and other measures if Trump follows through with his plans. However, these retaliatory measures have been put on the back burner for the time being.

Part of the impact of Trump’s tariffs could be mitigated by an appreciation of the US Dollar and substitution of goods produced locally. Corporations may also choose to absorb some of the increase in costs via lower profit margins. But the magnitude of Trump’s initial tariff actions – if fully implemented – appear far greater than the trade wars he instigated against China and G7 countries during his first term in office.

Two significant dangers that face the United States include the potential selloff that sends equity markets and the value of Americans’ retirement plans plunging, and the prospect of inflation picking up again after gradually falling towards its two percent target over the past two and a half years.

Economists have warned that Trump’s proposed measures could push the personal consumption expenditures price index (PCE) – or headline inflation – above three percent compared to 2.6 percent at the time of writing.

There is a strong case for thinking that Trump’s tariffs may never take effect. But there’s also reason to fear that he might ignite a trade war with profound implications even if they are in a more modest form to what he initially intended.

One ominous sign is Trump’s tariff of 25 percent tariff on steel and aluminium, announced on 10 February, which will apply to all countries.