November 24, 2018

Trump’s Tariffs: Playing With Fire

by Hal Gershowitz

Comments Below

Of Thee I Sing Heading AuthorsPerhaps Chinese President, XI Jinping, may, sooner rather than later, make some concession that President Donald Trump can pocket as a major victory and, hopefully, bring the ill-advised Trumpian growing trade war to an end. That could happen because President XI, we suspect, is far wiser, more patient, and more of a long-game, strategic thinker than President Trump. But, then again, that might be wishful thinking on our part. Trump may actually believe that trade wars “are good and easy to win.”  If so, he’s playing with fire. His is the thinking that brought us the Smoot Hawley tariffs and a quickening of the collapse of world economies in 1930. Trade wars, almost by definition, are not good, nor are they really easy to win.

“Tariff” is a somewhat esoteric term. Just think of it as a tax on imports that the American consumer will have to pay. Of course, the American consumer could beat the tax by not buying the more expensive product that is burdened with the cost of the tariff. The consumer would have beaten the tariff, but many of the people who work for the companies whose products are no longer being bought would, eventually, lose their jobs. That’s what super-charged the great depression ninety years ago. The Smoot-Hawley tariff was a disaster. Trump’s tariffs will be too if they continue.

Trump is playing with fire:

If, instead of making some concession to Trump that would be sufficient to end Trump’s easy-to-win war, XI Jinping decided to hunker down and man the ramparts, he has some economic artillery with which he could cause some pain himself. Trump, of course, wouldn’t suffer but the American People could suffer mightily. Now, to be sure, China would suffer too, but if Trump leads us into a contest to see which people can tolerate pain the most and for the longest period of time, well, the Chinese people have a long history of living with unspeakable deprivation for eons. In a contest about which People can hold its breath the longest, China probably wins.

President Trump laments the fact that China doesn’t buy more American generated goods. He ignores the fact, however, that China buys more American debt than anyone else in the world—as much as $1.3 trillion worth so far, either directly or through proxies.  It serves China well to be our biggest foreign creditor. American debt is the world’s safest and most solid investment, and it serves us well too having China as an aggressive buyer of American debt. It helps to keep down our interest rates.  So, what if China started dumping the debt it holds or stopped buying the debt we issue? Interest rates would certainly creep up, but we would have defenses to be sure. The Federal Reserve could start buying the US debt the Chinese were unloading, and the effect on our economy might (or might not) be manageable. We’d be back to having our Central Bank buying our debt as it was doing in response to the meltdown that began in 2008. Disruptive, but not necessarily catastrophic.

The Chinese could also look to buy more products from non-American suppliers such as Airbus, and the resulting loss of Boeing jobs would have a bigger effect on the American psyche than the loss of soy bean sales, which is already playing havoc within the American agricultural sector.

China certainly understands that the American trade deficit with China isn’t quite as big as President Trump understands it to be (or tells us it is). Nothing unusual there. President Trump publicly laments a $500+ billion trade deficit with China. He says we are losing $500 billion with China. Well, not quite. We’ve purchased assets with those dollars. Someone should also remind President Trump that China did import about $130 billion worth of American goods, which adjusts the so-called deficit to $370 billion. Then there’s another $50 billion in services we sold to China which lowers the real so-called deficit to about $320 billion.

This direct comparison, however, of what we buy from China with what China buys from us is a bit nonsensical anyway.  To a great extent, it doesn’t matter.  That’s because world trade is tightly interconnected and highly dependent upon the US dollar as the international reserve currency. To illustrate, the United States might buy plastics from China with US dollars. China might then use those US dollars to buy ore from Australia, and Australia might then use those dollars to buy machinery from the United States. In this example, we spent US dollars to buy plastics from China. This gave China US dollars with which to buy ore from Australia, which, in turn, enabled Australia to buy machinery from the United States with the US dollars Australia earned from the sale of ore to China.

Similarly, China might wish to buy electrical control boards from Germany. It would buy Euros with the dollars it received from sales of plastics to the United States, and use those Euros to purchase the electrical control boards. Germany, meanwhile, might decide to buy pharmaceuticals from the United States. It would convert the Euros it received from China to US dollars and use those dollars to purchase the pharmaceuticals.

You get the picture.  Contrary to what President Trump seems to believe, trade is not a zero sum game where one country wins and one country loses. Trade and investment flow constantly throughout the modern world.  Trade causes investment, in some cases to protect markets and in some cases to develop markets.  As we write this essay, the United States is the worlds largest beneficiary of foreign direct investment. We are the greatest destination for investment on the planet.  As we began 2018 the United States had attracted over $4 trillion in foreign investment. This investment manifests itself in facilities and jobs. Lots of jobs.

But today, the Trump Administration is preoccupied with a mercantilist trade war. Exports good, imports bad. What nonsense. So, for the foreseeable future, war it will apparently be. Thus far, China has identified the products it will target in response to the US tariffs.  According to the Brookings Institution, retaliatory tariffs China has identified so far will affect about 2.1 million jobs spread across 2,783 U.S. counties. Well, what’s a couple million jobs lost at the outset of a trade war?

Sadly, many more Americans are employed by industries that use steel and aluminum in the manufacture of their products than by industries that simply manufacture steel and aluminum. Those industries that have to purchase steel and aluminum will be burdened by Trump’s tariffs because they will have to buy more expensive steel and aluminum to manufacture their products. That could well make imported finished products made with steel and aluminum (not subject to the tariffs) from, say, Europe, or Mexico less expensive than the products of American producers who have to pay more for the steel and aluminum used in their products because of the tariffs. Result? Lost jobs in the United States.

Every economist since Adam Smith has understood, even if President Trump doesn’t, that protectionism often hurts the country imposing protective tariffs.  When a country taxes steel imports, it cripples the ability of its own domestic makers of cars, planes, and anything else containing steel to export their products, because their products will then be more expensive.  That’s not rocket science, it’s common sense. Every school of business and economics understands this including the Wharton School, even if its  graduate who occupies the White House doesn’t.

Now, Trump knows that China doesn’t buy enough from the United States to continue the tit- for-tat tariff retaliation very long. They will run out of American-made products on which to impose a tariff. In other words, Trump believes he holds all the cards.  Well, not quite. China can further devalue its currency sufficiently to offset the higher cost of the tariffs. They would risk capital flight by doing that, but they might consider that a risk they’re willing to take in the face of what it considers to be trade aggression by the United States.

Finally, President Trump should stop talking about our trade deficit with various countries as a loss as though we sent American dollars into the nether world and got nothing in return. People have chosen to own Mercedes Benz, Audi and Lexus automobiles and Ram pick-up trucks and Sony televisions and American Girl dolls (yes, they’re made in China), and we could go on. Those automobiles and other products are sold and serviced through  American shippers, warehouses, dealerships, wholesalers, repair shops and retail outlets that employ millions of Americans. Trade creates wealth for both sides of the manufacturing, sales, service and delivery process.

Something to keep in mind:  Any nation that consumes more than it produces will, generally, have a negative balance of trade. It can solve that problem (if it is foolish enough to believe it is  a problem) if its people start consuming much, much, less and simply live with the recession (or depression) that may result. Or, its people can simply take a pledge to always buy the most expensive product, which is all a tariff accomplishes anyway.

We’re not sure where or when this trade war will end, only that there is plenty of damage to go around.

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8 responses to “Trump’s Tariffs: Playing With Fire”

  1. Leonard Sherman says:

    What about what is happening to American farmers i.e. Soy beans are major export to China.

  2. Hal Gershowitz says:

    Indeed, Mr. Sherman is correct. We did allude to the extremis the Trump Traiffs are causing American soy bean growers. But just wait until China begins retaliating by buying passenger jets from Airbus instead of Boeing.

  3. Charles Anderson says:

    Hal, thank you for your concise assessment of our current president’s complete ignorance of most anything but his inflated ego and self interest. He clearly has as little knowledge of basic economics as he does of basic civics.
    Unfortunately our failing education system has created a sizable portion of our populace who are just as ignorant as our president.

  4. Robert borns says:

    Americas problem is not trump or tariffs. For many many years we didn’t realize that we were no longer the rich uncle playing fancy free with our wealth and resources both material and intillectual. It took trump to wake us up. You may not like the way he does it but he alone has done it. Americas success has not been only because we have been so smart. It’s also because the rest of the world has been so dumb. But dumb is over and much of the rest of the world is aggressively moving forward. And we better recognize that or we will be losers. Trump said he is president of Pittsburg not Paris. That sentence and the deep meaning behind it should be the wake up call to make us start pulling together.

  5. Hal Gershowitz says:

    History will judge whether or not President Trump has been helping to pull us together. We doubt, however, that tariffs, which are the subject of this essay, will contribute to pulling us together.

  6. Steve Marcus says:

    Even a broken clock is right twice a day.

  7. Mike Regan says:

    I love your essays but this particular subject does not lend itself to a Blog type analysis.

    Like the points in your article, I was intensely concerned about the fallout from a Trade War. But then I interviewed some professionals Last month I interviewed noted economist, Gary Shilling and also interviewed Carolyn Gleason, the Chair of McDermott, Will & Emery’s Global Trade Practice. (The interview is available at Tranzact.com in the Perfect Storm Center. They raised some very interesting issues which I had not considered.

    Perhaps the most important factor in this battle is the issue of theft of Intellectual Property. In fact, there are some people who believe that looking to the future and a world that is increasingly influenced/driven by technology, letting China continue to steal our intellectual property over a multi year period is worth hundreds of billions of dollars in R&D.

    And as one business associate noted, we have kicked this can down the road long enough. It will never get easier to address and the consequences of waiting are too significant.

  8. Hal Gershowitz says:

    I agree.
    Tariffs, however, are certainly not an effective way to deal with theft of intellectual property. The thief might just decide the tariff is a cheap price to pay for what they’ve stolen.

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