In the following individual essay, I will identify short and long-term impacts on the Chinese and American economies because of the actions of tariffs on China and the potential trade war. My hypothesis in this essay is that the United States of America will in the short-term benefit from this escalating trade war, however, in the long run, both countries will lose and will result in a worse off the global economy.
On the 29th of May 2018, President Trump of the United States of America (USA) announced that the USA would charge importers of Chinese goods 25% tariffs on 50 billion dollars’ worth of goods chosen. China negotiated up to 70 billion dollars worth of additional imports from America if the tariffs were not to go ahead, this was declined and in retaliation has identified its own 50 billion dollars’ worth of goods to create tariffs for (LEMIEUX, 2018).
When a National government imposes tariffs on the importation of goods from another national government, this has historically been shown to cause a tit for tat escalation (LEMIEUX, 2018). Although President Trump has stated that “winning trade wars is easy” (Trump, 2018) we know from history that the stakeholders of the trade wars on both sides rarely win in the long run (CHI, 2018).
Across the world, news of a potential trade war is on people’s mind, and this has already had an impact of the loss of business confidence (ECONOMIST, 2018). As the world’s economies are globally linked, the realisation that the two largest economies are escalating does not provide the conditions for investment in future gains, therefore, in the next twelve months (short-term), globally there will be little appetite for investment and global growth would most likely halt (Aizenman, 2018).
The USA. From the implementation of these tariffs in June 2018, Chinese made goods would be more expensive for the end consumer, as the quantity demanded of these goods will not change, the consumer will choose the more affordable products and this leads to the USA manufactures becoming more competitive. If these manufacturers could not be competitive domestically by themselves, they can be with government assistance. These tariffs were designed to help declining industries and the American stakeholders indirectly (LEMIEUX, 2018).
Over the short term, companies in the USA will have the ability to raise prices up to, and including being just under the competitive Chinese price, this additional profit to the bottom line will allow more technology and efficient use of USA competitive advantages. With more demand for the goods produced in the USA mixed in with larger profits, the USA companies could hire more workers and invest in short-term projects to sustain themselves moving forward.
Importer firms who work with China will be paying 25% tariffs, in the short term they will be forced to reduce importing as the demand for Chinese goods will decrease meaning they will be decreasing jobs, as importers are around the oceans and industries are located inland predominately, this confirms President Trump’s promise pre-election to look after dying industries.
With increases in prices of products like Steel, this will increase the prices to secondary manufactures and therefore decrease their prospects of scaling, causing less growth and higher consumer prices of their products, of which will have a lower quantity demand due to increased prices. (Layton, 2016)
Product alternatives, products such as Steel can only increase their prices as much by what makes them competitive with other alternatives such as aluminium. It is likely that these competitors will also increase prices, with less total competition in the market (Layton, 2016).
The law of supply and demand agrees with the hypothesis that the USA will increase jobs overall by increasing uncompetitive markets while decreasing competitive ones (Harding, 2018). The USA government will effectively benefit from more jobs in the short term, even though the consumer prices are now higher causing dead space and thus not economising the resources for the most efficient purpose; the USA government are effectively taxing part of an industry to do what they perceive as social good. These tariffs in effect only help the companies adjust in local areas, not in the wider economy (Krugman & Wells, 2005).
History in 1929-1933 commonly known as the Smoot–Hawley Tariff also confirms this hypothesis; the trade war between the USA and Canada, increased jobs, construction and industrial product production initially and was deemed a success (Beaudreau, 2017).
If China was to retaliate with lowering prices; by either financing, the exporters in China, lowering the Yuan through quantitive easing or mitigating the tariffs by exporting via other countries, the consumer may achieve the same lower prices from China made products. Resulting in more tariffs from the USA and escalating further. If China retaliates with tariffs of their only on investment and imports, then Americans will see a rise in prices, rising inflation and reducing the amount of investment in their future economy both from China and domestically.
China. With less demand for Chinese made goods, China would have to ensure their workforce isn’t overproducing; there are many solutions for how China can ensure equilibrium.
Currently, China is already under scrutiny for diverting around tariffs by heavily investing in neighbouring companies and ports, by shifting production from China to other ports and then repackaging, China can effectively skirt around the majority of the tariffs in the short term (Barron, 2018).
With less quantity demanded Chinese made goods into America, the Chinese government can increase capital investment to help new industries grow, which would then mean those manufacturers would be repurposed to make new goods which will not have the 25% tariff or may find new markets in different countries. With the volume in which China supplies the USA, targeting other affluent countries may result in larger profits for Chinese manufacturers.
To avoid fewer profits and worker layoffs caused by a reduction in demand, Chinas (other options are to supplement exporters with an exporter tax or lower the yuan to compensate. This will be effectively increasing debt for China which is not their strategy. Increasing debt for China relative to gross domestic profit (GDP), will be diverting from a more profitable industry to a not so profitable industry causing allocation of resources to not be as productive (Harding, 2018).
Initially causing a lower yuan relative to the USD and higher debt for China. The social good will mean retaining jobs for China yet lowering their standard of living (Kent, D & O’Brien, P, 2017). In effect, China’s short-term plan could merely help to increase Americans standard of living through supplementation.
If China retaliates with restrictions on imports from the USA and investment in the USA, this would cause redistribution from one industry to another and prohibit further investment in American companies, causing a spike in investment in more secure investments such as Gold Australia economy and New Zealand economy. With less trade with America, it would be advantageous for China to reduce if not to zero their US treasury bonds, which would free up capital for investing in new economies.
Throughout history, there have been many escalating trade wars that have come from physical wars or have been the lead up to conflict. Smood-Havley tariff in America is a good example to use as it was a similar broad range of products and was designed to provide jobs in the early 1930s. The USA started with an increase in jobs and production (Beaudreau, 2017). However, economists agreed that these tariffs exacerbated the great depression (Morris, 2018). Leading the USA to high unemployment from 8% in 1930 to 25% in 1933, reducing gross production from 103.1 billion dollars’ worth of productivity in 1929 to 55.6 billion in 1933 (Census, 1945) and although Canada suffered, they forged new alliances with the British empire allowing them to mitigate to the trade war and causing theUSA a longer recovery when they wanted to start trade again.
The USA. After the initial potential increases in jobs, as the trade war continues, consumers will pay raising amounts for all goods that used to be globally competitive, this rise in inflation will see consumers investing less in their local economy and on the stock exchange, causing a potential decrease in the American stock market (Dirkmaat, 2018).
Assuming China retaliates by increasing tariffs on American imports, exporters in American will be priced out of the market; this will create less shipping routes between the two countries and decrease jobs on these routes and any parallel industries. Any future trades will take time to set up and therefore increase the barrier to entry.
Higher prices in America will mean lack of investment in future returns, and with lower business confidence, businesses will focus on reducing costs and not on innovations, this will increase unemployment rates and leave the US behind on production technology. The US will probably lower interest rates to stimulate the economy. However, they are already at 1.75%, and the progression lower could lead to higher inflation and a reduction in support of the world for US bonds (Riedel, 2018). US GDP will likely decrease as China, and the rest of the world adjusts for the new prices, and trade routes, America’s nationalistic approach to trade will see lack of willing participants in the industry, causing long-term harm to future trade with Americans, i.e. taking much longer to fix. Historically Americas 1930 depression was increased in duration and severity by tariffs (Beaudreau, 2017), as the world recovers from the global financial crisis, this may segregate the US further and make their recovery longer.
An alternative long-term impact on the health of America will be dependent on the short-term decisions that China and allies choose to move forward with, if China were to stop purchasing US treasury bonds and sell their bonds on the open market, this would cause a spike in volume, ending in lower prices for bondholders. China holds 1.17 trillion dollars worth of US treasury bonds, if released the USD will fall, triggering other countries to do the same and sell, gold would increase in value, and the yuan would now be more expensive, making American products competitive with the rest of the world, however, they may not wish to open trade routes up quickly. If the world were to not value the US bond as a secure asset, they would sell, and this would lower bond prices, which would mean higher yields (Morrison, 2017).
Higher bond yields effectively make it more expensive for American companies to loan money for investment and this would see American market slow down further as companies are unable to grow. A slow economy will most likely see the American federal government decrease their interest rates again to try and stimulate the economy, increasing their publically held debt further and lowering the USD even further.
China. If China were to stop buying US bonds and sell all their current US bonds, they would cause their currency to increase relative to the USD (Layton, 2016), making imports much cheaper and increase the peoples standard of living (Kent, D & O’Brien, P, 2017). As China has labour forces around the world, including recently in Africa (World Bank, 2015) as well as high amounts of global investments (XIAMEN, 2018), it is most likely that this would help China recover faster from the trade war, due to their ability to supply themselves all goods and services.
I suspect China’s trade will increase with other major nations due in part due to their well-placed investments and also due to how the world will perceive them as the victim. Using game theory, we can presume China will increase tariffs and reduce investment knowing that America will do the same (Li, C. et. al, 2018). It is not clear if China will be as affected as much as America through this trade war as they can increase their currency and shift exporting to other countries. Their investments could then focus on China, Australia and New Zealand where they could drive their country to a financial and technologically driven economy leveraging robotics and lower barrier to entry products.
With no trade agreement with America, China may also move with Russia and India and recreate, for instance, the worlds pharmaceutical products, bypassing US patent laws among new economies it could create.
I hypothesised that the United States of America would in the short term benefit from this escalating trade war, however, in the long run, both countries will lose and will result in a worse off the global economy. When examining the short-term and long-term effects of the escalating trade war, this essay has shown through historical accounts and economic theory, that the USA will benefit in the short-term but will likely become the only loser in the long run.
As we can see, a few months later America is growing a 20 trillion dollar country at 4.5% yet their deficit is at 7% of GDP, or in other words, putting off problems today, for tomorrow! We said this earlier in the essay above re short-term impacts would make America look strong and one way they can do that is to continue to spend those bonds instead of reducing debt (or at least not get more). With the availability of credit now in America we are seeing higher house loans and soon to be lower interest on the bond prices compared to the rest of the civilised world.
The one mistake I did make in my prediction above, was that we would see an increase in interest rates to stop such a large growth, nope…. Trump is going hard! Which means too much cheap credit going around and for this amateurs, opinion meaning there is nowhere for Trump to go down on his interest rates when things go tits up.
Interesting if America continues, we will have a real bubble America, a weak china, house prices up in the western world and global nationalism socialism on the rise (i.e no new economies being enabled)
Imagine what happens if the GFC v2.0 2018 will have no options: we can’t lower interest rates, we have high deficits, people have printed money and well… the 100-year cycle is upon us 🙂
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