Some sanity returns as trade war talk rages on

Fears of an impending trade war with China returned over the past week, as the US detailed its plans to institute $50 billion in tariffs on Chinese imports, targeting approximately 1,300 different products. China responded late Tuesday with an announcement of retaliatory tariffs targeting key US exports to China such as soybeans and automobiles.   

The prospects of an escalating trade war with China are certainly daunting, and markets reacted negatively to the news initially, with markets down severely at the start of trading on Wednesday. Calmer heads prevailed and markets rebounded by the end of the day, however, and a closer look at these announced tariffs gave several reasons why this spat with China may not be the doomsday that many fear.

The tariffs may not happen  

It’s important to remember that these announced tariffs may not ever be implemented, at least not in their announced form. The global economy was stunned a month ago by the announcement of tariffs on steel and aluminum coming into the US, but by the time the tariffs were placed into effect in late-March nearly all of the major steel importing countries were granted exemptions from the tariff.

With these most recent tariffs, the US has signaled that there may be significant changes by the time they are finally implemented. For one, US Trade Representative Robert Lighthizer announced a 30-day period where his office would accept feedback, after which the administrations could conceivably modify the tariffs to reduce the effects on the US economy.

Additionally, there is a growing sense that these recent announcements are just being used for positioning for potential negotiations between the two nations. When asked about the use of tariffs as a negotiating tactic, National Economic Council Director (and frequent free-trade advocate) Larry Kudlow said: “Potentially. It’s part of the process. I would take the president seriously on this tariff issue. There are carrots and sticks in life… Both sides benefit by positive solutions that lower barriers.”

China, for its part, has also left the door open for negotiations over trade with the US. In announcing the retaliatory tariffs, China did not provide a timetable for implementation, instead opting to wait until the US makes more concrete plans. In addition, Chinese officials have repeatedly asserted the desire to avoid any escalating trade dispute with the US. As a result, much of this still looks more like posturing between the two sides as each tries to show the other exactly what it is capable of doing on the trade front.

In fact, so far the biggest damage done by tariffs is the result of the uncertainty around policy that exists now. This move towards increased protectionism is a reversal in direction from over 30 years of policy aimed at increased globalization. This, in turn, has forced business leaders and global governments to reevaluate their strategies in a world that is now pushing against the trend of becoming more integrated.

Even if implemented, the tariffs are still comparably small

Of course there is still a decent enough chance that these tariffs actually do get put into place. But consider that the tariffs are only designed to affects $50 billion of goods coming in from China. This represents less than 2% of all imports into the US and less than 10% of the more than $500 billion that the US imports from China every year.

Similarly, the tariffs on US goods flowing into China represent only a fraction of goods imported into that economy. And while exports and investment helped drive China’s growth during much of its emergence as a global economic power, its economy has re-balanced quite a bit, with growth in consumer spending becoming the primary driver of growth.

Of course, the worry is that these tariffs are just the beginning. While the announced tariffs aren’t large enough to derail international trade, China is still an important trade partner with the US and escalation between the two nations could cause a much bigger shift in the overall trade picture for the US.

In addition, tariffs on goods coming from China have spillover effects on other nations. Many of the manufactured goods there are made from parts imported from other nations, which are then assembled and sent to the rest of the world. A cellphone imported from China into the US might contain a lithium battery made in Japan and an OLED screen made in South Korea. These nations have favorable trade relations with the US, but would also feel the effects of tariffs on Chinese imports. As a result, there is some risk that the global community would begin to retaliate and this situation with China could spill out into a broader war.

The US economy is performing well already

Even a broad wave of protectionism may not be enough to derail the US economy. For one, instituting tariffs either forces higher prices on imported goods or leads to a shift toward more expensive domestic production. This is certainly not good for the economy, but it is not by itself catastrophic.

Many point to the infamous Hawley-Smoot Tariff Act, put into effect during the early part of the Great Depression in 1930, as the poster child for what can go wrong with tariffs and trade wars. But the US economy in other aspects is performing well, with lots of evidence suggesting that the economy is either performing at its capacity or close to it. Moreover, the economy has proven itself to be quite resilient to shocks, from debt ceiling standoffs and government shutdowns, to recessions in manufacturing activity.

That is not to say that the economy can just shrug off the notion of a trade war. A broad, prolonged, trade conflict is never good for the economy overall and targeted sectors are certain to feel significant pressure. Still, the idea of protectionist tariffs sending the US to a deep recession seems far removed for the current situation.

Transportation and freight would have to adjust

The ramifications for freight markets are quite a bit larger however. For one, global carriers and logistic companies have long relied on the advance of globalization to open up new markets and drive profits. Rising trade volumes provide a benefit to these companies even if imports far exceed exports, and any reversal towards protectionism could cripple profits.

Domestic carriers also will likely see significant changes should these trade wars become more than rhetoric. Any reduction in overall activity due to higher prices on imports is likely to be felt by carriers directly. In addition, the kinds of transportation flowing through the economy is likely to shift as more of the production takes place domestically, with less drayage from ports to rails, and more inland movements throughout the economy. In the end though, much of the challenge will be in businesses and carriers adjusting to disruptions in existing supply chains rather than an outright collapse in activity.

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Ibrahiim Bayaan, Chief Economist & Market Expert

Ibrahiim covers developments and trends in the global economy. His focus is on understanding the links between movements in the macroeconomy and the implications for freight markets. Ibrahiim is also a one of FreightWaves’ Market Experts. Prior to FreightWaves, Ibrahiim spent nearly a decade building up the forecasting capabilities and creating the economic messaging at UPS. Ibrahiim and his family live in Atlanta, Georgia.