The U.S.-China trade war has escalated further. On May 10, President Donald Trump announced a new wave of tariffs ranging from 10 percent to 25 percent on $200 billion of Chinese imported products. On May 13, China retaliated by announcing that it would raise tariffs, starting June 1, on $60 billion of U.S. products imported to that country. The tariffs range from 10 percent to 25 percent on consumer, industrial, and agricultural products. As the two economic superpowers up the ante in this conflict, we are given a textbook lesson on how the trade war is distorting economic factors.
Upon announcing the U.S.’s latest salvo of tariffs on Chinese goods, Trump tweeted, “Tariffs will make our Country MUCH STRONGER, not weaker. Just sit back and watch!” He also claimed that China is the party that will be paying the tariffs, and that the U.S. will be making money from them. The first assertion is being contested by most economists and the stock market, which took a dive based on fear of continued economic conflict. The second assertion is clearly incorrect, as it is U.S. businesses and consumers who will bear the brunt of higher tariffs in the form of higher prices on imported Chinese goods. This was acknowledged by none other than Larry Kudlow, the president’s economic advisor, who admitted that U.S. businesses and consumers will indeed be shouldering the burden of higher tariffs on Chinese goods – in direct conflict with Trump’s statement. A joint study by the Federal Reserve, Princeton, and Columbia Universities concluded that in 2018, American businesses and consumers were paying more than $3 billion in higher costs per month and losing $1.4 billion per month because of the tariffs.
Distortions in the economy occur when the government artificially tries to direct supply and demand by utilizing tools such as tariffs, in a trade war of this type. Many of these goods cannot be easily or economically produced in the U.S. And if some products requiring a lot of labor can be produced here, they most likely will be more expensive. If the tariffed Chinese products become expensive in the U.S., supply might shift to countries such as Mexico. However, the U.S. Congress still has to approve the newly-renegotiated North American Free Trade Agreement, but this is far from certain and Mexico might eventually be in the same boat as China.
U.S. producers selling agricultural, industrial, and consumer products to China are being hurt by the tariffs, because their products become more expensive in the Chinese market. Competitors from other countries can pounce on this disadvantage and take business away from American companies. In reaction to the pain being experienced by the U.S. farmers and ranchers who depend on their exports to China to keep their operations going, the Trump administration announced that it will seek $15 billion in relief to support these producers. In other words, the U.S. consumer is not only paying extra for the tariffs on Chinese goods imported to the U.S., he/she is going to pay billions for U.S. agricultural products that are going to lose their market share in China. Farmers and ranchers will essentially become welfare recipients. The Congressional Research Service published a report last December stating that national net farm income plummeted by 12 percent, or more than $9 billion – very likely caused by the loss of market share in China by American products made more expensive via tariffs.
And of course upon hearing of the trade war escalation, stock markets lost value because of future economic uncertainty and the curtailing of investment in new projects that are related to the interaction of both countries. In the long run, it is a good bet that investment could be shifted from both China and the U.S. to other countries that are not involved in the trade war, and whose goods are thus not subjected to tariffs in either country.
Because the U.S. imports more from China than it exports to that country, the U.S. will have more imports from China on which it can keep imposing tariffs. However, China is not helpless. Its government can start picking on U.S. companies that have made huge investments in the country, and which depend very much on the huge Chinese market for its revenues. By simply employing tactics such as increased scrutiny, delays in approving permits, or arbitrarily changing the rules of the game, it can disrupt American companies’ operations, making them inefficient and lose money.
Many economists fear that China can use its investment in U.S. securities to hit back at the U.S. According to the Treasury and Securities Industry and Financial Markets Association, China owns $1.13 trillion out of a total of $22 trillion in U.S. Treasury Securities. While this does not sound like a lot, it does account for nearly 18 percent of all foreign-held securities in the U.S. If it decides to start flooding the market with U.S. securities, changing values could disrupt the U.S. economy, which depends on these securities to finance our national debt. While this would also decrease the value of China’s own portfolio, it could jolt the U.S economy. In essence, this potential self-destructive action is a good microcosm of the state of the current trade war between the two countries.