The US has officially imposed tariffs on $34 billion of imports from China, and China in response has imposed tariffs on $34 billion of US goods exported to China. We want to share some of the relevant facts to put the tariffs in perspective.
In 2017, total US imports were $2.9 trillion and total US exports were $2.35 trillion. The $34 billion of tariffs equates to 1.2% of total US imports, and 1.4% of total US exports. We think this is important because both the US and China are imposing relatively small tariffs that should have a relatively small impact on both economies. Essentially, we think these are measures to show both countries are willing to act. With that said, our base case remains that these are negotiating tactics and that neither country desires a full escalation trade war.
Since we began discussing tariffs and the renegotiation of global trade, we stated that it would NOT BE EASY. Over the last two decades the Chinese economy has steadily grown, and with it, China's assertion as a global super power. They've joined the World Trade Organization, they've began asserting control in the South China Sea, challenging the Philippines, Taiwan, Brunei, Indonesia, and Vietnam. In the East China Sea, China and Japan are engaged over a territorial dispute. China has made investments in some of the World's largest tech companies and now owns the world's two fastest supercomputers. Chinese scientists have built the world's first quantum communication network, China's on track to have 81% of the world's high-speed rail systems by 2030, and the list goes on.
China cannot quietly accept US demands without compromising its position of power. Further, events in the last few years have demonstrated that China is willing to push limits, perhaps testing how the global community will respond to their actions. And as it is with China, if the US does not push back against China's refusal to accept US demands, it could be seen by some as weakening US influence. This struggle for power introduces new risk, and certainly things between the US and China could escalate out of control, but we don't believe they will.
The new tariffs will cause pain in both the US and China. An escalation of tariffs to more significant levels, like the $500 billion that has been mentioned by both the US and China could indeed have dire consequences for the entire global community. However, we believe the mutually felt pain will help contain the situation. We believe the gradual increase in tariffs will allow the pain to be felt (and future pain to be more accurately forecast) before long-term damage is done. Looking at the Federal Reserve's actions since 2008 may provide a framework to view the advantages of gradual change in economic terms.
While building up its monetary stimulus, the Federal Reserve announced its intentions, and then made one change at a time. Over time, the Fed made massive changes, but by doing so gradually, they were able to observe (and more accurately predict) probable outcomes to their decisions along the way. This helped them to both build up and unwind the significant monetary stimulus that was put in place during the Great Recession of 2008 without causing harm to the US and Global economies. During the buildup and the winding down of the stimulus, pundits boldly proclaimed that inflation would soar out of control, or that the economic growth we're experiencing would be rapidly extinguished. Their proclamations have been wrong.
With the current tariff dispute, we see pundits making the same type of bold proclamations. On July 5, 2018 the NY Times wrote, "The escalation of the trade war from threat to reality is expected to ripple through global supply chains, raise costs for businesses and consumers and roil global stock markets, which have been volatile in anticipation of a prolonged trade fight between the United States and almost everyone else." On May 31, 2018, the Guardian published and article saying, "So how big a deal is this? Potentially massive. The world is currently closer to a full-scale trade war than at any time since the 1930s, when the American Smoot-Hawley tariff prompted a domino effect among other industrialized nations. Many protectionist measures have been introduced since the global financial crisis of a decade ago but, for the most part, they have been small scale. The current tension is far more serious: it involves the world’s three biggest economies – the US, China and the EU – and it is too big to ignore."
As has happened with past events, the media will publish all sorts of opinions with all kinds of different predictions, and most them will probably be wrong. We believe observing the actions taken and removing our emotional involvement from the facts will help make better, more sound decisions.