For a week in which the China trade war ramped up from $50 billion to $250 billion and beyond, the experience has seemed anticlimactic.
Markets have burbled along happily, acting as if barely aware. Commerce Secretary Wilbur Ross said the new tariffs were so tiny that “nobody’s going to actually notice it at the end of the day.”
Secretary Ross is wrong. We will notice it at the end of the day; we just haven’t gotten to the end of the day yet. His claim does raise the question of why a massive tariff fight between the world’s two biggest economies seems to have had so little observable effect.
Here are some reasons why the effects may have appeared minimal so far, but are likely to get significantly worse:
1. Math problems: Secretary Ross suggested that a 10-percent tariff on $200 billion of trade would raise $20 billion in revenue, which would be trivial when spread over thousands of goods. The problem with this is twofold:
First, the 10-percent tariff is supposed to jump to 25 percent within a few months. Second, no matter how thinly you spread it, 10 percent is still 10 percent.
If one is hoping that an importing firm will just swallow this cost, the relevant comparison is to the company’s profit margin, not to overall revenue. Ten percent is significant; 25 percent is much more so.
2. Implementation lags: It may seem like we’ve been fighting trade wars for most of this year. In fact, if one follows the China case, the action has been very recent.
To illustrate, President Trump announced the first round of China tariffs — $50 billion — on March 22, but that was not when those tariffs went into effect. There was a long delay for public hearings and for negotiations.
The first tariffs actually went into effect on July 6, and that was on only $34 billion. The remaining $16 billion was applied only on Aug. 23. So it may seem like the tariffs have been around for half a year, but it’s really only been a month or two.
3. Product selection: The administration, in setting its list for the first $50 billion in tariffs, tried to minimize the observable impact as much as possible. It did this in two ways: by avoiding consumer goods and by focusing on those products that had more readily-available substitutes (i.e., where there were plenty of suppliers outside China to whom U.S. importers could turn).
This sort of selectivity gets much more difficult when tariffs cover 50 percent of U.S. imports from China, and it disappears all together if the president follows through on his threat to ramp up to 100-percent coverage.
4. Lags in supply chains: When the cost of an input into a supply chain goes up, most producers do not immediately hike their prices on stores shelves. Sooner or later they have to do something, but it takes time.
Further, retailers place orders and take delivery of goods well in advance. That business inclination is magnified when there is advance notice that tariffs are coming. It means importers can boost orders before the tariffs hit, as they seem to have done. Thus, tariffs will have an effect but only after the inventories are worked down.
5. Lags because of contracts: Producers often pre-commit to supply or purchase at a given price, rather than just buying on the spot market. This can leave them vulnerable to price swings, of the sort that new tariffs would represent.
After a while, the contracts expire and new ones are negotiated. That’s when one would expect to see a change in prices. Those changes may then last even after tariffs are withdrawn.
6. Inflation: Secretary Ross may have a point if consumers only look at overall inflation numbers. By some estimates, the initial 10 percent China move could add as little as 0.2 to 0.5 percent to measured annual U.S. inflation.
It might not be obvious to consumers what caused such a blip, as it could be lost amid a background of 2.7 percent inflation. Yet such a change could rise with the expansion of the trade wars. Even the smaller bump could be important for the Federal Reserve, as it ponders how much to worry about inflation and hike interest rates.
7. Exchange rates: Since President Trump first announced his plan to hit China with tariffs, the Chinese renminbi has fallen from 6.33 to the dollar to roughly 6.85. That’s a depreciation of just under 8 percent.
If you pair a 10-percent tariff with an 8-percent currency depreciation, you’ll get a minimal effect. That’s less true when tariffs jump to 25 percent.
None of this is to say that the trade war is unimportant. It is only to suggest why the heavy damage will come later. When U.S. businesses opine on the escalating trade conflict, they strongly predict ill effects to come. In tariffs, as in other matters, past performance may not be indicative of future results.
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