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With China, Trump is getting closer to his goal

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05/06/2019 | 10:34am EDT

Those who thought that Donald Trump had softened up his stance against China were wrong. Those who doubted its incredible influence on the financial markets too. The President's tactics could be successful. If, and only if a Sino-American agreement is reached, the only possible way forward is for customs barriers to disappear.


Over the weekend, Donald Trump drew a new threat, unexpected to say the least: either China accepts as soon as possible a trade agreement with the United States (on American terms, of course), or the White House raises the surtax currently imposed on $200 billion worth of Chinese products from 10 to 25% as of Friday. In addition, an additional $325 billion basket would be subject to tariffs of 25% of its value in the coming weeks.

The announcement, made in two tweets, comes at a time when the financial markets thought that nothing could derail the negotiation process. This explains the violent negative reaction of Asian markets this morning and the tremors suffered by Western stock exchanges in their wake. There would be a lot to write about the incredible impact of Donald Trump's announcement on his favorite social network. But let’s focus on the mechanism at work with the protectionist measures deployed at the initiative of the self-proclaimed "Tariff Man".


This will come as no surprise to anyone, the US Treasury has collected significant additional customs duties since 2018 and the first entry barriers imposed by the United States. Over the six months from October 2018 to March 2019, earnings increased by 89% to USD 34.7 billion. This is a direct and quantifiable consequence of these barriers. Knowing how much money is collected at the borders is easy. There is no doubt that the federal coffers are filling up. "We have billions of dollars coming from China into our billions of dollars treasury," Donald Trump rejoiced earlier this year. But for this economic policy to be truly effective, however, the improvements it brings must outweigh its disadvantages. In other words, if the US Treasury gets rich on one side, it should not lose more on the other because of the measures adopted.

Who pays for what?

Through a skillfully maintained blur, the White House suggests that China is feeding US coffers. This is the case to some extent, but it is indirect and infinitely more complex. First, customs duties are paid by importers, not by the exporting power. These importers are generally American companies. They can charge their Chinese suppliers to compensate for the extra cost. Companies from the former Middle Kingdom therefore contribute quite directly to inflating the American coffers. But most of the time, the importing company uses several measures to mitigate the impact. Among them, let us mention:
  • Take some of the surtax burden by cutting back on his margins.
  • Reduce costs to offset the increase.
  • Negotiate discounts from Chinese suppliers (resulting in lower customs revenues).
  • Find alternative non-Chinese suppliers.
  • Pass on the increase to consumers.
  • Produce / buy in the United States.

Depending on the type of shock absorber used, the load can slip from one economic actor to another. The equation is therefore complex, but several recent studies suggest that at this point, the cost to the U.S. economy is greater than the benefits. Consider a study published in early March, conducted for the Centre for Economic Policy Research by three Fed researchers from New York, Princeton and Columbia. It said that while in principle the effect of the increase in customs duties on domestic prices can be offset by a reduction in pre-tariff prices charged by foreign exporters for these products, it found little evidence of such an improvement in the terms of trade so far, implying that the burden has shifted back to domestic consumers. The researchers even consider that their results imply that the customs revenues currently collected by the United States are insufficient to compensate for the losses suffered by consumers of imported products. In concrete terms, real income is reduced by $1.4 billion per month by the current measures. The study also shows that supply chains are disrupted and the diversity of available products suffers. In the end, the balance sheet is fully in line with what economic theory describes. Moreover, the conclusions are identical for those countries that have also erected barriers.

Effective tariffs... if they disappear

Trump-Bashing is fashionable and deserved in many ways. But it is undeniable that the American President is seeking to rebalance the terms of trade with China, which will benefit not only the United States but all the country's other trading partners. Issues related to counterfeiting and more generally to intellectual property, data exploitation or foreign investment in China will probably find concrete answers if Washington and Beijing reach an agreement. In such a scenario, customs barriers will disappear because they will have been only an instrument to achieve a probably legitimate rationalization of Sino-American trade relations. Finally, the Trump doctrine, not as simplistic as it seems, will have proved its effectiveness.
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Anthony Bondain
© MarketScreener.com 2019
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