Since the threat of a trade war is all the news outlets seem to report on these days, we thought it might be helpful to give readers a refresher on how trade tariffs work and how they can impact the economy and consumers.
Q: What are trade tariffs?
In short, tariffs are a tax on imports. They are typically charged as a percentage of the transaction price that a buyer pays a foreign seller. For instance, a ton of steel from China may cost a US buyer $700. If the US government places a 10% tariff on it, the new price to the buyer would be $770 per ton. In the US, tariffs are collected by US Customs and Border Protection agents at 328 ports of entry around the US.
Q: What are they supposed to accomplish?
Two things. First, they raise revenue for the government. Second, they protect domestic industries from foreign competition and unfair trade practices. An example of an unfair trade practice would be a foreign government which subsidized its exporters allowing them to dump their products at unfairly low prices.
Q: Why is China in the headlines?
China is a large trade partner with the US. The US and China are really fighting over much broader issues – like China’s requirements that American companies share advanced technology to access China’s market. And trade tariffs are the ammunition each country may use to negotiate. (The White House has also mentioned possible tariffs on Canada and Mexico.)
Q: How much pain will Trump’s trade war with China create for the US?
This largely depends upon how the negotiations are concluded, but let’s assume that the White House ends up taxing all Chinese imports. That would amount to about $140 billion in additional costs for imports. Goldman Sachs estimates that the hit to the US economy (and consumers) would be about 0.25% of annual GDP, which is currently running at about 3.2%. So, it’s not the end of the world, but it would place a greater burden on companies and consumers of Chinese products in the US.
Q: Do US businesses and consumers bear all the costs of the tariffs?
Theoretically, yes. But in real practice, here’s what happens: First, companies will switch to alternative sources of imports, reducing the extra costs. The longer tariffs last, the more US supply chains will move to other countries or domestic manufacturers. Second, customers will switch spending to other types of goods altogether if prices go up too much. Third, Chinese companies might lower prices to compensate for the higher costs for their customers. You might call this “capitalism in practice”. Money flows to the most efficient source of products and services with the lowest prices.
Q: When will this all be resolved?
Who knows? It’s hard to imagine that ongoing negotiations will not result in a deal soon, but the President has made it clear he’s in no hurry unless the terms benefit the US. As a result, the uncertainty may continue to weigh on the stock and bond markets here and abroad in the near term. So far, markets have reacted with moderate levels on fluctuation, but much will depend upon the final resolution.
As long as the US economy keeps chugging along, we would expect the longer-term impacts to be relatively modest. As always, we encourage investors to remain focused on the long game. Economic vital signs continue to signal generally positive signs.
We will keep you updated as further events unfold. In the meantime, please don’t hesitate to call us if we can be of assistance.
(This article was originally posted on June 11, 2019)