How Important Are The Tariffs?

The stock market will likely continue to struggle with the imposition of additional US tariffs on Chinese goods.  Although the tariffs, themselves, should not have a significant effect on US GDP, increased uncertainty about the outcome of the trade negotiations and US/China relations -- as well as the potential hit to profits of companies with operations in China -- should be a market negative as it was in Q418.   The absence so far of scheduled further talks is a negative.

The 25% Trump tariff on $200 Bn in Chinese imports should impart only a modest drag on US economic activity.  Ironically, they also have the potential to move US spending toward public goods.   They could be exactly what critics of the "consumer society" would like.

The tariff would likely have only a modest effect on the US economy for several reasons.  /1/ If the entire cost is passed through to US consumers, the direct hit would be $50 Bn or only 0.2% of GDP.  /2/ 40% of the hit already has been in effect since January.   So, the additional tariffs would have closer to 0.1% pt hit to GDP.  /3/ Any pullback of spending because of the tariffs will hurt Chinese manufacturers as well as US companies.   So, the direct impact on the US economy is even smaller than the overall impact.  /4/ The tariffs should boost the dollar, inasmuch as the expected trade deficit would be smaller because of the tariffs.  The stronger dollar would lower import prices, offsetting some of the impact of the tariffs on the targeted goods and lowering prices on others.  /5/ The stronger dollar also should lower commodity prices, particularly oil, which should work to offset the drag from the tariffs.  /6/ The tariffs could be absorbed by Chinese manufacturers, lowering their prices to attempt to keep market share.

The tariffs offer an opportunity for the US to shift spending from consumer goods to public goods.   From a revenue perspective, the added government receipts could encourage the bi-partisan desire for infrastructure spending.   The tariffs can be viewed as a "sales tax" on selected items.   The tax is paid by US consumers if the tariffs are fully passed through to prices.  Or, it is paid by the Chinese if they absorb the tariffs by lowering their own prices.  (In this case, US companies with operations in China could see their profits cut.)  The tax revenue would be lost, however, if production shifts from China to other low-wage countries that are not subject to the tariffs.  From an economic perspective, the resources freed from dealing with imported goods from  China (eg, warehousing, transportation, etc) could be available for public policy projects.  If this way of looking at the tariffs gains support, the desire to eliminate them could wane. 

The impact of the tariffs on inflation should be minor.  The prices of the targeted imports would ratchet up, but this would be a one-off adjustment.  In contrast, other import prices could fall further because of the stronger dollar.  This combination is what has occurred since January.  Lower oil and other commodity prices would operate to hold down inflation, as well.