The trade war between the U.S and China shows no signs of abating, with each side boosting tariff levels. From the U.S. perspective, such tariffs might appear inflationary, as the levies are added to the costs of imports and passed on to their ultimate users. A 25% jump in the cost of all $575 billion in goods imported from China, even without markups and follow-on increases from competing U.S. producers, would add about 1% to consumer prices.
In reality, however, import tariffs and the whole trade war are more likely to be deflationary as governments, businesses and consumers here and abroad take offsetting actions and the conflict takes its toll on global economic growth. News reports say U.S. importers are switching to suppliers in more-certain countries such as Vietnam, Thailand, Pakistan and Taiwan. This is costly and disruptive, but has been underway ever since Trump’s 2016 election victory.
Enphase Energy and SolarEdge Technologies, which control most of the market for residential inverters that convert solar DC current to AC, are planning to open plants in Mexico and Vietnam, according to the Wall Street Journal. Telecom gear producer Ericsson is preparing to shift some manufacturing operations out of China to the U.S., Estonia, Brazil and Mexico. Taiwan-based AsusTex Computer is moving some production to Taiwan and Vietnam from China. Stanley Black & Decker plans to move production of Craftsman wrenches back to the U.S. from China, the Wall Street Journal also reports.
More modern equipment such as robots and faster-forging presses will help boost output about 25% above the older machines used in China and keep production costs about the same. Whirlpool is moving production of some small KitchenAid appliances from China to the U.S.
The permanent loss of an important export sector does, of course, put pressure on China to come to terms with the U.S. on trade. At the same time, Chinese retaliation is retarded by its dependence on the U.S. for key imports. Only about 14% of China’s semiconductors come from domestic suppliers, and it imported $6.7 billion in chips from the U.S. last year. Also, U.S. chipmakers already are subject to a 25% import duty from China and, in response, are reported to be routing their products to China indirectly through third countries.
With U.S. consumer spending slowing after a disappointing holiday season at the end of 2018, many importers and retailers are being forced to shave margins to avoid passing on the full cost of the new tariffs. Unwanted retail inventories are rising. Consumer discretionary goods merchants, excluding internet retailers, were already expected to suffer a 5.2% contraction in profit margins, according to Bank of America Merrill Lynch analysts. A future squeeze on margins is likely since retailers can’t raise prices to pass on tariffs without losing sales. A 2.3% average price rise would be needed to offset the 25% tariffs. If they can’t raise prices, tariffs could compress earnings by 39% on average this year. Home Depot plans to spread cost increases over more items to limit the impact on sales.
Consumers simply refuse to accept price increases. Attempts are met by switches to lower-price retailers, online sources and house brands. In fact, the Fed is worried that expectations of low inflation or deflation retard spending as potential buyers wait to purchase. The Federal Reserve Bank of New York’s April Survey of Consumer Expectations shows that the public’s outlook for inflation fell to the lowest since late 2017. Fed Chair Jerome Powell said earlier this month that “inflation expectations over time could be pulled down and that could put downward pressure on inflation and make it harder for us to react to downturns.”
A stronger dollar is also depressing prices of U.S. imports. Prices of Chinese imports fell 1.1% in April from a year earlier, the steepest drop in two years. Declining import prices forced domestic producers to follow suit and is another offset to high import tariffs. U.S. import prices overall have recently declined. But so, too, have export prices, which points to a final reason that the tariff increases and the trade war with China is likely to prove more deflationary than inflationary: the resulting downward pressure on already-slowing global economic growth. The International Monetary Fund forecasts worldwide GDP growth of 3.3% this year and 3.6% in 2020, compared with its estimate in October of 3.7% growth in both 2019 and 2020.
If you’re worried about the Fed overreacting to trade war-induced inflation, relax. The deflationary implications of the trade imbroglio are more likely to speed up the Fed’s timetable for an interest rate cut.
A. Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, a Registered Investment Advisor and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” Some portfolios he manages invest in currencies and commodities.
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