SHANG-JIN WEI
NEW YORK – After months of threats and speculation, US President Donald Trump has officially launched his long-anticipated trade war. He has just imposed 25% tariffs on all steel and aluminum imports. His new 10% tariff on Chinese imports will further strain the world’s second-largest economy, which is already grappling with slowing growth and unfavorable demographics. And his postponed – but not canceled – 25% tariffs on Canada and Mexico, together with threats to impose new tariffs on the European Union, India, and many more countries, put greater pressure on key US allies.
While many countries are considering retaliatory tariffs on US goods, such measures are both unproductive and unlikely to deter Trump. One reason is that most countries run trade surpluses with the United States and therefore have fewer US goods to target than the US does. More importantly, higher tariffs on US imports would hurt their own citizens and firms. Consequently, their ability to counter Trump’s tariffs is severely limited.
A more productive approach would be to focus on minimizing the economic fallout. To do so, it is important to recognize that both a trade and a financial channel could cause Trump’s trade war to trigger a global economic downturn.
Beyond his tariffs on metals and China, Trump has previously pledged to impose a 10% tariff on all imported goods. More recently, he proposed targeting only countries with which the US has a trade deficit, as well as a “Fair and Reciprocal Plan” that would tailor tariff rates to US trading partners’ own barriers. While that may sound like a more measured approach, the US currently runs bilateral deficits with most countries – including 12 of its top 15 trading partners.
Although Trump’s tariffs will inflict economic pain on US households and businesses, that is unlikely to discourage him, partly because he views tariffs as a way to offset – at least partly – the revenue losses from his planned tax cuts. The fact that his tariffs will ultimately be paid by American consumers, especially middle- and low-income households, does not appear to concern him.
Although Trump’s tariffs probably will not reduce the US trade deficit, they will have far-reaching implications for interest rates worldwide. If the Federal Reserve takes no action, the tariffs will drive up the prices of both imported goods and domestically produced goods that compete with them or rely on imported inputs.
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