“A Permanent Output Loss”: One Bank Quantifies Likely Damage From Trump’s Trade Pissing Contests

A pervasive theme here at the Heisenberg Report is that Donald Trump’s determination to start a trade war with Beijing – by, among other things, slapping tariffs on imports – is probably a really bad idea.

For one thing, China isn’t going to just on its hands in the event Trump decides to make good his threats (and given who he’s surrounded himself with, it seems highly likely that he will indeed try to “walk the talk” so to speak). As noted last week, the Politburo is already preparing for what seems like the inevitable. Here’s a list of measures Beijing is considering if this turns into a tit for tat pissing match:

  • antitrust probes
  • tax probes
  • tighter scrutiny over imported goods from the U.S.
  • limiting Chinese government procurement of U.S. products
  • launch of WTO-compliant anti-dumping investigations

Clearly, this will end up being a lose-lose scenario (which you’d think Trump would avoid at all costs because that’s two “losers” and if there’s anything Trump hates, it’s “losers”).

For anyone who needs a refresher, here’s Citi’s list of reasons why deliberately stepping on Chinese toes might be a rather foolish thing to do:

  • The US has been China’s largest export market for decades until recently with a share of 18% in 2015. However, US access to China’s markets has been improving steadily since China’s ascension to the WTO in 2001, and rising rapidly since the global financial crisis. US exports of goods to China rose from merely US$16bn in 2000 to US$116bn in 2015, while the Chinese market share of total US goods exports has seen a marked increase from just 2.2% to 7.7% over the same period.
  • In particular, the US runs a large services trade surplus with China reflecting its comparative advantage. In 2000, China accounted for only 1.8% of total US services exports, but the number has increased fourfold to 6.0% in 2014. Out of the US trade surplus in services, China contributed to 12% in 2014, rising from only 2.6% in 2000 (Figure 23).
  • After a period of rapid growth, US foreign direct investment into China appears to have peaked, and its share declined to 1.5% in 2015. However, the accumulated FDI in stock terms by US multinational companies remains one of the largest among OECD economies in China.
  • The Chinese market has become progressively more important to US S&P 500 corporates. In 2015, the Chinese market accounted for about 2% of earnings, against only 1% of earnings made in the Japanese market.
  • With China’s huge reserves, the US has also become the largest market for Chinese capital outflow. As of September 2016, China holds 18.8% of foreign UST holdings (against the total outstanding of US treasuries at US$15.4tn). China’s reluctance to own US treasuries would mean higher risk-free rate for the world, which would potentially affect the volatility if not the level of funding costs, in the US economy (Figure 24).

So it would appear as though Trump’s trade war could very well end up being a “big league” example of cutting one’s nose off to spite one’s face.

Despite Trump’s bombast and myopic assertions, curtailing trade (and implicitly rolling back globalization) would likely have meaningfully negative consequences for the US over the long-term. This is a point I’ve tried quite hard to drive home since the election.

Well now, Morgan Stanley has quantified things for me. Below, find a bit of color and some visuals from the bank which help to explain why Trump’s trade talk is probably best left confined to Twitter.

Via Morgan Stanley:

Potential for near-term upside. Depending on the size of the tariff, the first-order implications work out such that the initial impact on US GDP growth could be modestly positive in the near term—i.e. despite across-the-board negative impacts for domestic demand, for a large enough tariff the GDP accounting works out positively,as imports fall and the trade balance narrows considerably. We have considered three hypothetical, illustrative tariff scenarios (5%,20%,and 45%) —over the course of a year, our model simulations suggest a net GDP impact of -0.2%, +0.3%,and +1.3%, respectively (Exhibit 5). Upside stems entirely from a narrowing of the trade balance,as our model simulations suggest imports fall below the baseline by 2.2%, 6.8%,and 13.5%, respectively in the three different scenarios considered. Our model shows somewhat weaker exports in all three scenarios, but the first order impact on the export side of the ledger pales in comparison to the fall in imports. Long-term output loss. Beyond a one-year horizon, the longer-term impacts on the US are negative in all scenarios, with long-term, permanent output loss of ~ 0.2%, 0.9%,and 2.3% in the three respective scenarios (Exhibit 6).

bigly

(Charts: Morgan Stanley)

Perhaps it’s time for Trump to exclaim that Morgan Stanley is “overrated.”

 

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