The US/China trade concessions

The decision of the US and China to both lower their tariffs on each other by 115% was welcomed by the market. It is, however, only a pause for 90 days which will require further negotiating success to create a more stable tariff schedule for the future.

Both countries stated they see the need to continue trading with each other. Tariffs at 145% by the US and 125% by China made that very difficult or impossible. The US insists there must be a different basis for trading than before the Trump reciprocal tariffs were announced. The US remains very concerned about the size of the China trade surplus, and by the degree of its import dependence on China.

We have written of the battle in President Trump’s mind and between his advisers over whether the aim is to use the threat of high tariffs to wrestle tariffs down generally, or whether tariffs are seen as good in themselves as a source of revenue and a means of switching activity from imports to home production.

Both Mr Trump in his first term and Joe Biden imposed tariffs and bans on trade with China to wean the US off dependence on Chinese technology and to impede China taking technology from the US. They both defined a strategic and defence need for the US to make more of the chips, materials and weapons needed for the military as well as welcoming the onshoring of production.

It is becoming clearer that President Trump is going to do a bit of both. He has used high tariffs to force down tariffs and barriers elsewhere. He is planning a permanently higher average tariff on goods into the US as a source of revenue and a further inducement to companies to set up factories on the US side of the tariff wall.

What next for the talks?

The US and China need to move on from a 90-day pause to a new settlement. It is possible the new tariff levels established for 90 days can be rolled over and become the new reality. The US will need to compile a new full tariff schedule for all product lines to clarify what the effective rates are on each item going forward.

The president will need to check the legal powers and deal with Congress who could seek to get involved in matters where they have standing. It is normal for Congress to approve trade agreements. The president has some executive powers he can use. It is best to proceed by agreement between the branches of government on how it is being executed.

The China model has similarities with the rushed through US/UK deal, which was a pathfinder for the bigger one. The UK agreed to accept higher tariffs into the US along with the removal of the 25% tariffs on steel and aluminium. The 25% for cars was lifted with a limit on how many are exempt. Cars ended up with a new 10% tariff compared to the existing 2.5%. In return, the US gets lower tariffs into the UK on a range of products, particularly in food where some UK tariffs were high.

The US needs to resolve outstanding issues with its two neighbours, Canada and Mexico, which are important trade partners. There is a free trade agreement in place, negotiated by President Trump himself in his first term. Recent high tariff threats have overridden that agreement unilaterally.

There will need to be talks with the European Union (EU). The president is a strong critic of high EU tariffs in areas such as food, and its use of regulatory standards to keep out US products and to limit the activities of US digital companies. He is critical of the fines and taxes imposed on US technology businesses.

The Japanese and other Asian country trade deals will be of interest to markets as well. It is likely all these will be guided in the direction of accepting higher average tariffs into the US, with the 10% universal tariff seen as some kind of minimum, coupled with easier access concessions for the US to the other markets.

The impact of these changes

The move to a higher average tariff into the US will have a one-off impact on the US price level. Some of the extra tariff is bound to be passed on, with the amount varying by product depending on the availability of domestic substitutes and the strength of the market position of the suppliers. As the US only imports goods worth under 10% of its Gross Domestic Product (GDP) the impact on the Consumer Price Index (CPI) will be well under 1%.

There will be a dampening effect on world trade and on growth, as overseas companies lose sales and sacrifice profit and margins to offset some of the tariff impact on consumers. The level of tariffs in the UK and China deals is unlikely to cause a world recession but will underwrite some of the lower growth forecasts commentators have produced in recent weeks. Markets will be relieved as the extreme tariffs are written out of the script for the longer term.