- Average tariff rate on all imports could more than triple from the average of past half-century.
- This has strong near-term inflationary implications for the US.
- Exchange rates would also likely adjust to the terms of trade shock.
- Asian FX has already sold off against the USD.
- More could be in store, especially for those with high export share to the US.
Commentary: The coming trade shock and Asia
With Trump 2.0, higher tariffs are guaranteed. Beyond going after China, US trade and commerce officials will go after Mexico and Vietnam to restrict China’s attempts to divert trade. There may well be a 10% (some have even floated 20%) across-the-board tariff on all US imports. Beyond tariffs, restrictions on investments and market access are all likely to be ramped up further.
Countries trading intensively with the US are about to step into unchartered waters. Over the last half a century, the average US tariff rate on all dutiable imports has been below 4%. Despite 8 years of trade wars, average tariff is below 3% presently. A trebling of that rate would be a substantial shock.
How does the tariff transmission channel work? In theory, it should only impact the exporters through the demand channel, with the tariff being paid for by the US importer, and by extension, the US consumer. Certain products, such as washing machines, saw their demand decline after tariffs were imposed in 2018 by the Trump administration. Indeed, price of those products jumped immediately. In response, South Korean manufacturers diverted some of their production to the US, creating some jobs, but all at the expense of US consumers paying more. As soon as those tariffs were allowed to expire by the Biden administration in 2023, washing machine prices began to decline in the US, demonstrating that shielding domestic industries from competition is a tax on consumers.
The last eight years have shown that once tariffs are imposed, a complex web of responses take place between producers, importers, and consumers, beyond the dynamics of the washing machine case. When pricing power is limited, as was likely the case pre-pandemic, a three-way split of burden sharing takes place. Additionally, over time, trade is diverted, some to the US, a lot to partner countries like Mexico and Vietnam.
We doubt if similar dynamic prevails in the current juncture, given the experience of the pandemic and the sustained strength of the US labour market. We think that much more of the tariff would be passed along to customers this time, especially as trade diversion would make less sense with across-the-board tariffs.
An additional spillover from tariffs is the exchange rate. If markets believe that an economy is particularly vulnerable to US tariffs, that economy will see selling pressure on the currency to adjust for the impending terms of trade shock. The 2-4% depreciation of Asia currencies against the USD since the elections is a harbinger for things to come, in our view. A ranking of exports intensity vis-à-vis the US is a marker of the vulnerabilities out there.
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