US Edition
There have been few, if any, more turbulent weeks in the markets during the whole of my professional life than the last one. Heaven knows what is going to happen next. But what are the likely economic effects of the situation that we are in now?
Donald Trump may have introduced a 90-day pause on his reciprocal tariffs imposed on all countries except China, but this does not mean the tariff issue is now dead and buried.
To start, the tariff rate on China has now risen to 145pc. Moreover, the 10pc base tariff still applies to all other countries and the 25pc tariff on particular goods, including cars, is still in place.
What’s more, although most people are assuming that there will be no return to the enormous tariff rates for most countries apart from China, this is by no means certain. And with China retaliating on Friday, there might yet be another round of American measures against Beijing, and so on and so forth.
Accordingly, there is still going to be quite an impact from tariffs on the American economy and a series of effects elsewhere in the world.
One of the big surprises of last week was the behaviour of the dollar. Having weakened on the imposition of tariffs, contrary to almost all expectations, the dollar then weakened a bit more after the announcement that for most countries, reciprocal tariffs were being put on hold. That is a reflection of the uncertainty created by President Trump and the damage he has done to America’s standing.
Supposedly, a strengthening dollar was set to mitigate the effects of tariffs on US inflation. In practice, despite lower energy prices, it now looks as though inflation will rise to 4pc by the end of the year. This will ring alarm bells at the Federal Reserve, which I believe is likely to sit on its hands for the rest of this year.
It seems that while the Trump was prepared to accept extreme drops in stock prices, he was less bold when it came to plunging bond prices and rising yields.
He was right to be worried. The American government has a huge debt to service, proportionately greater even than our own, and high yields have a depressing effect on aggregate demand.
More importantly, when you have such wild swings in equity and bond prices as we have just experienced, there is a good chance that some major institutions will have registered significant losses. We simply don’t know what is lurking in the undergrowth. This should have been one of the lessons from the Global Financial Crisis of 2007-2010.
In this regard, it was bizarre to see Trump apparently glorying in the billions of dollars that have supposedly been made during these fluctuations by some of his billionaire cronies. Regardless of whether their dealings were based on inside knowledge, as some critics have alleged, Trump apparently has no inkling that such gains are balanced by someone else’s losses.
For all the guff about wanting to make America wealthier, he doesn’t seem to understand where real wealth comes from – other than for those individuals who profit at the expense of others.
Here in Britain, it still seems that our economy will not be seriously damaged by tariffs. It looks as though the overall hit to UK GDP will be less than 0.1pc. Of course, this won’t help the fiscal position. In fact, though, this effect is likely to be small beer compared with the potential impact of higher bond yields, which rose last week in line with what happened in America.
One upside impact is that the forces bringing inflation down in the UK should now be stronger. As long as it endures, the stronger pound against the dollar will help to reduce some import costs, although the pound is lower against other currencies. Meanwhile, lower energy prices also point in the same direction.
Moreover, with exports from China into the United States subject to huge tariffs, there may be a significant diversion of those goods into other markets – including the UK. This will tend to put downward pressure on prices here.
The overall effect of this may be to strengthen the case for interest rate reductions from the Bank of England. That is certainly the view of the money markets, which are now pricing in three rate reductions by the end of the year. This is the main reason why the pound has weakened so much against almost all currencies, except the still weaker dollar.
These effects on economies and markets could be overshadowed by the geopolitical impact. Trump grossly underestimates the risks of what he is doing. The close parallels between the current situation and the 1930s continue to impress. The imposition of the Smoot-Hawley tariffs by the US in 1930 was a precursor of the Japanese invasion of Manchuria in 1931. Could China now be emboldened to attack Taiwan?
Worse than imposing tariffs on friends and foes alike are the ideas floated by some of Trump’s advisers for imposing various forms of financial penalty on foreign holders of US assets. Even though nothing like this has yet made it into a concrete policy proposal, the very idea of it has rattled institutions and markets across the world.
Coming on top of the tariffs and Trump’s truculence and unpredictability in foreign affairs, there has been a loss of trust in America, involving both its institutions and its assets.
One important side effect of this may be that Trump is unwittingly hastening the end of the dollar as the world’s only significant reserve currency. But the overall impact could be much larger.
Paradoxically, just as the financial crisis shattered the world’s confidence in American-led global capitalism, Trump runs the risk of undermining American supremacy. This can only strengthen China’s position in the world.
Roger Bootle is senior independent adviser to Capital Economics and a senior fellow at Policy Exchange. roger.bootle@capitaleconomics.com
Trump’s chaos has shattered confidence in America
The US president is unwittingly hastening the end of the dollar as the world’s only significant reserve currency