Our US public policy and global economics experts discuss how an
escalation of US tariffs could have major domestic and
international economic implications.
----- Transcript -----
Ariana Salvatore: Welcome to Thoughts on the
Market. I'm Ariana Salvatore, Morgan Stanley's US Public Policy
Strategist.
Arunima Sinha: And I’m Arunima Sinha, from the
Global Economics team.
Ariana Salvatore: Today we're talking tariffs, a
major policy issue at stake in the US presidential election.
We'll dig into the domestic and international implications of
these proposed policies.
It's Tuesday, October 1st at 10am in New York.
In a little over four weeks, Americans will be going to the
polls. And as we've noted on this podcast, it's still a close
race between the two presidential candidates. Former president
Donald Trump's main pitch to voters has to do with the economy.
And tariffs and tax cuts are central to many of his campaign
speeches.
Arunima Sinha: You're right, Ariana. In fact, I
would say that tariffs have been the key theme he keeps on coming
back to. You've recently written a note about why we should take
the Republicans proposed policies on tariffs seriously. What's
your broad outlook in a Trump win scenario?
Ariana Salvatore: Well, first and foremost, I
think it's important to note that the President has quite a bit
of discretion when it comes to trade policy. That's why we
recommend that investors should take seriously a number of these
proposals. Many of the authorities are already in place and could
be easily leveraged if Trump were to win in November and follow
through on those campaign promises. He did it with China in 2018
to 2019, leveraging Section 301 Authority, and many of that could
be done easily if he were to win again.
Arunima Sinha: And could you just walk us
through some of the specifics of Trump's tariff proposals? What
are the options at the President's disposal?
Ariana Salvatore: Sure. So, he's floated a
number of tariff proposals -- whether it be 10 per cent tariffs
across the board on all of our imports, 60 per cent specifically
on China or targeted tariffs on certain goods coming from
partners like Mexico, for example. Targeted tariffs are likely
the easiest place to start, especially if we see an
incrementalist approach like we saw during the first Trump term
over the course of 2018 to 2019.
Arunima Sinha: And how quickly would these
tariffs be implemented if Trump were to win?
Ariana Salvatore: The answer to that really
depends on the type of authorities being leveraged here. There
are a few different procedures associated with each of the
tariffs that I mentioned just now. For example, if the president
is using Section 301 authorities, that usually requires a period
of investigation by the USTR -- or the US Trade Representative
--before the formal recommendation for tariffs.
However, given that many of these authorities are already in
place, to the extent that the former president wants to levy
tariffs on China, for example, it can be done pretty seamlessly.
Conversely, if you were to ask his cabinet to initiate a new
tariff investigation, depending on the authority used, that could
take anywhere from weeks to months. Section 232 investigations
have a maximum timeline of 270 days.
There's also a chance that he uses something called IEEPA, the
International Emergency Economic Powers Act, to justify quicker
tariff imposition, though the legality of that authority hasn't
been fully tested yet. Back in 2019, when Trump said he would use
IEEPA to impose 5 per cent tariffs on all Mexican imports, he
called off those plans before the tariffs actually came into
effect.
Arunima Sinha: And could you give us a little
more specific[s] about which countries would be impacted in this
potential next round of tariffs -- and to what extent?
Ariana Salvatore: Yeah, in our analysis, which
you'll get into in a moment, we focus on the potential for a 10
per cent across the board tariff that I mentioned, in conjunction
with the 60 per cent tariff on Chinese goods. Obviously, when you
map that to who our largest trading partners are, it's clear that
Mexico and China would be impacted most directly, followed by
Canada and the EU.
Specifically on the EU, we have those section 232 steel and
aluminum tariffs coming up for review in early 2025, and the
US-MCA or the agreement that replaced NAFTA is set for review
later in 2026. So, we see plenty of trade catalysts on the
horizon. We also see an underappreciated risk of tariffs on
Mexico using precedent from Trump's first term, especially if
immigration continues to be such a politically salient issue for
voters.
Given all of this, it seems that tariffs will create a lot of
friction in global trade. What's your outlook, Arunima?
Arunima Sinha: Well, Arianna, we do expect a hit
to growth, and a near term rise in inflation in the US. In the
EU, our economists also expect a negative impact on growth. And
in other economies, there are several considerations. How would
tariffs impact the ongoing supply chain diversification? The
extent of foreign exchange moves? Are bilateral negotiations
being pursued by the other countries? And so on.
Ariana Salvatore: So, a natural follow up
question here is not only the impact to the countries that would
be affected by US tariffs, but how they might respond. What do
you see happening there?
Arunima Sinha: In the note, we talked with our
China economists, and they expect that if the US were to impose
60 per cent tariffs on Chinese goods, Beijing may impose
retaliatory tariffs and some non-tariff measures like it did back
in 2018-19. But they don't expect meaningful sanctions or
restrictions on US enterprises that are already well embedded in
China's supply chain.
On the policy side, Beijing would likely resort less to Chinese
currency depreciation but focus more on supply chain
diversifications to mitigate the tariff shock this time round.
Our economists think that the risk of more entrenched
deflationary pressures from potential tariff disruptions may
increase the urgency for Beijing to shift its policy framework
towards economic rebalancing to consumption.
In Europe, our economists expect that targeted tariffs will be
met with challenges at the WTO and retaliatory tariffs on
American exports to Europe, following the pattern from 2018-19,
along with bilateral trade negotiations. In Mexico, our
economists think that there could be a response with tariffs on
agricultural products, mainly corn and soybeans.
Ariana Salvatore: So, bringing it back to the
US, what do you see the macro impact from tariffs being in terms
of economic growth or inflation?
Arunima Sinha: We did a fairly extensive
analysis where we both looked at the aggregate impacts on the US
as well as sectoral impacts that we'll get into. We think that a
pretty reasonable estimate of the effect of both a 60 per cent
tariff on China and a 10 per cent blanket tariff on the rest of
the world is an increase of 0.9 per cent in the headline PCE
prices that takes into effect over 2025, and a decline of 1.4
percentage points in real GDP growth that plays out over a longer
period going into 2026.
Ariana Salvatore: So, your team is expecting two
more Fed cuts this year and four by the first half of 2025.
Thinking about how tariffs might play into that dynamic, do you
see them influencing Fed policy at all?
Arunima Sinha: Well, under the tariff scenario,
we think that it's possible that the Fed decides to delay cuts
first and then speed up the pace of easing. So, in theory, the
effect of a tariff shock is really just a level shift in prices.
And in other words, it's a transitory boost to inflation that
should fade over time.
Because it's a temporary shock. The Fed can, in principle look
through it as long as inflation expectations remain anchored. And
this is what we saw in the FOMC minutes from the 2018 meetings.
In a scenario of increased tariffs, we think that the uncertainty
about the length of the inflationary push may slow down the pace
of cuts in the first half of 2025. And then once GDP deceleration
becomes more pronounced, the Fed might then cut faster in the
second half of [20]25 to avoid that big, outsized deceleration
and economic activity.
Ariana Salvatore: And what about second order
effects on things like business investment or employment? We
talked about agriculture as a potential target for retaliatory
tariffs, but what other US sectors and industries would be most
affected by these type of plans?
Arunima Sinha: That's something that we have
leaned in on, and we do expect some important second round
effects. So, if you have lower economic activity, that would
lower employment, that lowers income, that lowers consumption
further -- so that standard multiplier effect.
So overall, in that scenario, with the 60 per cent tariffs on
China, 10 per cent on the rest of the world that are imposed
fully and swiftly, we model that real consumption would decline
by 3 per cent, business investment would fall by 3.1 per cent,
and monthly job gains would fall by between 50- and 70, 000.
At the sectoral level, this combination of tariffs have potential
to increase average tariffs to the 25 to 35 per cent range for
almost 50 per cent of the NAICS industries in the United States
when first put into place. And we expect the biggest impacts on
computers and electronics, apparel, and the furniture sectors;
but this does not take into account any potential exclusion lists
that might be put into place.
Ariana Salvatore: Finally, what does all this
boil down to in terms of a direct impact to the US consumer
wallet?
Arunima Sinha: So, the impact of higher tariffs
on consumer spending would depend on many factors, and one of the
most important ones is the price elasticity of demand. So how
willing would consumers be to take on those higher prices from
tariffs, or do we see a pullback in real demand? What we think
will happen is that higher prices could reduce real consumption
by as much as 2. 5 per cent. The impact on goods consumption is
much more meaningful because imported goods are directly affected
by tariffs, and we would expect to see a drag on real goods
consumption of 5 per cent. But then you have lower labor income
and higher production costs and services prices that is also
going to bring down services consumption by 1.3 per cent.
Ariana Salvatore: So, it's important to keep in
mind here that US tariff policy would undoubtedly have far
reaching consequences. That means it's something that we're going
to continue to follow very closely. Arunima, thanks so much for
taking the time to talk.
Arunima Sinha: Great speaking with you, Ariana.
Thank you,
Ariana Salvatore: And thanks for listening. If
you enjoy Thoughts on the Market, please leave us a review
wherever you listen and share the podcast with a friend or
colleague today.
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