A US border tax would hit growth abroad, sending a global deflationary shock that may be magnified if other countries take defensive steps that result in round-robin currency depreciation. A particular concern is that a sharp appreciation in the dollar caused by a border tax prompts China to break its controlled peg of the yuan, in what could be the biggest shock to global financial stability since the crisis of the last decade.
House Republicans, with uncertain support from President Donald Trump, are pushing a border adjustment tax of 20 percent on imports while excluding export revenue from corporate taxable income. Corporate income tax under the plan would be cut to 20 percent from 35 percent. In theory, a 20 percent import tax would push the dollar higher by a similar amount.
Economists argue that a border tax arrangement, such as a 10 percent tariff and import subsidy, would increase US growth by 0.9 percentage point but would cut growth everywhere else by 0.4 percentage point. — James Saft
Economists at UBS argue that a border tax arrangement, such as a 10 percent tariff and import subsidy, would increase US growth by 0.9 percentage point over the following 18 months but cut growth everywhere else by 0.4 percentage point. “The disinflationary impact abroad is larger than the inflationary impact at home and roughly of a similar magnitude as the oil shock of the past two years. Because the rest of the world is four times larger than the US, the policy’s net nominal impact is actually negative globally,” Pierre Lafourcade and Arend Kapteyn of UBS wrote in a note to clients.
While that analysis, and much else, depends on how the Federal Reserve reacts to such a scenario, it would amount to a significant disinflationary shock globally. Trump may have as many as four Federal Reserve seats to fill, giving him some influence over the monetary policy reaction. He and the US have a lot less control over how all this goes down internationally. The US is famously the consumer of last resort, so exporting nations may be reluctant to inflame what would already be a trade war.
The first step would probably be to fight the policy at the World Trade Organization (WTO), a tactic that may or may not slow retaliation. As ever with Trump administration policy, much is unclear: What he intends, what his Republican colleagues actually want, and what they together can bring about.
It is possible the more significant impact globally will be from dollar strength, which unlike other similar bouts of dollar appreciation will not be cushioned by a rise in exports to the US. The trade-weighted dollar is already not far off 20-year highs, and has risen by more than 20 percent in the past two and a half years.
Foreign governments are less vulnerable to dollar strength than in the past, many having built up large reserves of dollars. Foreign corporations, particularly in China, would see their debt burdens rise as the dollars they have borrowed become more expensive to pay back. Chinese non-financial corporations could see their debt burdens rise to more than 190 percent of China’s gross domestic product (GDP) if the dollar rises by 20 percent, according to calculations from Manulife Asset Management.
Brad Setser of the Council on Foreign Relations observes that as China manages the yuan against a basket of currencies, a mechanical adjustment matching global currency movements might still leave China at a relative disadvantage to other Asian exporters. That seems unlikely, both as a domestic policy for China and because a prospective devaluation of the yuan will turn into a self-fulfilling prophecy, with increased legal and illegal capital flight out of China by yuan owners wanting to front-run losses. Remember too that exporters, who will be affected, have perhaps more freedom to get money out of China than others.
“The risk to China comes from the potential impact of outflows (and the policies introduced to stem outflows) on domestic financial stability,” Setser writes in his blog. “And the risk to the world in turn comes from the trade impact from a complete break in China’s peg and a major depreciation of the renminbi. One that overwhelms any border adjustment.”
Chinese officials may be tempted or forced to let the yuan go against the dollar to mitigate the impact of a border tax, both in their economic relationship to the US and to other competitors. Be in no doubt, a float of the yuan will be a sharp weakening, and we will once again be talking not about a Trump reflation, but about global deflationary forces.
