Trump’s war sets up America for a painful future

The US inflation rate is falling, but what might otherwise be regarded as good news is being overshadowed by the ramping up of Donald Trump’s trade wars this week.

The inflation data for February was positive. The headline showed a drop from January 0.5 per cent to 0.2 per cent, and an annual rate that edged down from 3 per cent to 2.8 per cent. Core inflation (excluding volatile food and energy prices) was also 0.2 per cent, month on month, with the annual rate falling from 3.3 per cent to 3.1 per cent.

Donald Trump refused to rule out the prospect of a US recession last weekend and has played down the sharemarket meltdown.Credit: Bloomberg

While it is possible that the March inflation numbers will also be encouraging and, in normal circumstances, would spur the US Federal Reserve Board to lower interest rates again, beyond that, the outlook is cloudy because, by then, the initial impacts of Trump’s tariffs will start to show up.

Trump can’t claim credit for the lower inflation numbers, given that he had been in office for less than six weeks by the end of last month.

Joe Biden handed over an economy that, while it faces some significant fiscal challenges, with deficits and debt levels that aren’t sustainable, was growing solidly. Unemployment was low and the inflation rate that was declining, albeit slowly. From this point on, Trump is responsible for economic outcomes.

The auguries aren’t promising. Even Trump has said that his policies – the trade policies in particular but also Elon Musk’s purge of the federal bureaucracy – will create “a little disturbance”, and that there will be “a period of transition” because “what we’re doing is very big”.

What’s unclear at this point is what the US economy will look like when that transition period has ended.

The lack of certainty about the impacts of Trump’s policies will present a challenge for the Fed, which meets next week.

The decision at that meeting won’t be difficult, with the Fed expected to keep rates on hold. It will, however, get more complicated when the first effects of the tariffs and Musk’s assault on federal agencies start to show up in higher prices, higher unemployment, reduced consumer spending and lower growth.

Does the Fed raise rates to head off a renewed outbreak of inflation, or does it cut them to support a slowing economy? How does it respond to the threat of stagflation – high levels of inflation coinciding with weak economic growth?

Fed chair Jerome Powell. The lack of certainty about the impacts of Trump’s policies will present a challenge for the Fed, which meets next week.Credit: AP

The US sharemarket, having wiped out the best part of $US5 trillion ($7.9 trillion) of market value in response to Trump’s tariffs, is capitalising on fears of a recession. There’s a self-fulfilling aspect to sharemarket slumps, because of their impacts on household wealth and consumer confidence (which is falling rapidly), which the Fed will have to consider.

The futures markets are currently pricing in at least two 25 basis point rate cuts this year, with a materially better than even money chance of a third, based on a relatively recently developed expectation that there will be a significant economic slowdown.

Trump refused to rule out the prospect of a US recession last weekend, and has played down the sharemarket meltdown where, in his first term, he regarded it as a barometer of his achievements.

What he hasn’t done is indicate how long he thinks his transition period will be or what America might look like at the end of a transition that could include a recession and the economic distress that would cause.

He has spoken of a revival of US manufacturing and about making America “rich”, but the experience of his first trade war in 2018–19 says that tariffs aren’t going to do that.

His tariffs on steel in 2018 did increase the profitability of US steel producers and added some steel industry jobs, but a number of studies have concluded that the increased cost of steel inputs flowed through to a much larger group of manufacturers and construction companies and reduced their profits by a far larger amount.

Trump’s latest steel and aluminium tariffs, which kicked in this week, are broader. As we know all too well, there are no exemptions from them. They also, unlike their 2018 predecessors, apply to products made from the metals.

They will bolster domestic steel and aluminium producers; indeed, they already have, with the US steel companies already raising their prices. But the US companies produce a minority of America’s primary aluminium and steel-consuming industries rely on imports for about 25 per cent of their supply.

In 2023, the US produced less than 800,000 tonnes of primary aluminium and imported roughly the same amount, mostly from Canada.

Does Trump really expect aluminium producers outside the US to close their existing facilities and build enough plants in the US to secure its domestic supply?

Even if they did, that process would take years, and meanwhile, the cost of aluminium to US manufacturers, the biggest of which are the auto and construction industries, would rise significantly and permanently. Similar things could be said about America’s steel industry, although it is less reliant on imports (about 25 per cent of demand) than the aluminium industry.

The tariffs on steel and aluminium are, of course, only the start of Trump’s war on trade. His “reciprocal” tariffs are due to start on April 2. (Their launch was originally planned for April 1, which would have been appropriate, but someone in Trump’s orbit must have realised what the headlines would have looked like).

From this point on, the responsibility for economic outcomes is Trump’s.

Those tariffs will be applied to any economy that has a tariff or non-tariff trade barrier that impacts US exports. Trump has included the European Union’s value-added tax system, variants of which are used in many other countries, including Australia (the GST), as a target for his reciprocal tariffs.

Canada and the EU have responded to his actions against their steel and aluminium industries, with Canada announcing 25 per cent retaliatory tariffs on about $US21 billion of US products and the EU announcing measures that, imposed over two stages, would hit about $US28 billion of US products.

Trump has threatened to hit back with higher tariffs to anyone who retaliates to his tariffs – and Canada and the EU have said the same – raising the prospect of ever-escalating, tit-for-tat rounds of tariff increases.

US consumers will feel the pain of Trump’s trade war.Credit: Bloomberg

Trump has also imposed a 20 per cent tariff on all goods from China, and China has responded with highly targeted tariffs of its own aimed at US energy and agricultural exports. In 2018, when China responded to Trump’s tariffs with its own tariffs targeting US agriculture, his administration had to provide about $US28 billion of subsidies to US farmers to compensate them for their losses.

China is better prepared today than it was in 2018, having significantly reduced its reliance on the US farm sector by diversifying its sources of supply. Brazil has displaced the US, for instance, as the biggest exporter of soybeans to China.

Beijing is also prepared to protect its manufacturing base.

After Walmart tried to pressure its Chinese supplier to absorb some of the cost of the US tariffs on the goods they supply America’s biggest retailer, Walmart executives were hauled into a meeting in Beijing this week by Chinese officials and reportedly warned that asking suppliers to reduce their prices could violate contracts and result in legal actions.

If the suppliers don’t reduce their prices, Walmart and other US retailers will either have to absorb the increased costs generated by the tariffs and experience reduced margins and profits or pass them on to consumers, which will feed into the inflation rate.

Which is what critics of Trump’s trade policies have always argued. It will be the US and its consumers who suffer the pain from his tariffs for no meaningful, if any, economic gain or, more likely, significant economic loss.

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