Photo-Illustration: Intelligencer; Photo: Michael Nagle/Bloomberg/Getty Images
With his extreme new round of tariffs in effect as of Wednesday morning, President Trump’s trade war is at full throttle. Stock markets around the world keep plummeting, and chaos and uncertainty are the order of the day. but in order to gain a modicum clarity into the situation, I spoke with Olu Sonola, the U.S. Head of Economic Research at Fitch Ratings. We discussed why the trade war as it stands is untenable, what a trade war with only China might look like, and one sign that a recession might be near.
Markets rebounded sharply on Tuesday morning, seemingly because of a few comments by Trump administration officials who said other countries want to make bilateral trade deals with the U.S. Then stocks fell back down again. It may be foolish to try to divine what the market’s doing hour by hour, but what did you make of those developments?
I try to stay away from market ups and downs and stay in the economics lane as much as possible, but what I can say is that clearly the volatility is expected. Particularly because literally every minute now is “breaking news,” and markets are primed to react to it every time it pops up. Clearly, market direction is basically hinged on any news at all on the trade front.
Looking at the big picture, which is what I tend to focus on, at some point you hope an off-ramp is taken. It has to be taken; it’s just a question of when. We have to have a conversation — and by “we,” I mean the U.S. government — that is reasonable. I think ultimately where that would end up is that reciprocal tariffs will move lower. It’s a question of when that signal will come. Are we talking about days? Are we talking about weeks?
You frame it as this has to happen because if it doesn’t happen — calamity?
Yeah, because you can’t fight a trade war with the entire world. You just can’t. You can select a few countries and have this sort of tension, but you can’t with the entire world.
What if there’s a scenario — and this seems fairly likely — in which some countries, like, say, Japan and South Korea, get much more favorable terms than other major trading partners? Trump hates the E.U., for instance, and could punish it more than others.
Coming in, I always thought that was going to be the outcome, that some countries would be singled out and others would get very preferential rates. There may end up being a full-blown trade war with China, but I think the U.S. will still be somewhat reluctant with the E.U., just given deep relationships that go back. The tariff rate on them is 20 percent, which is below average. That suggests we still look at the E.U. as a relatively favorable partner from a trade standpoint, which may also suggest that it may not take much for us to come to some sort of compromise with the E.U. — unlike with China, where we’re really far apart. They’ve also levied a retaliation rate, and it looks like it’s just going to escalate before they de-escalate.
But still, the notion that every country has to negotiate separately like this, just the uncertainty embedded in that assumption — how does that affect the overall economic picture?
Uncertainty is bad for business. It’s just that simple. Even if you get clarity on three or four countries and your uncertainty persists for many other countries we have major trading businesses with, you are going to see that likely cascade through investments, through hiring, because you don’t know what to do.
If you also have existing tariffs in place, even just from China, you also would be wondering, Do I place that order now? Am I going to pay 100 percent when it shows up? What if that tariff rate goes away in two months? So I’m not going to be left holding that bag? Am I going to get a refund on my 100 percent? So you’d rather just sit on your hands, do nothing, and not invest. And if you’re not really doing anything, to what extent does that cascade to jobs?
We import a lot of inputs from China — a lot of intermediate inputs, a lot of capital goods. Most of it goes straight into the manufacturing process. Does that slow down manufacturing in the U.S.? Does that cost jobs longer term? These are all uncertainties that immediately will be around because reshoring is going to take time — months, years. But the impact of uncertainty is here and now. When you think about the short term versus the long term, that’s what the stakes are. That is where the rubber meets the road.
Let’s say our other major trading partners make more favorable deals, or the U.S. just ratchets down the tariff rates on them, but we’re still in a serious trade war with China. How much would that alone affect the United States’s medium-term economic outlook?
It’s negative without question. To quantify that, we’ll have to see how a few things go. Everybody knows that a lot of Chinese products come into the U.S. more or less tariff-free, or with much lower tariffs, through Vietnam, Cambodia, even Mexico. But if you narrow it down to just China, we imported $430 billion last year. And as I said earlier, a big chunk are inputs, intermediate goods, and capital goods. So I think that’s going to blow back.
The other point is prices, right? Some of it — probably the majority of it — will be passed along. But if you’re talking about a tariff rate in the range of 100 percent, where do you even start having the conversation? People are just not going to import. Then you’re not just talking about the price function; you’re not just talking about inflation. It’s really about to what extent those inputs will slow down manufacturing in the U.S., and that’s also going to be a negative. Yes, manufacturing in the U.S. is only 10 percent of GDP, and at the moment it accounts for only 8 percent of employment. And China is just one of many countries we get our inputs from. So to that extent, maybe if we still have growth in other places, if we still have a relatively strong economy, it will offset the weaknesses.
I have not quantified it yet because so much is uncertain. It also depends on — are we still going to go after Vietnam? Are we still going to go after Cambodia? If we’re saying, “Hey, absolutely nothing from China through those countries,” that’s an even bigger deal. If we’re not and everything just goes through other countries rather than coming straight from China to the U.S., then obviously that cushions the blow. But the U.S. will probably want to put things in place to avoid that. Really, there are so many things at play, and so many things to think about.
And of course the idea of reshoring is also affected by the kind of uncertainty you mentioned. If you don’t know whether these measures will stay in place, why go all in on anything?
Exactly. The uncertainty is bad for business, particularly business investment. At some point, it’s going to start showing up in their employment numbers. I went back to the 1950s and looked at every single quarter of contraction we’ve had since then; when you look at that, the bulk of the contribution to those contractions, about 70 percent of it, came from business investment.
Business investment is only about 15 percent of the economy, but in terms of volatility, that’s what gets you. The only time we had a significant downturn with most of it coming from the U.S. consumer was COVID, and that was obvious. But once you take COVID out of it, probably 80-plus percent were all about the downdraft in business investment. So that will be an important thing to watch going forward.
This interview has been edited for length and clarity.
