Thursday 28 Mar 2024
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(Feb 17): A US border tax would hit growth abroad, sending a global deflationary shock which may be magnified if other countries take defensive steps which result in round-robin currency depreciations.

A particular concern is that a sharp appreciation in the US 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 Trump, are pushing a border adjustment tax of 20% on imports while excluding export revenue from corporate taxable income. Corporate income tax under the plan would be cut to 20% from 35%.

In theory a 20% import tax would push the US dollar higher by a similar amount.

Economists at UBS argue that a border tax arrangement, like a 10% 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 of 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.

First steps would probably be to fight the policy at the World Trade Organization, a tactic which might or might 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'S ALWAYS DIFFERENT THIS TIME

It's possible the more significant impact globally will be from US dollar strength, which, unlike other similar bouts of US dollar appreciation, will not be cushioned by a rise in exports to the US The trade-weighted US dollar is already not far off 20-year highs and has risen by more than 20% in the past two and a half years.

To be sure, foreign governments are less vulnerable to US dollar strength than in the past, many having built up large reserves of US dollars. Foreign corporations, particularly in China, would see their debt burdens rise as the US dollars they have borrowed become more expensive to pay back.

Chinese nonfinancial corporations could see their debt burdens rise to more than 190% of China's GDP if the US dollar rises by 20%, 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."

China officials may be tempted or forced to let the yuan go against the US 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.

The opinions expressed here are those of James Saft, a columnist for Reuters.

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