(Bloomberg) China’s devaluation of the yuan has proved U.S. President Donald Trump both right and wrong. He’s right that, by allowing its currency to weaken, China is now paying for at least part of his tariffs. And because it is, the tariffs are unlikely to provide the boost he promised to U.S. businesses.
This is the fundamental dilemma of Trump’s trade war: If the U.S. consumer is paying for the tariffs, then they help improve U.S. competitiveness, by making U.S.-made goods relatively cheaper. If China is paying for the tariffs, then there is no price differential and no improvement in U.S. competitiveness. It’s impossible to have it both ways.
Trump has long asserted that China, not the U.S. consumer, is paying the cost of his tariffs. This is demonstrably false. As economists have pointed out, the cost of the tariffs has largely been passed on to U.S. consumers in the form of higher prices on Chinese imports.
As a result of the tariffs, some U.S. companies may see a temporary increase in their sales, but it won’t be as great as the loss Chinese firms experience. That’s because the U.S. goods are higher-priced to begin with. Some U.S. consumers may switch their purchases to U.S. goods, but they won’t be able to afford as many, and other consumers may simply put off purchases altogether.
Now China is taking steps to reduce the harm to their producers. The Chinese government has allowed the value of its currency to fall to its lowest level in three years. This makes Chinese exports cheaper immediately. There is no need for Chinese producers to cut prices because the falling yuan reduces the price of all Chinese exports.
This is obviously good news for Chinese producers and U.S. consumers. If the Chinese allow the yuan to keep falling, it could theoretically undo the effect of the tariffs. Consumers would see the same prices they did before the tariffs were imposed.
Since the tariffs are still in place, however, the U.S. government would still be collecting revenue. Who, then, would be paying for the tariffs? The answer is Chinese consumers: A weaker yuan makes things much harder for them, as the agricultural, energy and other commodities they buy from abroad are more expensive.
So what’s the downside for the president? China is paying for the tariffs, as he has said, and U.S. consumers aren’t. The problem is U.S. producers. The tariffs gave them an advantage in the U.S. market that they no longer have.
And there is a deeper problem. China’s paying of the tariffs doesn’t mean that the trade war isn’t hurting the U.S. economy. There are at least two more effects to consider.
First, there has been a sharp increase in uncertainty. China is paying for the tariffs now, but who is to say that the American consumer won’t be by tomorrow? Businesses can’t know for sure, and therefore have difficulty knowing where to invest. Modern supply chains are global, and so this is more than a simple choice of China vs. the U.S.
For a company such as Caterpillar, for example, increasing heavy machinery production in the U.S. may make sense only if it can get inexpensive steel and aluminum from China. Yes, the devaluation of the yuan pushes Caterpillar toward more domestic investment. But since the company can’t know how long the devaluation will last, the risks are still heightened.
What’s more, this uncertainty is compounded by the effects of the yuan’s devaluation on foreign producers. The European economy, and Germany in particular, was already struggling before this latest round of the trade war. The cheaper yuan will make it even harder for Germany’s export-oriented economy to compete. And Germany, in turn, is a major buyer of heavy machinery from companies such as Caterpillar.
U.S. manufacturers face a double-edged sword: China’s devaluation of its currency makes their inputs cheaper. But it also makes foreign demand for their products weaker.
All of this uncertainty is an enormous disincentive for U.S. investment — and the hesitancy is evident in the data. The U.S. consumer has remained resilient, but business investment is weakening. As long as the trade war continues, that weakness is likely to persist.
