US 25% Tax on Imports from China?
Posted by butalidnl on 19 March 2010
New legislation has been introduced in the US Senate to make it easier for the USgovernment to declare that China is manipulating its currency. When it does make such a declaration, the lawmakers are pushing the government to slap a 25% import tax on all imports from China. While this will unleash a trade war, the US lawmakers don’t seem to be afraid, saying that forcing the Chinese to raise the value of their currency will be worth it.
Shooting at its own foot
I doubt that a 25% tax on Chinese imports will help the US. While the strengthening of the Chinese Yuan vis-a-vis the US Dollar would help US exports, and even reduce imports; a one-sided tax on all Chinese imports would most likely backfire, and would hurt the US much more than it would hurt China. The proposed tax will make Chinese products in the US more expensive, and probably reduce volume of imports by a bit. But it will not in any way induce the Chinese to import more US products. In fact, the most likely response by China will be a reciprocal tax on US products, if not an outright ban on certain US exports.
And let us take a closer look at the effect of the US import tax. The effect will be that the price of Chinese-made products will rise by up to 25%. Actually, it will be less than that, since part of the increase will be absorbed by importers/retailers in a bid to maintain their market shares. The US consumers will suffer a big cut in their purchasing power, since many products have hardly any ready alternatives, and they will have to buy the marked-up products (at least for a while). The extra money that US consumers will have to use to buy the more expensive Chinese products will be taken from not buying other products, which they will not be able to afford anymore. This will cause a decline in sales of a whole range of products, resulting in job cutbacks.
Wouldn’t US production of these products replace the Chinese ones? Normally it should; but since US producers will be starting from a standing start, it will take them time to try to do this (probably a year or two). Retailers will most likely source the products from elsewhere in Asia – producers from India to South Korea have the plants and would only need to scale up their production. In fact, some companies have plants in China and other Asian countries, so it will be quite easy for them to shift production. Contracts could be closed with them rather quickly. And they will offer their products – from Bangladeshi garments, to Philippine furniture – at prices lower than the marked up Chinese products (note: not the old Chinese prices). So, the US tax will in effect be promoting the exports of other countries, and not reducing overall US imports. And the only difference is that the US will then be paying a higher price for everything.
And then there is the inflation. With the 25% import tax, the overall price level will increase by probably about 5% over the intrinsic inflation. This would be a rather problematic situation for the US Fed. They may have to increase interest rates before they are ready. Any increase in interest rates will mean that the US debt burden will increase.
Inflation holds the danger of further devaluation of the US dollar. And while some say that this is good, since it will promote exports and reduce imports (or so goes the theory). The US is a net importing nation, and this means that when its currency devaluates, the price of its imports will rise accordingly. The price of oil, for example, will rise with a devaluation of the dollar.
And what has China to do in response? Well, for one, it could restrict the entry of US products. But even if it didn’t, the resulting inflation, price rises of imports, and unemployment will hit the US anyway. But with the restricted entry of US products, US exports will be reduced. And all this is even without China playing its trump card – dumping its US treasury bills in the international market.
China holds about $900 billion worth of US treasuries. If it sells them all and exchanges them for Euro, Yen, Pounds etc. the US Dollar will really devaluate, and the interest the US will have to pay on them will have to rise. And the dumping of dollars by China will also push other moves e.g. countries like Saudi Arabia abandoning the dollar peg, and the possible pricing of oil using a basket of currencies and not the dollar. Chinese dumping of US dollars will set off a chain of events which will cause a dollar crisis, one which has been overdue. And when the crisis starts, US hedgefonds will abandon the dollar en masse, making the currency depreciate even faster.
So much for doom scenarios. It will only happen when the US does something stupid like slapping an import tax on Chinese products. Right now, an unusual alliance of US companies are lobbying intensely against it – importers and exporters alike see this as a threat to their profitability, and are working to stop such a law. So, let us hope that the cool heads prevail in the US, and that they will be satisfied to wait till the Chinese float their currency for their own reasons.