(The opinions expressed here are those of the author, a columnist for Reuters)
By James Saft
Feb 16 (Reuters) - A U.S. 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 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 percent on imports while excluding export revenue from corporate taxable income. Corporate income tax under the plan would be cut to 20 percent from 35 percent.
In theory a 20 percent import tax would push the dollar higher by a similar amount.
Economists at UBS argue that a border tax arrangement, like a 10 percent tariff and import subsidy, would increase U.S. 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 U.S., 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 U.S., have a lot less control over how all of this goes down internationally. The U.S. 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 dollar strength, which, unlike other similar bouts of dollar appreciation, will not be cushioned by a rise in exports to the U.S. The trade-weighted dollar is already not far off 20-year highs and has risen by more than 20 percent in the past two and a half years.
To be sure, foreign governments are less vulnerable to dollar strength than in the past, many having built up large reserves of dollars. Foreign corporations, particularly in China, would see their debt burdens rise as the dollars they have borrowed become more expensive to pay back.
Chinese nonfinancial corporations could see their debt burdens rise to more than 190 percent of China’s GDP if the dollar rises by 20 percent, 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. (here#more-8121)
“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 dollar to mitigate the impact of a border tax, both in their economic relationship to the U.S. 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. (Editing by James Dalgleish)