The longer the trade war, the sooner the recession

The standoff between the U.S. and China over a breakdown in tariff negotiations sounds a warning for the U.S. economy.

While the current economic environment of strong economic growth and stable interest rates will likely stave off a recession for the short term, higher prices on Chinese goods and the subsequent lost trade with China will hurt the U.S. economy. That could hasten a recession, which, given the cyclicality of the economy, is inevitable at some point.

{mosads}The longer the trade war with China remains unresolved, the sooner that recession will likely materialize. Given the political stakes — with China needing to save face by not caving into Washington and Trump’s bullying tactics in negotiations — expecting a quick end to the trade war is a fool’s fantasy.

The simple fact is that, without a trade deal, tariffs will be in place longer. On Monday, China announced it will impose tariffs of up to 25 percent on $60 billion worth of U.S. goods starting in June.

This was a response to the U.S. imposing 25-percent tariffs on $250 billion of Chinese goods. China, it appears, is expressing both restraint and goodwill by not responding tit-for-tat to Trump.

President Donald Trump has tried to downplay the trade war, reportedly calling it “a little squabble” while describing his relationship with China’s President Xi Jinping as “extraordinary.” That was enough to send the stock market into a rally on Tuesday, after Monday’s sharp sell-off.

But the relief rally belies a bigger truth: U.S.-China negotiations are very contentious and won’t lead to an easy or quick resolution. Trump is pushing China into a corner, which is not a successful trade stance and ignores the probable economic fallout.

Trump’s tweets paint a picture that does not reflect economic reality. For example: “The unexpectedly good first quarter 3.2% GDP was greatly helped by Tariffs from China. Some people just don’t get it!” And earlier: “I am very happy with over $100 billion a year in Tariffs filling U.S. coffers…great for U.S., not good for China!”

These statements reflect Trump’s fundamental misunderstanding of how tariffs really work and what their impact will be on the economy. As the New Yorker observed, Trump has “argued that higher import duties don’t represent an additional cost to consumers and a drag on over-all [sic] economic activity, as the economic textbooks say, but are, in fact good for the economy.” The president’s thinking amounts to an “alternate reality,” it added.

Unequivocally, tariffs raise prices on consumer and intermediate goods. Apple, for example, is seen as being particularly vulnerable. It assembles iPhones mostly in China, and higher tariffs would mean either absorbing that cost or passing it on to consumers with higher smartphone prices.

In addition, Apple sells to Chinese consumers. If trade pressures with the U.S. hurt the Chinese economy and anti-American sentiments continue to rise, Apple would likely feel the pinch in its sales to Chinese consumers.

More broadly, there are also indications that higher tariffs are harming the reputation of U.S. companies as “reliable global suppliers,” due to the uncertainty over prices and supply.

U.S. companies might try to apply pressure on Washington to come to a trade deal with China, but Trump’s stance seems intractable. That means the trade war with China could be a long haul, wearing on investors and businesses, alike.

The bottom line is tariffs raise prices and that will cause economic growth to slow in the U.S. No amount of presidential tweeting can change that fundamental fact.

Phillip Braun is a clinical professor of finance and associate chair of the Finance Department at the Kellogg School of Management at Northwestern University.