As President Trump ratchets up the trade war with China and as he threatens import tariffs on European automobiles, there are many reasons to be concerned about intensified U.S. trade protection.
This is especially the case insofar as those actions might negatively impact both the U.S. and the global economic recoveries by returning the world to the “beggar-thy-neighbor” policies of the 1930s. However, increased U.S. inflation should not be one of those concerns.
{mosads}To be sure, the direct impact of increased U.S. import tariffs might be to raise domestic costs and prices. However, there are important indirect effects from increased tariffs that might be expected to push down domestic U.S. costs and prices.
One might even expect that the indirect downward effects on costs and prices could more than offset the upward direct effects.
Those concerned about the inflationary impact of increased tariffs point to the increased cost of U.S. imports resulting directly from those tariffs. They also suggest that there might be a reduced degree of domestic competition as a result of a move to a more closed international trade system.
There are those who estimate that the combined inflationary effect of these two factors from the recent Trump import tariff increases to date could be as high as 0.6 percent.
Those worried about the inflationary impact of increased tariffs tend to overlook three indirect factors that could push U.S. costs and prices lower.
First, our trade partners are retaliating to our import tariffs by reducing their demand for some key agricultural products like soybeans and pork. This is pushing those prices sharply lower. Since March, when President Trump started intensifying protection, soybean prices have fallen by some 20 percent.
Second, and more importantly, increased U.S. protection is contributing to a slowdown in the Chinese and European economic growth by denting investor confidence in those economies. That in turn is being reflected in a generalized appreciation in the U.S. dollar and a significant drop in international commodity prices.
In this context, one would think that the 5-percent appreciation in the dollar and the 8-percent drop in international commodity prices since March would have a major moderating impact on U.S. inflation.
One might also expect additional dollar depreciation to occur in the period ahead as U.S. monetary policy becomes increasingly out of sync with that in Europe and Japan.
Third, an intensification of U.S. trade protection has the potential to slow U.S. and global economic growth. It could do so by increasing investor uncertainty, by disrupting global supply chains and by roiling global financial markets.
If such a cooling in the U.S. and global economies were to occur, one would expect that there would be a generalized deceleration in inflation. This would occur as employment got impacted and as the size of labor and product market gaps increased.
In short, the real reason to worry about an intensification of U.S. trade protection and the possible consequent drift to a global trade war is not that it will raise domestic inflation. Rather, it is that it has the potential of derailing both the U.S. and the global economic recoveries.
This is what occurred with the infamous Smoot-Hawley Act of increased U.S. import tariffs in the 1930s as the world economy drifted to beggar-thy-neighbor policies. Sadly, this is what could very well occur today with the Trump import tariffs.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.