What would a trade war actually look like?
'This would raise trade costs to levels last seen in the run-up to the Great Depression'
Donald Trump is threatening steep tariffs on all goods entering the U.S. from Canada, Mexico and China.
They'll be in place until the countries stop the flow of migrants and drugs illegally entering the U.S., Trump said. Mexico and China have threatened to respond in kind.
Businesses, economists and policymakers are trying to figure out how much of this is threat, how much is bluff and how much is real.
Trade wars are notoriously easy to start. But they can be difficult to unwind. And the consequences of this kind of global trade war could impact everyone.
"The result would be a swift and severe recession on America's northern doorstep that would crush demand for U.S. imports," wrote Derek Holt, vice-president of Scotiabank Economics.
Tariffs would raise trade costs to Great Depression levels
Scotiabank ran models exploring how tariffs would weaken demand and slow economic growth. Trump has threatened a 25 per cent tariff on all goods coming into the U.S. from Mexico and Canada.
The U.S. dollar, already surging against foreign currencies, would jump, forcing the Bank of Canada to hike interest rates, all while exporters struggle. Canadian GDP would fall by as much as 5.6 per cent.
If Canada responded with tariffs of its own, the Scotiabank model found interest rates would climb 275 basis points (or 2.75 percentage points). The loonie would fall by about 21 per cent, the unemployment rate would rise three percentage points and inflation would take off again.
Karl Schamotta, chief global strategist at the financial services firm Corpay, says Trump is threatening a level of trade barriers unseen in nearly 100 years.
"This would raise trade costs to levels last seen in the run-up to the Great Depression," wrote Schamotta in a note to clients.
Schamotta issued a chart highlighting the major changes in trade barriers going back to 1820. He measured the ratio of duties to value to see how tariffs impacted the U.S. economy.
The U.S. Smoot-Hawley Tariff Act is a widely used example of how tariffs can make things worse, Schamotta said. In that case, tariffs were aimed at protecting American farmers and preventing a recession in 1930.
They initially targeted wool and sugar, but snowballed as industries lobbied for more. Eventually, they were proposed on over 800 different products.
Other countries imposed tariffs of their own. (Canada, for example, increased tariffs on U.S. eggs by 233 per cent.) In the end, the act only worsened the effects of the Great Depression.
Schamotta has called it one of the worst self-inflicted economic wounds in U.S. history.
He says it hurt American farmers, crushed auto and steel exports, slowed global trade and helped drive down stocks on Wall Street. And he says, the only people who benefited were lobbyists.
"That any leader would want to repeat the experience is astonishing," said Schamotta.
Meanwhile, Mexico has said it would impose a 25 per cent tax on American companies, which Mexican President Claudia Sheinbaum says would result in a loss of an estimated 400,000 jobs in the United States.
"If there are U.S. tariffs, Mexico would also raise tariffs," Sheinbaum said.
The Mexican president says the United States–Mexico–Canada Agreement has been good for all three countries involved and said her country has no interest in a trade war.
China's response?
In China, the government is also urging co-operation. Trump has threatened an additional 10 per cent tariff on Chinese goods coming into the U.S., on top of any others, until it cracks down on fentanyl smuggling.
"No one will win a trade war or a tariff war," said Chinese Embassy spokesperson Liu Pengyu said in a statement.
Experts say China seems to be waiting to see what Trump actually does. But how China responds will have sweeping implications for the global economy.
Brad Setser, an economist from the Council on Foreign Relations, says one crucial thing to watch is whether China allows its currency to fall against the dollar.
If the yuan is worth less, it would take fewer dollars to buy Chinese products. That would help blunt the impact of tariffs.
"China faces a choice between allowing the yuan to depreciate in the face of expected tariffs (and risk triggering a negative reaction from Trump that leads to more tariffs) or waiting for the actual imposition of tariffs before allowing the yuan to move," wrote Setser on the social media platform X.
Beijing did precisely that when Trump imposed tariffs on Chinese goods in 2018 and 2019.
Back then, the move posed two problems. It led to a surge in cheap Chinese goods flooding into global markets. But a weaker currency also caused concern about the impact it could have on the domestic Chinese economy.
Skip ahead to 2024, and the Chinese economy is much more fragile, as consumer spending has fallen and business investment in the country has plummeted.
So heading into the second Trump presidency, China has less cushion than it did during the first.
"All of this matters for the entire world, as one of the main impacts of a weaker yuan is that it helps China offset the impact of any tariffs on its trade with the U.S. through higher exports to countries that themselves don't have tariffs," posted Setser.
That's how an already global trade dispute between Canada, Mexico, the United States and China can quickly expand into a series of tit-for-tat tariffs that spreads around the world.
Threat remains hypothetical — for now
It's important to note that for now, the threat of tariffs remains largely hypothetical. It wasn't announced as an official policy, but rather in a late-night social media post.
Oxford Economics ran the numbers on a handful of scenarios. Economists there reckoned Trump's proposal of 25 per cent tariffs on Canada and Mexico plus an additional 10 per cent tariff on China stands a 10 per cent chance of actually happening.
Far likelier — a 25 per cent likelihood — is something tougher on China but less aggressive toward Canada and Mexico.
"Universal tariffs of 30 per cent on imports from China and 10 per cent on all other imports from the rest of the world," wrote Oxford's lead U.S. economist Bernard Yaros.
Meanwhile, markets that would roil on actual tariffs and plummet through a trade war have remained largely muted since Trump announced his tariff plan. Investors, for now at least, are waiting for something more concrete to react to.
Which is probably good advice for everyone.
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