China vs. Trump

While the following is somewhat simplified and ignores some relevant consequences, it provides useful perspective.

China has made an unforced error that makes it possible for the US to gain at China’s expense. Trump can win if he plays it right.

First, Trump put tariffs on US imports from China. Downward sloping demand curves and upward sloping supply curves imply that:

•  Prices to US consumers of Chinese products rise, but not nearly by the amount of the percentage tariff.

•  US imports of Chinese products decline.

Suppose the US and China do nothing more. Then over time:

• Other countries with production costs almost as low as China’s would sell to US consumers at prices only slightly above the US pre-tariff prices of Chinese products.

• Assuming the other countries’ production rates did not increase, Chinese manufacturers would sell their products to the other countries’ consumers to make up the difference.

The result, over time, would be:

• US imports of Chinese products would decline substantially.

• US imports of these products from other countries would rise substantially.

• US consumer prices of the products involved probably would decline and approach their pre-tariff levels.

• Tariffs collected by the US would decline substantially.

• The distribution of production of the products involved across the various countries would not change much.

• Neither the US nor China would lose or gain much.

But China responded by devaluing its currency relative to the US dollar. Assume the devaluation percentage is the same as the US tariff percentage. Then China has given a free lunch to the US. To see this, consider the simplistic case where a US tariff increases the US consumer price by the percentage tariff and imports of Chinese products is unaffected.

Before China devalues its currency:

• The price of Chinese products to US consumers has risen by the tariff percentage.

• US consumers are paying the tariff to the US government and the pre-tariff price to China.

• The US government is collecting a substantial tariff.

Next:

• China devalues its currency with respect to the dollar by the tariff percentage.

• China’s pre-tariff price to US consumers drops by the tariff percentage.

• US consumers pay the tariff to the US government and the new lower pre-tariff price to China.

• US consumers net price drops to the original pre-tariff price.

• Tariffs collected by the US remain substantial.

• China has subsidized the US government by the amount of the tariffs collected.

• US consumer prices for Chinese products have not changed.

• The US is better off and China is worse off.