The trade war is renewed
The United States appears to be moving toward sustained, very high tariffs. The three trade deals reached so far (with the United Kingdom, Vietnam, and China) have left US tariffs historically high, potentially offering a template for future deals with many other countries. Although the United States has postponed final determination of tariffs until August 1, the framework for a new US relationship with the world is now emerging.
Japan and South Korea
President Trump sent letters to the leaders of South Korea and Japan indicating that the United States intends to impose a 25% tariff on imports from those countries unless they make unspecified changes to their trade policies. Under current law, the United States and South Korea have a free trade agreement that took years to negotiate and was approved by the US Congress. New tariffs will end that agreement. This raises the question as to what concessions South Korea could make to appease the US administration. In my view, there are none. Rather, the letter sent by the president focuses on the bilateral US trade deficit with South Korea and urges Korean companies to invest more in the United States. The idea is that, if Korean companies make more things in the United States, they will export less to the United States.
A few comments on this: first, increased inbound investment in the United States necessarily leads to a bigger trade deficit. That is because capital flows and trade flows must offset one another. Second, the bilateral trade imbalance between two countries is not consequential. Rather, the overall trade imbalance of a country is important but is not the result of trade rules. Third, If Korea cannot make any meaningful concessions that would satisfy the United States, then it will evidently be left facing a high tariff barrier for its exports. This will surely hurt Korea’s economy, but it will hurt US consumers even more. Although it might lead US consumers to divert trade to other countries, this would only make sense if tariffs are lower on other countries’ exports. That might not be the case if the US imposes high tariffs on most countries.
In Japan, it is reported that leaders are shaken by the US intention to impose a 25% tariff on imports. The country’s leaders had hoped that the expansive economic and political relationship between the two countries would protect Japan from severe tariffs. Indeed, Japanese Prime Minister Ishiba recently said that “Japan is the world’s largest investor in the United States and creates the largest number of jobs. We are in a different situation from other countries.” Evidently, that is not the case.
Trump also announced potential tariff rates on multiple countries, to take effect on August 1, provided no deal is reached with these countries. He left open the possibility of deals, rendering the proposed rates highly uncertain. What we do know is that the rates are very high—in most cases similar to the so-called “reciprocal” tariffs announced on April 2 but postponed. If these new rates are implemented, it would mean that the average US tariff rate would reach a level not seen in more than a century, likely disrupting global trade flows as well as cross-border investment flows. Moreover, these proposals say nothing about potential new tariffs on specific products that are currently being considered. Recall that a US court ruled that the country-level tariffs are mostly illegal. If this is upheld by higher courts, the administration is likely to turn to product-related tariffs as its principal tool.
If the average US tariff rate remains at the current level, or goes higher, it will change the dynamics of the global economy. It will almost surely boost US inflation, at least temporarily. This, in turn, will influence the trajectory of the Federal Reserve’s monetary policy. In addition, tariffs will lead to reduced imports and lower consumer purchasing power, likely causing US economic growth to decelerate and possibly leading to a US recession. For other countries, high US tariffs will reinforce efforts to boost trade with one another and to boost domestic demand. For some countries, retaliation will take place, as was suggested last week by Germany’s chancellor with respect to the European Union.
Southeast Asia
Regarding Southeast Asia, it appears that the administration is leaning toward very high tariff rates. This is important because, in recent years, much investment that might otherwise have gone into China went to Southeast Asia as companies sought to reduce the risk of doing business in China. Yet now it is reported that the US administration is considering tariffs ranging from 25% to 40% on imports from such countries as Cambodia, Laos, Indonesia, Thailand, Philippines, and Malaysia. If this happens, it will be significant for US consumers who purchase many goods assembled in these countries. It could have a big negative impact on these countries, likely disrupting existing supply chains.
On the other hand, this is not yet written in stone. Negotiations are taking place. The US administration already reached a deal with Vietnam in which the United States imposes a 20% tariff on imports from Vietnam, and Vietnam imposes a zero tariff on imports from the United States. It is not clear if this deal will be a template for Vietnam’s anxious neighbors. Even a 20% tariff is very significant.
Leaders in Southeast Asia have begun to react to the likelihood of high tariffs. For example, Malaysian Prime Minister Anwar criticized the new environment, saying that “across the world, tools once used to generate growth are now wielded to pressure, isolate, and contain. Tariffs, export restrictions, and investment barriers have now become the sharpened instruments of geopolitical rivalry.” Malaysia’s central bank cut its benchmark interest rate by 25 basis points—the first cut in 25 months—in an attempt to boost domestic demand and offset negative consequences for exports.
Canada
US-Canadian trade relations have returned to the top of the headline after several months of calm. Yesterday, US President Trump said that a 35% tariff will be applied to imports from Canada, excluding goods covered by the free trade agreement between the two countries—although that exemption might be changed according to the US administration.
Reaction in financial markets was mixed. US equity prices fell sharply before slightly rebounding, as did Canadian equity prices. The value of the Canadian dollar fell sharply but bounced back significantly due to expectations that the 35% tariff will not necessarily happen. Many traders believe that each threat made by the United States is simply an opening move in a negotiation. Yet the recent resolution of trade disputes with other countries suggests that the United States intends to keep relatively high tariffs.
The 35% tariff on Canadian imports is more than the 25% rate threatened earlier in the year. Since then, Canada has gotten a new prime minister (Mark Carney) who has worked hard to improve relations with the United States—going so far as to cancel a digital services tax about which the United States complained. Yet the latest announcement suggested that the tariff is partly about fentanyl. President Trump said that “if Canada works with me to stop the flow of fentanyl, we will, perhaps, consider an adjustment to this letter. These tariffs will be modified, upward or downward, depending on our relationship with your country. You will never be disappointed with the United States of America.” Trump also warned that, if Canada retaliates, the US tariff will go up further.
Although the volume of fentanyl crossing the border from Canada to the United States has reportedly been small, the Canadian government has vowed to spend US$1 billion to curtail the flow. Prime Minister Carney said that “vital” progress has been made on this front. He said that he will work with the US administration to resolve any differences.
Moreover, whatever happens regarding US-Canada relations will ultimately be replaced by the required review of the existing free trade agreement between the United States, Mexico, and Canada. This review must take place in 2026. It is likely that changes will be made to the agreement.
Brazil
When the US administration proposed severe, so-called reciprocal tariffs in early April, the size of each country’s tariff depended on the size of its trade surplus with the United States. For countries that had trade deficits with the United States, there was a baseline tariff of 10%. Brazil is one of the countries that has a deficit with the United States. Yet yesterday, President Trump threatened to impose a 50% tariff on imports from Brazil because the government is prosecuting former President Bolsonaro, who is accused of attempting a coup. This is a tariff not based on any economic factor but, instead, on a political one. Thus, the current US administration likely sees tariffs as the ultimate tool to pressure foreign governments, regardless of economic circumstances.
It is unlikely that Brazil will make any changes to satisfy Trump. In response to the US threat, the value of the Brazilian currency fell sharply while Brazilian equities declined as well. Moreover, if a 50% tariff is implemented, it will have a significant impact in the United States. Brazil is the largest source of coffee for the country. Coffee futures prices climbed sharply today on the news of the US threat.
In addition, Brazil is the third-largest purchaser of US steelmaking coal. Brazilian companies finish the coal and sell it back to the United States. Thus, for US steelmaking companies, this will represent an increase in their costs. Brazil also exports many other products, including medium-sized airplanes, that are popular with US airlines for short-haul routes. Thus, the potential tariff could be very impactful.
Copper
The US administration said that a 50% tariff on copper imports will take effect on August 1. Thus, it appears that the effective average US tariff, which is currently around 18%, is set to increase significantly by August. Recall that, at the start of the year, it was under 3%.
Regarding copper, the country imports about 60% of the copper it consumes, with most of it coming from Chile, which has a free trade agreement with the United States. About 40% comes from domestic mines or the recycling of scrap copper. In response to the threatened tariff, the price of copper has soared as companies have sought to purchase quickly in anticipation of tariffs. Indeed, copper inventories in the United States have also soared, roughly doubling since the start of the year. The latter is a concern in China, the world’s largest consumer of copper. Meanwhile, diversified mining companies, which might see their US mines benefit from the tariffs, saw their share prices fall, given the likely disruption of the global market.
