“Keep your friends close, and your enemies even closer.” Donald Trump most likely took these words to heart, as he has found new enemies very close by. Trump is openly declaring a trade war against Canada, Mexico, and China, imposing hefty tariffs on all products, marking a significant shift from the first trade war of his first term. Many American media outlets are calling this new trade war “the dumbest one in history”, though Donald Trump believes it is necessary to restore the United States' position on the international stage. Does the new trade war make sense? Is it just part of a strategy? Who and how much will lose due to the United States' aggressive trade policy?
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Although Trump had long promised to impose huge tariffs on the economies with which the United States has the largest trade exchange, the markets were not entirely convinced by his words. Ultimately, on the first day of February, Trump signed executive orders imposing 25% tariffs on all goods from Canada and Mexico, as well as 10% tariffs on all Chinese goods. The only exception is energy commodities from Canada, for which the tariffs will be just 10% and will not take effect until February 18, instead of February 4.
Economic consequences. Who will be hit the hardest?
The tariffs signed by Trump are set to affect $1.3 trillion worth of products, three times more than during the first trade war of Trump's first term. Back then, the tariffs were targeted at specific products and industries. This time, the tariffs are broad, raising questions about their justification and sustainability. However, assuming these tariffs are here to stay, the U.S. economy could take a significant hit. The estimates show that economic growth in 2025 could be reduced by 0.7 to 1.6 percentage points. By 2026, it could be over 2 percentage points. But that's not all. The Fed’s model estimates a substantial impact on inflation, around 0.7 percentage points. In such a scenario, the chances of further interest rate cuts would become negligible, which, from the perspective of American businesses, citizens, and Wall Street investors, sounds mostly negative.
Donald Trump himself admits that the impact of the trade tariffs could be negative for U.S. citizens, but he emphasizes the necessary sacrifice to bring about long-term improvements. However, if the tariffs are actually implemented, the declines in Canada’s and Mexico's GDPs are almost certain, as they rely heavily on trade with the United States. In Mexico, as much as 16% of GDP is tied to American trade, while in Canada, it’s about 14%. For China, this percentage slightly exceeds 2%, so the impact on its economy should not be as drastic as it is going to be for the North American countries.
It is likely that there will be a sharp slowdown in trade in North America, which could also negatively affect countries that supply products to Canada and Mexico. On the other hand, the U.S. might potentially look for cheaper alternatives in other regions of the world. This could present an opportunity for Asian countries (other than China) to increase their exports.
Which industries will be under pressure?
The U.S. automotive sector is highly integrated. Before a car is sold, some parts cross borders multiple times. Therefore, imposing tariffs on Mexico and Canada effectively means imposing tariffs on American manufacturers. Of course, Trump would like to bring all production back to the U.S., but this is not feasible in the short term and would come with huge costs. Initial estimates suggest that the average price of American cars could increase by about $3,000. This is significant, considering the price of such a car is around $45,000–50,000. It’s also worth noting that inflation in recent years has been heavily influenced by changes in the automotive sector.
Attention should also be given to the electronics and apparel sectors. Let’s take a look at some major companies. Apple, for example, manufactures the vast majority of its products in China, and the same applies to Nike. Of course, these are only two examples, but many companies would likely pass the increased costs onto consumers. Ultimately, the average U.S. household is estimated to lose around $2,500–3,000 annually due to the current scale of the trade war. If tariffs on China were increased further and tariffs were also imposed on European Union countries, these costs would be substantially higher.
Does Europe have reason to worry?
Europe has often fallen out of favor with Trump. He has pressured Europe to spend more on defense and not leave issues like the war in Ukraine solely on the shoulders of the United States. Trump also points to the large trade deficit with the EU, which could theoretically be reduced by increasing purchases of raw materials, primarily LNG gas. However, it’s quite likely that Trump will want to impose at least partial tariffs on European products.
The situation with Europe, specifically the European Union, is more complicated. Trump would probably prefer to limit tariffs to specific sectors or countries. He would certainly consider imposing tariffs on European cars—especially German ones. At the same time, Trump might avoid imposing tariffs on all economies, with the goal of ensuring that the European Union doesn't impose broad retaliatory tariffs on the U.S. It is speculated that tariffs on Europe are planned for early March.
On the other hand, Trump himself views his unpredictability as one of his greatest strengths. Therefore, we shouldn't be surprised if he seizes the moment and imposes tariffs on Europe as soon as next week, which could result in the EURUSD pair quickly falling below parity. It’s also worth noting that the trade imbalance between the U.S. and Europe is much larger than, for example, the trade imbalance between the U.S. and Canada.
How did the market react?
The U.S. dollar has gained on average 1% against most currencies worldwide. Larger moves were seen with the Canadian dollar and Mexican peso pairs. European currencies such as the Polish złoty, Hungarian forint, and Czech koruna have also significantly depreciated. There have been massive drops on European stock indices, where it is hard to find a broad market losing less than 1%. European investors are concerned that similar tariffs to those imposed on Canada and Mexico could be placed on Europe or specific economies.
Fear is also evident in the cryptocurrency market, where declines reached as much as several percent. Bitcoin has fallen back below $100,000.
Is this just a negotiation strategy?
The trade tariffs were introduced under the pretext of addressing the issues of drug trafficking and illegal immigration into the U.S. Therefore, there is a high likelihood that the tariffs could be challenged by the U.S. Supreme Court. The likely strategy in this case would be to impose tariffs on specific products or sectors, which would be easier to justify. Through the imposition of currently broad tariffs, Trump aims to send a clear message to his partners that the time for prolonged negotiations has ended and certain processes need to be accelerated.
In the long run, no trade war is justified, and its continuation could lead to a noticeable slowdown worldwide. Even now, at the moment Trump’s decision on tariffs has been made, it is uncertain how they will work or if they will even be implemented. Trump's decisions remain highly unpredictable, and it will only be after the tariffs have been in place for several weeks or months that the true impact on the economy or the average consumer can be assessed.
What can be stated at this point is that the market will remain highly volatile, and further significant movements are to be expected. Negative in the case of additional tariffs being imposed, but also positive if the situation becomes clearer and it is determined that the tariffs won’t have a strong impact on the current situation.
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