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Economic Forecasts

Trade Gap Narrows as Tariff Battle Intensifies

Kiplinger's latest forecast on the direction of the trade deficit.

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GDP 2.9% pace in '18, up from 2.3% in '17 More »
Jobs A tight labor market will make hiring more difficult More »
Interest rates 10-year T-notes at 3.3% by end '18 More »
Inflation 2.4% in '18, up from 2.1% in '17 More »
Business spending Up 7% in '18, boosted by expanded tax breaks More »
Energy Crude trading from $60 to $65 per barrel in October More »
Housing Price growth: 5.0% by end of '18 More »
Retail sales Growing 4.9% in '18 (excluding gas and autos) More »
Trade deficit Widening 5%-6% in '18 More »

A U.S.-China trade war is officially under way after imposition of tit-for-tat tariffs on some $34 billion of one another’s exports. That’s the opening shot in what likely will be a prolonged battle continuing into 2019 — expect another round of levies on an additional $16 billion to go into effect in August. The U.S. economy is in good shape, robust enough to avoid short-term damage. President Trump threatens to ramp up pressure on China by imposing even more tariffs later. So unless Beijing blinks, possibly by agreeing to buy more U.S. goods to help shrink its bulging $375-billion deficit with Washington, odds are high that the world’s number-one and number-two economies will be in a prolonged tussle. The wider danger is that an escalating fight between Washington and Beijing could slow global trade and cast a pall on an otherwise favorable outlook.

Trump’s anger at China is rooted in a belief that it takes advantage of the United States through a variety of measures, including forced turnover of U.S. technology as a condition of doing business in China. Other countries also complain about China’s tactics, such as its subsidization of home-based industries and protectionist policies. But Trump is also taking aim at U.S. allies, including neighbors Canada and Mexico. Renegotiations on the 24-year-old North American Free Trade Agreement have broken down. In addition, the administration extended duties begun in March on steel and aluminum exports not only to Canada and Mexico but also to Europe. That led Mexico to tax a variety of U.S. farm and industrial products, while Canada retaliated with tariffs on a long list of U.S. goods, ranging from steel and aluminum to yogurt and whiskey. Europe imposed penalties on imports from the United States of everything from motorcycles to blue jeans, leading to another threat from Trump to levy 20% tariffs on European-assembled cars. Against this volatile background, we continue to look for the U.S. trade deficit to widen 5%-6% this year, topping $600 billion. The key reason? An American economy expanding at a pace exceeding the rest of the world’s.

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Good news in May on the monthly deficit, but it may be fleeting. The shortfall dropped 6.6% from April to $43.1 billion — the lowest for any month since October 2016. But a surge in exports of aircraft and soybeans mostly accounts for the change. Both of those products were long seen as prime targets for retaliatory tariffs by China, and it’s almost certain that Chinese importers were buying ahead of the penalties that they knew were coming from Beijing. Expect soybean exports from the United States — a top Chinese import — to fall off as other producers, such as Brazil, step in. It’s also possible that aircraft makers in Europe will scoop up more Asian trade because U.S-made airplanes and parts will be more expensive in China’s markets.

The deficit with China surged 18.7% in May to $33.2 billion, unlikely to calm trade antagonism. The administration initially tried to get Beijing to agree to voluntarily shrink its huge annual surpluses with the United States by as much as $200 billion. China balked and talks fizzled, but it’s possible that Beijing may offer to buy more U.S. goods rather than face successive rounds of tariffs. Meanwhile, more fodder for U.S. unhappiness with its NAFTA partners as the May deficit with Mexico jumped 18.8% to $6.72 billion. With Canada, the monthly gap shot up by 86% to $1.5 billion. U.S. corporations, especially automakers that established cross-border supply lines to take advantage of the free trade zone, already are anxious about NAFTA’s renewal. The pact could become a political football in the run-up to November midterm elections if the Trump administration continues claiming that it benefits Canada and Mexico at the expense of American workers.

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Sources: Department of Commerce, Trade Data