Picture: REUTERS
Picture: REUTERS

One of the reasons investors are so alarmed about the escalating trade war between the US and China is that there isn’t an exact parallel in recent memory. It’s the fear of the unknown. But the impending cost of the latest round, with tariffs expected to be felt in household budgets, does have a precedent — in the form of higher oil prices.

There are many times in recent history when oil prices have increased enough to create a similar pinch to that consumers are about to feel should this latest round of tariffs on Chinese imports go into effect. A 10% tariff on $300bn of Chinese goods is a $30bn tariff bill that American consumers will end up paying.

The pocketbook effect is comparable to an increase of about US20c a gallon (3.78l) in petrol prices — definitely something consumers are going to notice, something that will squeeze household budgets, but not an immediate cataclysmic shock either.

In 2018, the US consumed 143-billion gallons of petrol. Not all of this went directly to consumers — it includes commercial consumption as well — but energy prices in the course of production tend to get passed on to consumers in the end, just like tariffs. 

Thinking about tariffs as akin to higher energy prices is helpful because there’s a familiar playbook for higher energy prices, and markets don’t lose their minds every time the price of oil moves a moderate amount. Instead the increase takes a toll over time.

Consider the great recession. People think of the proximate cause in the downturn in the housing market and how that put stress on an over-leveraged financial system. But the surge in energy prices from 2003 up to 2008 shouldn’t be discounted either. Regular unleaded petrol prices paid by US consumers went from an average of about $1.50 per gallon at the end of 2003 to as high as $4.00 a gallon by the middle of 2008. Over that period, higher energy prices meant an additional 2% of household budgets went towards energy consumption.

That energy cost on its own might have led to recession, and combined with the downturn in the housing market and accompanying ripple effects it led to the worst economic environment in 70 years.

We should expect that the next round of tariffs will be felt by consumers and slow economic growth somewhat, but we’ve had shocks of similar magnitude from energy prices in the past. Unlike when those shocks hit, this time the US Federal Reserve and other central banks are already acting to support growth. The decline in interest rates plus the fall in energy prices we’ve seen since the latest tariff announcement should help cushion the blow.

The percentage of household budgets spent on energy prices is near a record low, one of the reasons households continue to express high confidence in the economy.

The type of shock coming from US President Donald Trump’s tariffs may be new, but the magnitude of it is well within the familiar range.

• Sen is portfolio manager for New River Investments in Atlanta.  This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Bloomberg


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