On the Record
I don’t believe in "an eye for an eye" because, if we go that way, we’d all be left toothless and one-eyed.
Mexican President Andres Manuel Lopez Obrador, responding to U.S. President Donald Trump’s threat to impose tariffs on Mexican goods
On Our Radar
Another Week, Another (Massive) Trade War. Every immigrant caravan coming across the U.S.-Mexico border has been a reminder of how President Donald Trump has hit wall after wall in trying to get his border wall with Mexico funded. So when conservative talk show hosts pounced on the latest border-crossing figures this week, a frustrated Trump fell back on his favorite policy hammer to get the job done: tariffs. The self-proclaimed "Tariff Man" has threatened 5 percent tariffs on all imports from Mexico starting June 10, with 5 percent increases each subsequent month up to 25 percent on Oct. 1 if Mexico fails to stem the flow of migrants into the United States.
To be clear, the White House is threatening about $1 trillion in tariffs when calculating the extreme scenarios of 25 percent tariffs on all Mexican goods, 25 percent tariffs on all Chinese goods and auto tariffs on Japan and the European Union. A 25 percent tariff on Mexican goods blows the threat of ripping up NAFTA and going back to World Trade Organization-level tariffs (averaging less than 5 percent) out of the water. While the tariffs on China alone could cost the U.S. and global economies nearly 0.5 percent in GDP, U.S. tariffs on Mexico could shave around 1 percent off U.S. GDP and a whopping 10 percent off Mexico’s GDP. It is not an exaggeration to say that this tariff threat would be inviting a U.S. and global recession if carried out to the extreme. Even if border security appeals to a faction of Trump’s base, economic turmoil will have a much deeper, wider and negative impact on his 2020 reelection bid.
Now, the NAFTA renegotiation, for all its drama, is one example of the White House ultimately recognizing the very direct and massive economic cost of tearing up the agreement and exercising restraint. The Mexico trade war could also end up falling into that category. But a highly arbitrary demand to stop migrants from coming across a long stretch of the U.S.-Mexico border within 10 days makes the 5 percent tariff threat on June 10 very real.
Here’s what we’ll be watching:
- Any signs of a pullback or stalemate in U.S.-Mexico negotiations. Mexican Foreign Relations Secretary Marcelo Ebrard is expected to meet with U.S. Secretary of State Mike Pompeo on June 5. Mexico faces a big challenge in figuring out who to even negotiate with in a divided White House on an issue that spans immigration and trade policy.
- Trump’s trade salvo puts Mexican President Andres Manuel Lopez Obrador to the test, but Mexico does not have good options to retaliate. Tariff retaliation would only deepen a recession in Mexico. We could still see a more targeted approach where Mexico prioritizes tariffs on agricultural goods over intermediate goods.
- Trump is setting a new precedent in using the International Emergency Economic Powers Act to impose the tariffs, but there is a big legal question as to whether the act even gives the president the power to implement tariffs in response to a national emergency. We’ll be watching both the federal courts and Congress for challenges to Trump’s executive trade authority.
- We now have to weigh how a trade war with Mexico will play into other U.S. trade negotiations. Even as Trump has declared getting the United States-Mexico-Canada Agreement passed by Congress a major priority, imposing tariffs on Mexico undermines that goal. Trump could be calculating that the Mexico trade war threat will intimidate Senate Democrats into accelerating passage of the new North American trade deal and funding his wall, but that is already a big reach. And while a trade war with Mexico will be met with a lot of congressional resistance, Trump has far more bipartisan support in pressuring China on trade. If the White House had to weigh the economic costs of trade wars with both China and Mexico, we think Trump would be more willing to risk a tariff escalation with China and at least an initial tariff hike on Mexico before pulling back. Lastly, the U.S. threat of auto tariffs against the European Union and Japan is likely to be eased or at least delayed if the White House escalates tariffs on both Mexico and China.
Rebels in Rome. As tensions increase between Italy and the European Union over Rome's budget deficit, EU finance ministers will meet in Brussels on June 5 to discuss Italy’s fiscal situation. In a May 31 letter to the European Commission, Italy blamed a deeper-than-expected economic downturn for its fiscal deterioration and said its 2020 budget would comply with EU rules, Reuters reported June 1. Brussels will consider whether "relevant factors" are sufficient to avoid disciplinary action against Italy. If not, the European Commission could ask finance ministers to consider opening an excessive deficit procedure against Rome, a process that could lead to fines of up to 0.2 percent of Italy’s GDP. While it could be months, if not years, before Italy faces any sanctions, the real disciplinary force for Rome will again be financial markets. Investors are still buying Italian debt, but Rome could face higher borrowing costs if markets start to worry about its ability to repay its debt. This is not a minor issue for a country where debt exceeds 130 percent of GDP.
Israel in Political Chaos. The Israeli government was thrown into unprecedented chaos this week after Prime Minister Benjamin Netanyahu failed to cobble together a government coalition by the constitutional deadline. In an indication of Netanyahu's determination to hold onto his post, rather than passing the mandate of government formation back to the president, Netanyahu used his Likud party’s parliamentary strength to dissolve parliament and set up new snap elections in September, mere months after Israelis went to the polls in April. We’re watching for how Israel’s rule of law will prevail against efforts by Netanyahu to protect himself from corruption charges looming over his head through yet another campaign season, as well as how polling results throughout the campaign could nudge Netanyahu to embrace an even more hard-line policy against Iran and against Palestinian militants in the Gaza Strip.
Bolton Lobbies Europe on Iran. The U.S. Department of Defense and White House national security adviser John Bolton have linked the May 12 oil tanker attacks off the coast of the United Arab Emirates to Iran. Next week, the White House will be trying to build up more international support around its claims. Bolton will be taking unspecified evidence to the United Nations Security Council in an effort to spur the European Union to act against Iran. Even as the European Union has concerns over the safety of the shipping and energy sectors around the Arabian Peninsula, sanctions still require a unanimous EU consensus. A big question on European minds will be whether the White House is trying to incrementally build the case for eventual military action.
On Our Minds
A Test of Russia-China Ties. It's been an active week for Russia-China relations, with Russian officials floating the possibility of collaborating with China in the Arctic’s Northern Sea Route as part of Beijing's Maritime Silk Road initiative, just as the massive Power of Siberia pipeline is set to begin pumping Russian natural gas to China by the end of this year. This comes as Chinese President Xi Jinping plans to attend the St. Petersburg International Economic Forum next week and sign more than 30 economic deals with Russian President Vladimir Putin. While these developments point to growing cooperation between Russia and China — a growing threat to the United States in its great power competition with the Eurasian powers — the actual implementation of such agreements and whether they lead to further cooperation on more strategic transportation/port/facility agreements will serve as the true test of the Moscow-Beijing relationship. Beyond the energy sphere, the extent of economic ties between Russia and China so far remains limited, and Moscow’s concern over the strategic threat that China's rise poses to Russia in key theaters from the Arctic to eastern Siberia to Central Asia is likely to constrain a deeper alignment between the two countries.
Geopolitical Hustling Over South Asian Infrastructure. Iran’s careful balancing act on the Indian subcontinent was on full display last week. During his May 25 visit to Pakistan, Iranian Foreign Minister Javad Zarif proposed linking his country’s Chabahar Port — an India-funded project — with Pakistan’s port of Gwadar, the terminus of the multibillion-dollar China-Pakistan Economic Corridor. Zarif’s comment was doubtless aimed at India — just as New Delhi has halted its purchases of Iranian crude under the looming threat of U.S. sanctions. (India, seeking to appease Iran, is now contemplating resuming Iranian oil purchases using rupees.) The Chabahar Port has evaded U.S. sanctions because it supports Washington’s goal of boosting regional trade with Afghanistan. But linking it with Gwadar — admittedly a daunting task — would undercut India’s objective of circumventing archrival Pakistan as it seeks to blaze a trade route to Afghanistan and Central Asia. Washington’s intensifying pressure campaign will drive Iran’s continuing regional outreach, but it will also force India to seek creative solutions in striking its own balance between its two adversarial partners.
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On Our Calendar
In the coming week, U.S. President Donald Trump visits the United Kingdom, France and Ireland; Chinese President Xi Jinping visits Russia; and Theresa May steps down as British prime minister, though she will remain as a caretaker prime minister until a new leader is chosen. For more, see our Geopolitical Calendar.
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