Could tariffs cause a new recession?
Businesses, rural areas would be among those hurt in Colorado
The U.S. economic expansion marks its 10th year this month, matching the 1990s recovery for longevity. But rising tensions caused by trade disputes are raising worries that the expansion could tumble to the ground, taking the decade’s economic gains with it.
“If we can’t stabilize trade relations soon, that’s the biggest risk for a recession,” Carl Tannenbaum, chief economist with The Northern Trust Co., said on a recent visit to Denver.
Tannenbaum said any weakening of the economy will be much milder than the last time. But a trade-induced slowdown would hit businesses and industries that rely on the global supply chain, including Colorado’s farmers and ranchers. Consumers also could find themselves stretched as a host of goods become more expensive or unavailable.
“Potential causes of the next recession in the advanced economies include an escalating trade war, a geopolitical shock, a significant increase in policy and political uncertainty, a spontaneous sharp correction in asset prices, or a sudden downturn in China,” the investment firm Pimco recently told its investors.
Recessions typically result when the Federal Reserve tightens monetary policy to cool an overheating economy. The Fed had been lifting interest rates, but did a sharp pivot in January, largely easing those concerns.
The past two recessions came on the heels of financial excesses, a massive stock market bubble in the early 2000s and an unprecedented housing bubble that triggered a financial crisis in 2008.
Lenders are dealing with poor-quality auto loans, student borrowing has skyrocketed, and some corporations have piled on debt and not spent the money wisely. But the excesses, at least the ones that can be seen, aren’t on the
“Clearly, a recession will occur if the nascent slowdown in business activity spreads to more sectors both here and abroad. Confidence is a very fragile thing and can turn on a dime.” Andy Ratkai, president of Praxis Advisory Group in Greenwood Village
same level as those of the past two recessions.
Economists are quick to point out that recoveries don’t die of old age, and there are also a lot of things still right with the economy.
“The length of recovery is not a catalyst for a recession. Imbalances are the catalyst,” said Anthony Chan, chief economist with Jpmorgan Chase.
U.S. GDP rose a robust 3.1 percent in the first quarter, and Colorado’s economy advanced 3.5 percent last year, its best showing since 2015. Unemployment remains at 50-year lows nationally and that is pushing wages higher and lifting consumer confidence. Until recently, stock market indices were up sharply. Those all argue against a downturn.
And yet, some indicators are pointing to a slowdown. Auto sales are down from last year, including in Colorado, where they are off 3.2 percent this year. The housing market is cooling, industrial production is slowing and corporate earnings are stalling after years of robust gains. And while overall unemployment remains at a historic low, about 30,000 more people were looking for work in Colorado than in 2017.
Bond markets are offering a lower rate on 10-year Treasury notes than on three-month Treasury bills, an upending of the usual order. The gap or inversion is the largest since 2007, and an inversion has preceded every recession since the end of World War II.
“Stock investors have, until recently, ignored the dark clouds on the horizon, believing that a resolution to the trade conflict with China was just around the corner,” said Andy Ratkai, president of Praxis Advisory Group in Greenwood Village. “But reality has started to sink in, and investor optimism has started to sink as well.”
Some observers argue that the U.S. and China will sit down later this summer at the G20 Summit and things will get back on track. But Ratkai sees a bigger cultural battle at play, one pitting two very different economic models that won’t be easily resolved as China grows in power.
“Clearly, a recession will occur if the nascent slowdown in business activity spreads to more sectors both here and abroad,” he predicts. “Confidence is a very fragile thing and can turn on a dime.”
Where trade troubles already sting
For Sparkfun Electronics, higher tariffs are already biting into revenues. The Niwot company imports 2,400 different electronic components from 400 suppliers in 23 countries. It manufactures boards and assembles kits from those imported components, which it then sells to online buyers around the globe. It is exposed to tariffs in both directions.
“It doesn’t do anything but cause us pain,” said Nathan Seidle, who founded the company in 2003 out of his dorm room while a junior at the University of Colorado Boulder.
More staff, time and resources are now redirected to tracking the tariffs. Those increases are passed through to customers. Sales in the fourth quarter were down by double-digits, due mostly to a pullback by business customers. The imposition of a 25 percent tariff on $200 billion in Chinese goods in early May will likely only accelerate the decline.
“A lot of companies large and small will pull back given the uncertainty,” said CEO Glenn Samala. “It is all too murky right now.”
Sparkfun had to let go of staff who were going into schools to teach kids about technology and tinkering, promoting the kind of innovative spirit the country needs to remain competitive in the future. The company is also trying to figure out ways to rearrange its supply chain to avoid tariffs, but for many of the cheapest and highest volume components, China is the only game in town, Samala said.
Sparkfun also manufactures circuit boards based on the opensource inventions that its team of engineers comes up with. The company is studying whether it might be cheaper to make its products in areas free of tariffs. If the administration’s trade policy seeks to boost U.S. manufacturing, in the case of Sparkfun, it may work against it.
“We are stuck in the middle,” Samala said.
The Obama administration was heavily criticized for creating uncertainty for businesses, but trade disputes operate in the same vein, said Martin Shields, director of the Regional Economics Institute at Colorado State University.
Part of the problem is the whiplash. The message for weeks was that good progress was being made in the talks with China. That quickly vanished in acrimony and threats from both sides.
“How does it escalate? We are nowhere near as ugly as it could get,” Shields said.
On May 30, President Trump threatened Mexico with a 5 percent tariff that could increase each month to 25 percent on all its goods if it doesn’t control the flow of migrants headed to the United States, an unprecedented political use of what has been mostly considered an economic tool. Late Friday, Trump announced that the tariffs would not go into affect on Monday after an agreement that Mexico would take a rougher stance on migrants.
Why China (and exports) matter
China is the third-largest foreign market for Colorado products, purchasing $604 million in goods last year, led by navigational and measurement instruments, chemical preparations, meat products, scrap products and computer equipment, according to the U.s.-china Business Council.
Something that doesn’t get as much attention is that China also accounted for $1 billion in services purchased in Colorado in 2017. Of that, $431 million came in spending by Chinese tourists, followed by $150 million on education, $91 million in passenger fares, $48 million in royalties and $47 million in management and advisory services.
Goods exported from Colorado to China are up 37 percent since 2009, but they peaked in 2015 and have been falling since. Service exports, by contrast, are up 223 percent since 2009. Between the two, the council estimates that trade with China supports 12,180 jobs in Colorado. That is in a state economy that has added 49,100 jobs the past 12 months.
Colorado commodity exports to China are down 10.5 percent in the first quarter compared with the same period last year, and they are down 13.4 percent to Hong Kong. Worldwide, Colorado exports are down 10.5 percent, according to U.S. Census Bureau counts provided by the World Trade Center Denver.
Exports to Mexico, an important market for Colorado’s farmers and ranchers, were down by a third in the first quarter, the biggest retrenchment among the state’s largest trading partners, according to the World Trade Center Denver. Just when trade relations with Mexico seemed to be improving, they derailed again.
Colorado, however, isn’t as dependent on trade as most other states. Colorado ranks 49th in the ratio of exports to its overall GDP and it ranks 45th in terms of imports, said Brian Lewandowski, associate dean of the business research division at the University of Colorado Boulder’s Leeds School of Business.
“If the next downturn is caused by trade, Colorado may not feel the direct effects as deeply as some other trade-intensive states,” Lewandowski said. “The state is a relatively small exporter of goods. We are not competing in the same way that Ohio is.”
But if the rest of the U.S. economy contracts, Colorado will go along for the ride, he said. If the cost of imported goods rises high enough, consumers could pull back on their spending. Retailers, many already struggling because of online competition, have been especially vocal in criticizing current trade policy, and more stores could close.
Colorado buyers imported about $434 million worth of Chinese goods in the first quarter of this year. The long list of imports includes plastic items, telephone equipment, electrical components, seats, furniture, auto parts, paperboard, televisions, exercise equipment and insulated wiring and cable.
Trade Partnership Worldwide, an economic consulting firm, estimates that the average American family of four would face $2,300 extra a year in costs if the Trump administration follows through on threats to slap a 25 percent tariff on all Chinese imports.
Those kinds of price hikes could accelerate inflation, making it harder for the Federal Reserve to justify a cut to short-term interest rates. A more likely outcome from sticker shock would be lower consumer confidence and a pullback in retail spending.
But Ravi Batra, a professor of international economics from Southern Methodist University, argues that the relationship between tariffs and prices on the store shelf isn’t linear. As they sell fewer goods into the U.S., Chinese producers will likely have to lower prices to compensate. And China’s currency will become less valuable, making its goods more affordable abroad.
And yet there is another outcome, one where China’s economy weakens and contracts, exposing heavy borrowing in the past decade. That would knock out a major engine of economic growth and an important buyer of a whole host of commodities.
So, Colorado won’t be immune from a national slowdown, and sectors like technology and agriculture could take a bigger hit, Lewandowski said. But for now, economists at the University of Colorado are sticking with the forecast for 2019 they made in December — slowing but growing.
Rural areas in bull’s-eye
The problems that triggered the Great Recession last decade were centered in populated areas and global financial centers — loose mortgage lending, excessive home construction and dangerous financial engineering.
Despite that, rural Colorado was slammed harder than the Front Range and took much longer to recover. A trade-induced recession, while it may be more limited in scope, will spread to areas of Colorado that are the least equipped to absorb the blow.
“The U.S. agricultural economy relies on exports to sustain prices and incomes,” said Amanda Countryman, an associate professor in the Department of Agricultural and Resource Economics at Colorado State University. “This will have a negative impact on rural communities. The extent of the damage will depend on how long this lasts.”
Farm incomes nationally fell 16 percent last year and are down by half since 2013. Tariffs were a big contributor to the drop seen last year. Once levies came into the equation, commodity prices dropped immediately to account for reduced demand.
Countryman said there are good reasons why the U.S. is confronting China on its trade practices, and eventually, a future agreement could result in more open markets and more exports. Her issue is the way the talks have been handled, including not bringing Japan and the European Union to the table to put more pressure on China, and allowing hostilities to mount.
“It is going to be imperative for the U.S. and China to reach an agreement,” she said. “The way the current trade conflict has continued to escalate has been incredibly damaging and will make it more challenging.”
Colorado ranchers and meat packers have extra cause for concern. China is the top buyer of hides and skins and scrap meat from the state. Having a market for those less-desired parts boosted the economics of cattle production.
In 2017, China also opened up its markets to U.S. beef exports, and rising incomes in that country have created more disposable income. But that door is now closing.
“At the end of the day, you can’t replace China as an export destination,” Countryman said. “They are an incredibly important trade partner.”
Farmers who couldn’t sell their crops because of retaliatory tariffs last year put them into storage to wait for better prices. But heavy flooding in many parts of the Midwest ruined those stores and has also delayed the planting of crops. That boosted commodity prices until the Mexican tariffs were announced in late May.
Realizing that more farmers are reaching the breaking point, the U.S. government announced in mid-may a pledge of $16 billion in federal aid to soften the blow.
Tourism is another area where Colorado could take a hit from the trade war. Based on data from U.S. custom forms, Chinese visits to the U.S. dropped 5.7 percent last year to 2.9 million, according to the Chicago Tribune.
“The difficulty with trade skirmishes is that the unintended consequences are hard to predict, and we were concerned from the start that tensions with China might affect business and other travel to the U.S.,” commented Tori Barnes, a spokesperson for the U.S. Travel Association.
Chinese tourism generated a $30 billion surplus in the U.S. and had been on the rise for a decade. Chinese visitors spend an average of $6,700 per trip, about 50 percent more than the typical international visitor.
“At this time, we have only received preliminary 2018 data, but China is not showing a decline for inbound visitation to Colorado,” said Jill Mcgranahan, a spokeswoman for the Colorado Office of Economic Development and International Trade.
Shrink tourism and farm incomes and rural Colorado could suffer a blow it won’t easily recover from. And what happens to the rural workforce in a prolonged trade dispute? Countryman and some of her peers are taking that on as a research project.
“It is taking a situation that wasn’t good already and making it worse,” Countryman warned.