Trump's new tariff proposal could put the economy on a path to 'global recession'

On Thursday, CNN reported that President-elect Donald Trump's administration is considering imposing a 5% tariff on all imports into the United States.

While the decision is not final, sources told CNN the tariff could be implemented through an executive order in the early days of the Trump presidency.

The move is not surprising given that Trump made free trade one of the central topics of his campaign after criticizing China, Mexico, and Japan.

He suggested putting a 45% tariff on Chinese imports, said he would declare China a currency manipulator on his first day in office, proposed taxing imports from Mexico, argued in favor of "ripping up" trade deals, and called the Trans-Pacific Partnership, or TPP, "a rape of our country."

After the election, Trump has said in victory rallies that for trade "you have to look at it almost as a war," asking "who the hell cares if there's a trade war?"

Specifically for China, Trump said the country is committing "the greatest jobs theft in the history of the world."

Willem Buiter, chief economist at Citi, wrote in a note to clients before report of the new tariff that protectionist trade policies might spark a global trade war, "which could easily trigger a global recession."

Deutsche Bank has also addressed the negative risks of the Trump trade agenda. A team from the firm wrote in a note on Friday that "the biggest threat to growth is a possible protectionist turn, which could depress global trade and even trigger trade wars."

In addition to the tariff talk, Trump also appointed Peter Navarro as head of the new National Trade Council on Wednesday. Navarro has been a long-time critic of China, writing a book entitled "Death By China."

While these moves do not signal a coming collapse in international trade, they do suggest that Trump's more protectionist tendencies will come out during his time in office.

Additionally, a tariff of any kind is likely to spark a reaction from major US trading partners such as China. Chinese officials are reportedly weighing options on how to respond to hostile trade moves by Trump.

Given the moves by Trump, we've broken down just how a protectionist trade scenario could impact the US economy and the geopolitical order.

A macroeconomic drag

A 5% tariff may cause some impacts to the US economy - higher costs, a slight drag to GDP growth - but economists are worried about what it signals going forward.

Michael Gapen, a chief US economist at Barclays, has estimated the economic drag from tariffs on imports from China and Mexico may have on US GDP growth.

Assuming a 15% tariff on Chinese imports and a 7% tariff on Mexican imports - modestly above their current levels of 2-10% depending on the good - Gapen estimated that the US would see a 0.5% reduction in annual GDP growth in just the next year.

Meanwhile, Buiter said that Citi estimates trade and other policy uncertainties could be a 1% drag on US GDP over the next year.

And should the president-elect eventually decide to follow through with any of these policies, the US risks retaliatory measures from other countries.

"If tariffs are more punitive and lead to a public trade spat with China, markets will get nervous, especially if a sharp, retaliatory, [Chinese yuan] depreciation looks like a realistic response," Ajay Rajadhyaksha, head of macro research at Barclays, said.

If this pattern is followed by other countries, it could lead to a downward spiral, or litigation at the World Trade Organization.

"Depending on the specific measures, retaliatory action from elsewhere could be expected, while the risk of trade and currency wars could grow," said Janet Henry, chief global economist at HSBC.

Making it more expensive for consumers

As for how this affects individual Americans, an increase in tariffs could be passed through by companies in the form of higher prices.

Parts for consumer items are made abroad. And so, increasing tariffs could make it more expensive to import these parts for goods. In order to protect corporate profits and margins, companies could hike prices - which is not ideal for consumers.

A crucial thing to consider here is that this type of price increase is not caused by the virtuous wage and price increase cycle, but rather an exogenous shock to prices without a boost to the labor market. In plain English, that means that while parts manufactured in China instantly becomes more expensive for Americans under tariffs, wages do not necessarily go up the corresponding amount to offset this cost increase.

Theoretically, companies could avoid tariffs by producing more in the US. The problem here is, however, that labor is more expensive in America, so even if companies bring production to the US, the increased labor costs could push up prices, too.

A 'nail in the coffin' of the post-WWII economic order

Ultimately, a lot will depend on how much protectionist policy Trump is able to pass when he steps into the Oval Office.

Some observers say its unclear how much of the anti-trade rhetoric Trump genuinely intends to carry out. Additionally, there is a strong contingent within Trump's own party that is supportive of free trade.

The possible tariff and appointment of Navarro, however, are signs that protectionist trade could play a major factor in the Trump policy agenda.