What would a trade war actually look like?

Donald Trump is threatening high tariffs on all goods entering the US from Canada, Mexico and China.

They will remain in effect until countries stop the flow of migrants and drugs entering the US illegally, Trump said. Mexico and China have threatened to respond in kind.

Companies, economists and policymakers are trying to figure out how much of this is a threat, how much is a bluff and how much is real.

Trade wars are notoriously easy to start. But they can be difficult to relax. And the consequences of this kind of global trade war could impact everyone.

“The result would be a rapid and severe recession in the American North, crushing demand for U.S. imports,” wrote Derek Holt, vice president of Scotiabank Economics.

Tariffs would raise trade costs to Great Depression levels

Scotiabank ran modeling that examined how rates would weaken demand and slow economic growth. Trump has threatened a 25 percent tariff on all goods entering the US from Mexico and Canada.

The U.S. dollar, already surging against foreign currencies, would jump, forcing the Bank of Canada to raise interest rates as exporters struggled. Canadian GDP would fall by as much as 5.6 percent.

If Canada were to respond with its own rates, rates would rise by 275 basis points (or 2.75 percentage points), according to the Scotiabank model. The loonie would fall by about 21 percent, the unemployment rate would rise by three percentage points and inflation would rise again.

Karl Schamotta, chief strategist at financial services firm Corpay, says Trump threatens levels of trade barriers not seen in nearly a century.

“This would increase trading costs to levels last seen in the lead-up to the Great Depression,” Schamotta wrote in a letter to clients.

Schamotta released a graph highlighting the major changes in trade barriers from 1820 onwards. He measured the ratio of tariffs to value to see how the tariffs affected the U.S. economy.

America's Smoot-Hawley Tariff Act is a common example of how tariffs can make things worse, Schamotta said. In that case, the tariffs were intended to protect American farmers and prevent a recession in 1930.

Initially they focused on wool and sugar, but the snowball effect started when the industry started lobbying for more. Ultimately, they were featured on more than 800 different products.

Other countries imposed their own tariffs. (Canada for example increased rates on American eggs by 233 percent.) Ultimately, the act only worsened the effects of the Great Depression.

Schamotta calls it one of the worst self-inflicted economic wounds in U.S. history.

He says it has hurt American farmers, crushed auto and steel exports, slowed global trade and sent stock prices down on Wall Street. And he says the only people who benefited from this were lobbyists.

“That any leader would want to repeat this experience is amazing,” Schamotta said.

Meanwhile, Mexico has said it will impose a 25 percent tax on U.S. companies, which Mexican President Claudia Sheinbaum said would result in an estimated 400,000 job losses in the United States.

“If there are US tariffs, Mexico would also increase tariffs,” Sheinbaum said.

The Mexican president says the agreement between the United States, Mexico and Canada has been good for all three countries involved and said her country has no interest in a trade war.

China's answer?

The government in China is also pushing for cooperation. Trump has threatened an additional 10 percent tariff on Chinese goods entering the US, on top of all others, until it cracks down on fentanyl smuggling.

“No one will win a trade war or a tariff war,” Chinese embassy spokesman Liu Pengyu said in a statement.

Experts say China appears to be waiting to see what Trump will actually do. But the way China responds will have far-reaching consequences for the global economy.

LOOK | The impact of Trump's threatened tariffs:

The real impact of Trump's 25% tariff on Canada and Mexico | About that

Newly elected US President Donald Trump has promised to impose massive tariffs on all goods entering the United States from Canada and Mexico. Andrew Chang explains why experts say the move would be “devastating” for the Canadian economy and examines how likely Trump is to make good on his threat.

Brad Setser, an economist at the Council on Foreign Relations, says it is crucial to monitor whether China lets its currency fall against the dollar.

If the yuan is worth less, fewer dollars are needed to buy Chinese products. That would help soften the impact of tariffs.

“China faces a choice between allowing the yuan to depreciate due to the expected tariffs (and risk provoking a negative response from Trump that leads to more tariffs) or waiting for tariffs to actually be imposed before the yuan is allowed to move,” Setser wrote. on the social media platform X.

Beijing did just that when Trump imposed tariffs on Chinese goods in 2018 and 2019.

At the time, the move presented two problems. It led to a wave of cheap Chinese goods flooding into world markets. But a weaker currency also raised concerns about the impact it could have on China's domestic economy.

Moving forward to 2024, China's economy is much more vulnerable as consumer spending has fallen and business investment in the country has plummeted.

So heading into Trump's second presidency, China has less support than it did during the first.

“All this matters for the entire world, as one of the main consequences of a weaker yuan is that it helps China offset the impact of any tariffs on its trade with the US through higher exports to countries that do not have tariffs themselves. Seter wrote.

Thus, an already global trade dispute between Canada, Mexico, the United States and China could quickly spiral into a series of tit-for-tat tariffs spreading around the world.

The threat remains hypothetical for now

It's important to note that the threat of tariffs remains largely hypothetical for now. It was not announced as an official policy, but rather in a late-night social media post.

Oxford Economics has based the figures on a handful of scenarios. Economists there assumed that Trump's proposal to impose 25 percent tariffs on Canada and Mexico plus an additional 10 percent tariff on China has a 10 percent chance of actually happening.

Much more likely – a 25 percent probability – is something tougher on China but less aggressive on Canada and Mexico.

“Universal tariffs of 30 percent on imports from China and 10 percent on all other imports from the rest of the world,” wrote Bernard Yaros, Oxford's top American economist.

Meanwhile, markets that would roil on actual tariffs and plummet due to a trade war have remained largely quiet since Trump announced his tariff plan. Investors are waiting, at least for now, for something more concrete to respond to.

That's probably good advice for everyone.