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In the news today they were talking about how the US is "threatening to increase proposed tariffs on Chinese imports from 10 percent to 25 percent." One of the reasons they gave for this was that Chinese currency has depreciation 8% which rendered the previous 10% tariffs ineffective. The news even described China as "fiddling" with their currency as if it was intentional to get around tariffs. I'm wondering how these two are related. How does a currency being worth less effect the percent based tariffs?

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  • $\begingroup$ You might want to read this answer, discussing the equivalence of tariffs and currency depreciation. $\endgroup$ – Iñaki Viggers Aug 2 '18 at 14:01
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Assume that a chinese company is selling a product for 100 RMB or 16 USD.

With the 10% tariff the cost for an american importer rises to 17.6 USD.

If the the RMB depreciates 8% and the price in RMB is unchanged the importer pays 8% less in USD or 16.192 USD.

Depreciating the RMB by 8% offsets (almost all of) the effect of the 10% tariff.

This calculation does not account for the fact that chinese imports get more expensive. If the good is manufactured using imported oil the cost of that oil will not be offset by the depreciated RMB.

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One answer and one comment here make the false claim that tariffs are equivalent to currency depreciation, playing around with the exchange rate of your currency can "eliminate" a tariff, and so forth.

I think they are being confused by a well-known equivalence result, which says that a simultaneous import tariff and export subsidy at the same rate is equivalent to a currency depreciation. If instituted, it would be offset by a real currency appreciation - either a rise in the foreign for domestic exchange rate, or (in a fixed exchange rate regime) domestic price inflation. This kind of taxation/subsidy scheme is a part of most VAT systems around the world - it is a trade-neutral adjustment with the purpose of preventing possible large exchange rate movements in response to the institution of a VAT. A standalone tariff (import tax) is not trade-neutral, exchange rate movements are. So it's impossible for a tariff to be offset by currency appreciation.

It's not hard to see this - imagine that a country A trades in an international goods market. If it imposes a simultaneous %10 export subsidy and %10 import tax, then a firm in country A can sell a good worth 1 unit of foreign currency abroad for 1.10 units, but the old domestic price of this good is 1 unit of foreign currency. Likewise, a consumer in country A can purchase a good domestically for 1 unit of foreign currency, or can purchase it abroad for 1.10 units. The result is that in equilibrium the domestic currency must undergo a real appreciation of %10, and trade is unaffected, since relative prices remain identical.

Now, imagine the same thing without the export subsidy given to firms selling goods abroad. Then, a %10 domestic price inflation (more generally, %10 real appreciation of the currency) does not offset the tariff, because while it restores balance in the import market, it causes an imbalance in the export market. What happens is that in equilibrium the price paid at the margin for the same good in all markets must be equal, so consumption and the use in production of imported goods must decline until their value at the margin rises sufficiently to justify the increased price. In other words, the tariff affects the relative price of exports versus imports, not just the price level. Since it has a relative price effect, it is not trade or production-neutral.

US administration officials (including President Trump himself) have said on several occasions that they believe the border-adjustment of a VAT, i.e a simultaneous import tax and export subsidy at the same rate, is not trade-neutral, and that it gives countries using a value-added taxation system an unfair advantage over the US. They have made similar claims about policies of deliberate currency depreciation by other countries. This is contrary to the consensus in the field of international trade - see this paper by Krugman and Feldstein for the consensus view on this subject. However, if you take this belief as granted, then you can imagine that the administration wants to regain the competitive edge that they believe they have lost due to Chinese renminbi depreciation.

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  • $\begingroup$ I am NOT claiming they are equivalent. I am claiming that the depreciation offsets the tariff and that is a weaker claim than equivalence. $\endgroup$ – Klas Lindbäck Aug 3 '18 at 8:08

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