Tariffs and Trade
Tariffs and Trade
“We can afford to differ on currency, the tariff, and foreign policy; but we cannot afford to differ on the question of honesty if we expect our republic permanently to endure.”
Please open your economic textbooks to page forty-seven, class, because it’s time to talk about something you probably haven’t thought of since college: tariffs. On Thursday, March 1, President Trump announced a new plan to institute a 25% tariff on steel imports and a 10% tariff on aluminum.1 Like so many things these days, the response was radically different depending on who you talk to, more on that in a moment. Traditionally, tariffs are something most of us don’t have to think about, especially as tariff levels in the United States have been low for decades. But for investors, President Trump’s announcement has the potential to be significant as other countries may retaliate with their own tariffs against the United States and consumer products may increase in price.
What are tariffs and why do they matter?
Since it’s probably been a while since your Economics 101 class, let’s quickly cover a few basics. To put it simply, a tariff is essentially a tax on imported goods and services. Tariffs can be levied on almost anything: metals, food, consumer products, etc. Historically, tariffs are most commonly used when a country wants to protect certain industries within its own borders. For example, the Tariff Act of 1930 was designed to protect farmers by increasing the cost of importing agricultural products. By making it more expensive to import crops from other countries, people would be forced to buy mainly from American farmers. This is known as protectionism. Once upon a time, tariffs in the United States were both high and common. But after World War II, average tariff rates dropped significantly, and have stayed low ever since. In fact, since the 1970s, the average tariff rate on imports has been well under 10%.2
So are tariffs good or bad?
Remember how I said the response to President Trump’s announcement was radically different depending on who you talk to? That’s because a tariff’s effects can vary wildly, too. Tariffs can bring two major benefits:
- Because tariffs are a kind of tax, they can bring more revenue to the government.
- Tariffs and protectionism can be a major boon to certain industries – including the workers within those industries. In this case, the U.S. steel industry would benefit from a 20% tariff on steel, because it means more people are buying from them instead of their competitors overseas.
You can see why the idea of tariffs can be attractive for many people. Unfortunately, tariffs can also cause some negative side effects. Specifically:
- Tariffs can make life more difficult for consumers, whether they are individuals, families, or businesses. That’s because higher tariffs often lead to higher prices, which in turn lead to higher expenses. For example, if companies must pay more for the steel they need, that could significantly eat into their own profits.
- Higher tariffs can lead to retaliatory tariffs by other nations often referred to as a trade war.
Okay, so what is a trade war, anyway?
We live in a global, interconnected world. Toss a stone into the water off one shore and the ripples can be seen near another. In this case, higher tariffs can cause some very large ripples. When one country raises tariffs on a certain kind of product, other countries that depend on exporting that product won’t take to it kindly. As a result, those countries might retaliate by increasing tariffs on their imports, thereby harming the first country. Before you know it, tariffs become weaponized and a trade war breaks out. Trade wars are risky things, because they can quickly jump from industry to industry. Let’s take the current situation as an example. After President Trump announced his plan to raise tariffs on steel and aluminum, the European Union threatened to do the same to U.S. imports – everything from motorcycles to bourbon to bluejeans.3 Other countries like Japan and Canada, which are both major steel producers and important trading partners, have threatened similar measures. Should all this happen, the currents of international trade will quickly become choked. That would lead to higher prices on many goods and services, which in turn would lead to lower profits, higher costs of living, and even – potentially – higher unemployment. Should all those things happen, the markets will surely suffer. As an investor, you don’t need me to tell you what that means.
So why did President Trump decide to raise tariffs?
For decades, the United States has seen a worsening trade deficit with many countries. In other words, we pay more for importing their goods than they do for ours. According to the Wall Street Journal, the U.S. “ran a global goods deficit of $810 billion” in 2017.4 One of the president’s most long-standing campaign promises was to address that deficit. He has often claimed that bilateral trade agreements where both countries levy tariffs at the same rate is fairer, and I think many would agree. It appears that tariffs, along with renegotiating certain trade agreements, like NAFTA, are his tool of choice. Geopolitical economics is a loaded topic, and there’s a lot of disagreement out there about causes and effects. Again, tariffs can unquestionably bring lots of advantages, and there’s no question the United States is on the lower end of a trade imbalance with many countries. My observation of President Trump is that he always negotiates with a big first demand. A good negotiator starts with an aggressive first demand so there is plenty of room to negotiate toward the middle. My guess is that he probably won’t take a hardline with all our allies and slap massive tariffs on them; rather he will get them to start thinking in a manner of fair trade that offers a good deal to both countries and their industries. This brings me to my next point, Trump will make us all think past the sale. In this case, the “sale” is President Trump’s desire to reduce our trade deficit and boost US jobs. Now everyone assumes tariffs will be used to reduce our trade deficit and boost US jobs, but now they are only debating the details. This is classic persuasion. The President never let the country spend time debating whether or not we wanted tariffs. Instead, he made us focus on how to do it. He made the sale before the country thought it had anything to buy.
What happens now?
There are still so many things we don’t know. For instance, we don’t know what a renegotiation of NAFTA will look like. When Trump says he wants to end NAFTA, you need to remember that if he does, we don’t know if the tariffs will apply across the board, or if they’ll only be levied against certain countries. Also, Trump threatening to end NAFTA is part of his big first demand negotiating strategy. The big first demand is the unconscious psychological anchor where the negotiations will start. I believe NAFTA will stay in place with slight tweaks that leaders from Mexico and Canada will ultimately find agreeable. At the end of the day, tariffs are taxes and for the most part are bad for the American people and economy as a whole. President Trump’s best interest is to have a strong economy and low unemployment. Therefore, at this moment, I don’t believe we need to take any action. Back in February, the markets took a hit due to the threat of inflation and rising interest rates – and then recovered. While the markets dipped slightly in response to President Trump’s announcement, it’s far too early to make any changes to your portfolio.
However, this is why my team and I keep such a close eye on what’s going on in the world. Part of my job is to keep you informed of any ripples in the water so that you always stay afloat. It’s impossible for me to say what’s going to happen next, but I’ll tell you this: We’ll always be here keeping our hands on the tiller. In the meantime, please contact me if you have questions, or if there’s anything I can do for you!
1 “Trump to Impose Steep Aluminum and Steel Tariffs,” The Wall Street Journal, March 1, 2018. https://www.wsj.com/articles/trump-wont-quickly-announce-new-tariffs-on-aluminum-steel-1519921704
2 “Average U.S. tariff rates, 1821-2016,” U.S. International Trade Commission, https://www.usitc.gov/documents/dataweb/ave_table_1891_2016.pdf
3 “U.S. allies around the world steel for Trump tariff tussle,” The Wall Street Journal, March 2, 2018. https://www.wsj.com/articles/asian-allies-steel-for-trump-tariff-tussle-1519977304
4 “Trade Wars Are Good, Trump Tweets,” The Wall Street Journal, March 2, 2018. https://www.wsj.com/articles/trade-warsare-good-trump-tweets-1519996161
5 “U.S. Stocks Tumble After Trump Announces New Import Tariffs,” The Wall Street Journal, March 1, 2018. https://www.wsj.com/articles/global-stocks-struggle-after-bad-month-1519868670?tesla=y
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Dow Jones Industrial Average - The Dow Jones Industrial Average is a popular indicator of the stock market based on the average closing prices of 30 active U.S. stocks representative of the overall economy. S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot directly invest in the index.