HOW DO TARIFFS AND A POTENTIAL TRADE WAR AFFECT THE LOWCOUNTRY?
Financial markets don’t generally deal well with uncertainty, and we have been witnessing a lot of uncertainty in the markets recently. President Donald Trump’s unconventional style of diplomacy, particularly when it comes to international trade, has caused increased volatility in both the equity markets and the fixed-income markets.
While both corporate and public debt markets have traded in a fairly tight range, the yield curve has continued to flatten with the “spread” between the two-year U.S. Treasury bill and the 10-year U.S. Treasury bond, narrowing to a mere 30 basis points. We haven’t seen that a spread that narrow since 2007, and most economists believe that a flat or inverted yield curve signals a recession in the not too distant future. The equity markets have traded “sideways,” in other words essentially unchanged, since the beginning of 2018 — notwithstanding 200 or 300 point swings, up or down or sometimes both, on a daily basis.
Economic circumstances like this naturally lead to a discussion of tariffs and a potential trade war. But first we should define a tariff and the potential impact of a tariff. A tariff is a tax imposed on certain imported goods that will ultimately make those goods more expensive for consumers. In theory, consumers would then shop for a competing good that is produced domestically and thus avoid the cost of the tariff. The short-term impact of the tariff might be inflationary and have a negative impact on consumer confidence. The long-term impact would ideally be increased domestic production of that good, leading to more domestic jobs.
The office of the United States Trade Representative was created in 1962. This office is housed in a wonderful yet low-key building directly across the street from the White House. There, trade policy and, in particular, general agreements on tariffs and trade are carried out. The current United States Trade Representative is Robert Lighthizer, and he reports directly to Trump.
Since the early days of the Trump presidential campaign, fair trade has been a key issue. With his tax reform act passed, consumer confidence is at a near all-time high and, with unemployment now in check, all attention is on trade and reducing the trade deficit facing our country. The first order of business was to review the multilateral trade agreements negotiated by prior administrations. Many view these trade agreements as unfair due to limitations placed on U.S. exports and a lack of tariffs on goods imported into the U.S.
Let’s examine the magnitude of the issue of a trade deficit: In general, the United States exports $2.2 trillion in goods and services and imports roughly $2.7 trillion in goods and services, leaving a deficit of $500 billion. To understand the overall impact of this deficit, we must look a little closer at the numbers. About 30 percent of the $2.2 trillion in U.S. exports is services like tourism, intellectual property and finance, while imports are dominated by capital goods like electronics, apparel, automobiles and oil. So Trump makes the case that our trade deficit on capital goods, or stuff people make, is actually $750 billion with almost $350 billion coming from China alone. Some economists refer to this as the “China shock,” resulting from Beijing undertaking deep economic reforms and implementing policies to subsidize production. Interestingly, these moves on the part of the Chinese coincided with the entry of China into the World Trade Organization, thus the “unfair” treatment Trump says WTO has shown the United States.
On July 6, tariffs went into effect on approximately $50 billion in Chinese goods coming into the United States. Over the following few months, another $16 billion in Chinese goods will become subject to tariffs. The Chinese on the other hand, have announced retaliatory tariffs on U.S. goods — the first “battle” in a looming trade war. The USTR has also announced tariffs on steel and aluminum coming from Mexico and Canada, with retaliatory tariffs from the two countries focused on our agricultural industry.
To date, it remains to be seen if a full-on trade war will develop or if these actions are the tools of our “negotiator in chief.” But, as I’ve said, the financial markets don’t deal well with uncertainty and we have uncertainty in spades. Clearly, markets will continue to be volatile, especially when companies are active globally.
Elihu Spencer is a local amateur economist with a long business history in global finance. His life work has been centered on understanding credit cycles and their impact on local economies. The information contained in this article has been obtained from sources considered reliable, but the accuracy cannot be guaranteed.
