Today the market managed to snap an eight-day losing streak, finally finishing the day higher, while still closing the week at a loss. Dominating the headlines for the entire week is one subject that shouldn’t surprise anybody with an interest in the financial markets – tariffs and a the resulting trade war between the United States and its largest trading partners. Whether you’re talking about Europe, Canada, Mexico, or China, there really doesn’t seem to be anybody that thinks tariffs are a positive for the economy, and the speculation that it could generate a full-blown recession seems to be increasing.
Is the concern warranted? Maybe. The fact is that the longer this plays out, the more nervous investors will be. The stock market hates conflicts of any type and prefer civility at all times – which really means that the market is not very good at taking a long-term view of anything that threatens the status quo. The problem is that sometimes the status quo is based on old information that doesn’t apply any longer. The problem with what’s going on right now is that when President Trump, or anybody in his administration begins to point out some of the inequities that exist in the current world trade structure, people seem to be operating on the assumption that structure is necessary for business to continue to operate successfully. So let’s think about some of the things that have driven the world economy to this point.
We have to start by going all the way back to the end of the Word War II. At that point, most of the industrialized world had been almost completely decimated. There was really no part of Europe or Asia that hadn’t been crippled by that conflict. Some of that was intentional, since only a complete and utter humiliation of Germany was going to be sufficient to bring their global ambitions to heel. A similar theme could be said of Japan, where the mind-numbing devastation of atomic bombs was the tool that brought their Empire into submission.
The plain and simple fact is that the United States stood alone at the top of what remained. As a student of history, I find it interesting that instead of doing as other empires would have done – or have done in previous eras – America decided to help rebuild the economies of devastated allies as well as those of its enemies, in the process making them important allies as well. It was done by structuring trade agreements with favorable terms for those economies that stood on the brink of annihilation not so long ago, and with the U.S. taking the lead worldwide – militarily and financially – as the first line of defense against Communism.
Fast forward to today, and you have to recognize that the world today is a much different place. The vast majority of Europe has not only recovered and rebuilt, but is now unified under a single governing body that includes many of the countries that battled against each other during the second World War. Japan has emerged as an economic power of its own. Even the Communist countries that remained after World War II have changed. The Russia and China of today differ in multitudinous ways from their Communist roots, and have each embraced the role of capitalism and global trade in providing prosperity for their citizens. Is it perfect? Of course not; but as a result of those early nation-building efforts, the world economy is a much more dynamic place than it was just a few decades ago. Previously weakened allies have been made strong, and old enemies have been rebuilt, turned into allies, and turned into global competitors.
So what kind of “favorable terms” has the world been operating under, and which have been in place for so long now that they are naturally assumed to be the de facto standard for what should define America’s relationships with its trade partners?
Let’s start with one of the first tariffs that Trump began talking about long ago, and that was centered on the European Union. Presently, cars that are imported into the U.S. from the European Union are taxed at a rate of 2.5%. U.S. cars exported to the E.U., however are taxed at a rate 10%. In 2016, the total value of cars imported to the U.S. from the E.U. was more than $250 billion, while the total value of U.S. exported to the E.U. totaled a little over $100 million. While I don’t believe that difference is bad, or that it can entirely be attributed to the difference in import duties, it is also unrealistic to believe that the higher cost of importing an American-made car to Europe doesn’t play a role. To provide a truly competitive landscape that can be more correctly measured, the playing field should be even, which it clearly isn’t.
Another interesting example comes from India, which the World Bank projects will be the fastest-growing economy in the world for the rest of the decade. America taxes Indian imports at an average rate of only 2.4%, where the Indian average is 9.4%, but in some cases runs much higher. Some American goods, like American motorcycles, are taxed at rates throughout Asia of anywhere from 23.3% (Malaysia) to 100% (India). China taxes U.S. motorcycles at a rate of 30%.
Some of the same inequities exist with our closest neighbors. Canada, for example charges very high tariffs on U.S. dairy products – on average they are as high as 270% on a wide range of products including milk and butter. Those high tariffs aren’t just directed at the U.S., either – import rates of more than 200% for dairy from any country is a means Canada uses to prop up its own dairy industry. The implication here is that some of the tariffs that the Trump administration has been talking about – ranging from 10% to 25% on a variety of imported goods from all of our largest trading partners – are really saying that if those countries don’t want to lower their tariffs on U.S. exports, the U.S. will level the playing field by raising theirs.
Of course, there are other concerns that are playing themselves out through these tariffs as well. A main point of contention around tariffs on China relates to intellectual property theft and the security of technology developed in the United States but produced in China. Also, a significant portion of the tariffs on Mexico can be tied back to the Trump administration’s desire to shore up a leaky immigration system. So it’s also true that tariffs and the resulting trade tensions that has the market shaken up right now are not only about fair trade right now, but also about additional issues with far-reaching, long-term implications.
What does this mean for investors? I still think that a lot of what we’re seeing right now continues to be posturing that is probably just another part of the negotiation process. It’s still true that the market abhors trade tensions, and so while these issues linger, nations continue to rattle their sabers, and President Trump keeps tweeting, there is probably limited near-term upside. But remember that the economy continues to be growing at a conservative modest pace, corporate earnings are strong, and even though interest rates have been rising in the 3% range, they remain well below longer-term averages, which are in the 5 to 6% range. Employment remains tight, as well, and consumer confidence is up. We may see some near-term turbulence tied to trade tensions, and that could last into the next year depending on when the nations involved find a satisfactory resolution. In the long run, however, a turn of the economic cycle from growth to recession is more likely to be tied to other issues than the effects of trade tariffs.