Trump's Terrible Tariff Tragedy
by David Bahnsen
The second half of last week's market action was dominated by the shocking decision of the White House (namely, it's head occupant) to implement sweeping tariffs on imported steel and aluminum to the United States, creating a shockwave in stock markets, but also stoking fears about the peripheral implications for the broader economy. Investors do not have the luxury of paying attention only if they perceive themselves to be exposed to steel or aluminum (either in the production or usage of such), as the ramifications of this decision are potentially profound across all sorts of global markets.
The stock market's attempt at a late February comeback were stopped dead in their track last week (and reversed) by the President’s announcement of sweeping tariffs against imported steel (25%) and aluminum (10%). The Dow Jones Industrial Average, which saw the January high of 26,500 fall to 23,500 in early February, had made a valiant comeback all the way to 25,800 as of last Tuesday morning, February 27. That Tuesday peak resulted in a drop of well over 1,000 points by Friday’s close, the majority of which came after news broke of the aforementioned tariff announcement. But alas, perhaps stock market woes are the least of our concerns out of this protectionist impulse in the president come to life.
The United States currently has a $566 billion trade deficit, something that the President believes to be catastrophic for the health of the U.S. economy. The public consumption of this statistic and rhetoric is somewhat poisoned by the fact that, (a) Virtually no one outside economic circles actually knows what a trade deficit is, or why it is allegedly bad; and (b) The word "deficit" has been programmed in our consciousness to be a negative, largely stemming from its common usage in describing our budget deficits (i.e. spending more money than we bring in). Incidentally, for rabid opponents of trade deficits, like the President and others, no explanation is generally offered as to why trade deficits are ipso facto bad (they are not), and budget deficits are perfectly fine (they are not). But I digress.
Trade deficits can, indeed, point to an economic weakness or vulnerability, but they certainly do not automatically do so. Russia, for example, has the third largest trade surplus in the world and has lived in borderline economic depression for years. Other countries in economic catastrophe that actually have trade surpluses, not deficits, include Italy, Brazil, and yes, Venezuela. The reality is that trade deficits and surpluses do not tell us anything at all about economic health or weakness, in and of themselves. The value of imports vs. exports has no meaning in a relative or comparative sense. It is the total amount of trade that matters most, for one looking to measure economic activity, health, and ultimately, quality of life.
But this is even more true for the United States, where our currency functions as the world's reserve currency. Our trade deficit is effectively the inverse of our capital account surplus. Put differently, while if we export less than we import, the difference is made up with, well, money. This is called "balance of payments" - and for the United States, the nations that we export goods from receive dollars from us, and in turn, invest those dollars where? In the United States. If we imported fewer goods and services, the trade deficit would shrink, but so would the dollars flowing into the United States. This would increase the value of the dollar relative to other currencies, and make exports less attractive. In other words, a declining trade deficit would actually just reduce the total volume of imports and exports, unless there was an increase in savings and investment. A focus on the trade deficit as a stand-alone piece of economic data is meaningless. Aggregate savings and investment drive economic results. Total aggregate trade reflects economic health. But the trade deficit, in and of itself, means nothing.
The United States has not had a trade surplus since 1975. Many would argue that the 1980's and 1990's were pretty solid decades for U.S. economic growth since they were the strongest periods of economic expansion in history. In fact, the smallest trade deficit we have had since 1975 was in the recession of 1991, as demand for imports and foreign capital fell precipitously. Indeed, the aforementioned examples of Russia, Brazil, and Venezuela make this point clear: A lack of demand for imports, or government policy blocking and impeding imports, are signs of economic malaise, not strength.
As the economic super team of Larry Kudlow, Art Laffer and Stephen Moore have pointed out, the economic pain of depriving a country of imports is called "sanctions" when we do it to North Korea or Iran. But when we do it to ourselves for some inexplicable reason, we call it addressing our trade deficit.
The flaws of this misguided policy go beyond the economic ignorance underlying it. In the most practical of senses, the tariffs are unnecessary, poorly designed, and almost sure to create far more damage than whatever benefit they provide to the U.S. steel industry. Investors should always be wary of policies designed to help one particular business or sector at the expense of others (the proper term is "crony capitalism"), as it distorts free markets and undermines confidence in the system at large. The intervention is all the more disturbing considering the present state of affairs. American steel behemoth, Nucor, has seen its stock more than quintuple over the last 15+ years. Last quarter, U.S. Steel saw its profits move from a $100 million loss to a $160 million gain year over year. These are not the metrics we normally use to describe desperation. But alas, apart from the un-American cronyism of these targeted protections, the reality is that they miss the aggregate priority substantially.
Consider, there are well over 6.5 million jobs in the U.S. alone related to companies that heavily use steel and aluminum, and there are 150,000 jobs related to the production of such. We are told that China is not playing by the rules when it comes to steel production, and that may very well be true, but China represents 2% of U.S. imported steel. Canada is our leading import partner (~16%). Refusing to exclude allies and friendly partners from this egregious policy move adds salt to the wound.
One of the key tenets of free market economics is the belief in efficient allocation of capital. The profit motive and decision makers with skin in the game are largely believed to be integral pieces to the success of the free enterprise system. Proponents of these tariffs (the President himself, and his trade advisor, Peter Navarro) have belittled the economic impact, stating that it will amount to one penny per soda or beer can, and have a minuscule effect in the cost per automobile. The reality is different - in aggregate, the impact just on soda cans is nearly $1 billion per year, and in automobiles over $3 billion per year. The real and actual impact is hardly measurable, as one must factor in all supply chain impacts from production to consumption, and ratios are not as measurable and linear as UCI Professor, Navarro, would like us to think.
But at the end of the day, the real fear for investors is not merely in the distortions that this represents across the supply chain of goods created with steel and aluminum (automobiles, tractors, airplanes, etc.). From our vantage point, those industries are substantial enough, but the true risk to such a reckless policy - one that creates no corresponding upside at all - is the blowback effect when other countries understandably retaliate. Friendly trading partners to the U.S. may very well be re-thinking if it is really China representing the great threat to the world's system of global trade. There is simply no reason to take this risk and expose our economy to the cascading effect of other tariffs on other goods in other sectors.
The final policy details have not been announced, and many cooler heads in the administration, including the top economic advisors of the President, are begging him to reverse course. Though the White House is stating this is not going to happen, the possibility exists that in the final hour the President will reduce this blunt instrument, and merely "target" certain countries. Markets hate uncertainty, and it is hard to believe that uncertainty will not rule the day until the final batch of policy details is announced, and counter-parties announce their retaliatory intentions. Perhaps more concerning than the policy itself is some of the rhetoric accompanying it (generally via Twitter), whereby the President has explicitly indicated the "ease" of winning a trade war. One can only hope this bluster is not a reflection of a real belief system. This unforced error by the Trump administration will surely offset some of the great benefits to the economy made possible by deregulation and tax reform.
Nearly 70% of the revenue of S&P 500 companies comes from overseas. Damages to global trade do not disproportionately hurt our trading partners; they disproportionately hurt us. The most likely scenario to come from this will be a weakening of the U.S. dollar, which will increase the relative attractiveness of non-U.S. equity investment. Countries most exposed to what come from this tariff war will possess risks all of their own. Countries least exposed will likely be Japan and certain emerging markets countries.
We are not ready to re-craft our 2018 projections for corporate earnings or economic growth, but one thing is certain for investors: The cogent and defensible premise for market bullishness that stemmed from robust economic forecasts is more vulnerable today than it was a week ago. And this is entirely unnecessary, and reversible.
forbes.com |
