Policies from government have driven the markets in the recent past. The domestic equity stock market (i.e., S&P 500) increased 7.3% after Congress passed tax reform. However, steel and aluminum tariff news pulled down the market 3.7%, then tit-for-tat trade tariff talk tantrums with China took the S&P 500 down another 4.8%—both occurring during the first quarter.
Here we are again. We are in trade tariff talk tantrums with Canada, Mexico, Europe and China. Some of these tariffs have been implemented, while others appear imminent. This begs the question: What are these tariffs and what should I do about them?
Tariffs sound complicated. Simply put, they are taxes on imported goods. However, historical background is important. The first tariff was the Tariff of 1789, the second act of Congress. There are two primary draws to tariffs. First, they are a revenue source for governments. Second, they can be used to protect trade (i.e., industries, companies, employees and consumers).
Going back to 1789, the United States was a fledgling nation with massive debt and little revenue. It had a massive trade imbalance with Great Britain and other nations. Because the nation hadn’t created taxes and therefore had little income, the U.S. government created the Tariff Act of 1789. However, it was not without controversy.
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It pitted much of the North (manufacturing sector) against much of the South (agricultural sector). Northern manufacturers favored high tariffs to protect their industries against foreign competition, while Southern plantations desired low or no tariffs to protect the exportation of cotton, tobacco, etc. Herein lies a root problem with tariffs: it pits winners against losers.
Tariffs are less important to our government revenues today than they were in 1789. From the late 1700s through mid-1800s, tariffs represented a significant part of the federal budget, often nearing 90% to 95%. Today, they represent about 1%.
As witnessed by our history, trade tariffs tend to be helpful for nations that aren’t competitive and need to protect themselves. However, they create winners and losers as one country retaliates and imposes reciprocal tariffs (often on other goods and services). Let’s take a closer look at the two recent tariff announcements.
Tit-for-tat trade tariff talk tantrums can escalate into a trade war. Perhaps one of the worst trade wars in our history came after the Smoot-Hawley Tariffs of 1929 (signed in 1930). These tariffs were started to protect the agricultural industry. As populism won out, it soon turned into tariffs on over 800 products when numerous other industries wanted in on the protectionism game. Many economists believe that the ensuing retaliatory tariffs and consequential trade wars contributed to the Great Depression.
It should also be noted that China’s (and others) tariff responses are directed at industries and corresponding states that voted in favor of Trump in the past election. We believe that the administration will realize that it cannot afford to abandon the recent economic gains that came about from reformed tax policy with a potential recession created by tariffs. Furthermore, with mid-term elections upcoming, this will be a lightning rod that many may not want to touch.
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Among the hardest hit would be farm states–Iowa, South Dakota and Nebraska—that rely heavily on exports of grains like soybeans and corn, and states that are major producers of a variety of other impacted goods—Wisconsin, Michigan, Indiana and Ohio. These and other states that would be negatively impacted turned out for President Trump in the 2016 presidential election. And, in recent months, Democrats have been winning in various regular and special elections in districts that Trump won in 2016. Currently, oddsmakers have control of the U.S House of Representatives up for grabs in this fall’s midterm elections.
From a fundamental perspective, these tariffs in isolation are not that impactful relative to the size of our economy. In fact, they are counterbalanced by recent stimulus packages. The following exhibit shows a potential negative impact of $81.5 billion being offset by approximately $800 billion in fiscal stimulus, including recent tax cuts, government spending and corporate tax repatriation. This is not to say that Mr. Stock Market will pay attention to these facts. Markets can be very irrational.
Source: Strategas Research Partners
Going forward, tariffs need to be closely monitored for their true impact—good and bad. We find some comfort that these tariff announcements and trade tariff talk tantrums may just be posturing and short-lived. And while it is apparent that we need to take a stronger stance against some of China’s bad trade practices, we are hopeful that this will be addressed through direct negotiations and by the World Trade Organization.
Please follow Reed Murphy on LinkedIn, Twitter at ReedMurphy@BTLReedMurphy or his blog at tcwealthpartners.com.
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Reed Murphy has over 27 years of experience, having held a variety of executive roles in the industry, including chairman of the investment policy group of a global financial services firm, which oversaw the creation and distribution of advice to approximately $695 billion in client assets. He currently serves as President and Chief Investment Officer…
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