Trump's volatile tariff policy is creating uncertainty in global markets. This could hinder not help the US economic outlook.
Trump’s Tariff Tuesday: What It Means for the US economy
Donald Trump’s endorsement of tariffs seeks to upend the major trends of the post-Cold War era, namely globalisation and free trade. Announcing the detail of the tariffs set to be imposed on some of the US’s most significant trading partners, Trump joked, “God, love, family, wife – they’re all my favourite words. But tariff is about no. 4 or 5 on the list”. The effect they may have on both global trade and international relations is somewhat less of a comical matter, however.
What do tariffs create problems?
Tariffs create drag within the world economy, which is why the people have taken so much time and effort to get rid of them.
They may potentially protect one domestic industry, but they are likely to have a secondary impact - and not a positive one - on the domestic economy they are designed to protect. They also have a more general negative impact on the aggregate world economy. In a globalised economy, when one country introduces tariffs, a handful of problems arise:
Why does Trump think tariffs are a good idea?
Our view is that Trump loves tariffs for the following three reasons:
The income generated by tariffs
Tariffs do not necessarily raise a lot of money in comparison to that brought in by income tax and corporation tax (see chart below). Any income they do raise is potentially outweighed by the precipitation of a slowing economy. For this reason, many economists see the only certainty outcome of tariffs as being higher and stickier inflation. But Trump may disagree.
Chart: Bloomberg
The abrasive nature of tariffs
The World Trade Organisation exists to reduce tariffs and friction between markets and economies. The mutual cancellation of tariffs has been a key element of globalisation. Reintroducing tariffs re-creates friction.
While in a globalised economy, people would tend to buy from the manufacturer with the lowest unit cost of production. In a protected economy, with manufacturing in the domestic market supported or even subsidised, this skews the competition. From the beginning of his political campaign in 2015, Trump’s core support has come from “rust-belt” constituencies where local manufacturing operations have been driven out of business by lower cost overseas production (particularly China and Mexico), resulting in unemployment and poverty. This set of voters in the manufacturing-based economy have been the losers in the process of globalisation, set in sharp relief by the winners, the liberal urban elites who largely participate in a service-based economy, have a higher quality of life and enjoy cheap labour and cheap goods. The UK’s Brexit campaign also bore the hallmarks of this divergence. In Trump’s first presidency, his calls to bring production back to the US were welcomed by many, and the refrain was quietly maintained by Biden as part of his anti-China narrative. It remains a key focus for Trump in his second term. While liberal free-trade politicians and economists may challenge the validity of this approach (and arch Republican President Reagan was against tariffs for the very same reason), this is the primary appeal of tariffs and indeed of Trump to US blue collar workers. How tariffs can be useful in negotiations
Trump has a clearly defined framework for his negotiating strategy, apparently learnt from his pugnacious lawyer Roy Cohn. His first move is “attack, attack, attack”, then “deny everything and admit nothing” and finally “always claim victory”.
However dubious his tactics, his modus operandi is so clear and consistent that there should really be no surprise in seeing the ways in which Trump aims to achieve his target outcomes. In this context, outlandish threats to “get Greenland,” or “retake the Panama canal,” should really be seen as the starting point in a negotiation. And in the same way, tariffs should be seen as a starting point for commercial and trade negotiations with other countries. The ups and downs of Trump’s tariff pronouncements – a threat, a moderation, an implementation, a U-turn – heightens market volatility as investors try to price in the potential impact on economic growth (higher friction can slow the economy), goods inflation (higher tariffs typically get passed on to consumers), and corporate earnings (higher import costs depress the earnings of import-dependent companies). Trump’s wilful avoidance of clarity, in itself a negotiation tactic, is exacerbating volatility in the stock market. The Panama example
In Trump’s inauguration speech in January, one of his promises was to reclaim the Panama canal on the grounds that it was a “foolish gift that should have never been made.” The suggestion that he may invade a smaller neighbour prompted condemnation. He also alluded to the fact that he felt there was too much Chinese influence over the canal because two nearby ports were “Chinese-owned” (referring to Hong Kong based conglomerate Hutchison Whampoa). What was the end result of all this rhetoric and bluster? A commercial deal serving US interests as Hutchison has now sold the two ports to a BlackRock infrastructure fund, thereby meaning that they are now US-owned. Trump’s methods haven’t changed.
What may come next?
With the Trump era, we are facing a new political regime with a new political playbook. While tariffs may be an opening salvo in advance of trade negotiations, they not only create short-term damage but if left unresolved, perhaps long-term damage too.
Furthermore, disputes provoke a scale up in rhetoric and market uncertainty. The Chinese Government responded: "If war is what the US wants, be it a tariff war, a trade war or any other type of war, we are ready to fight till the end," Apparently they may have read Trump’s book ‘The Art of the Deal’ and understand that escalation is Trump’s way of embarking on negotiations. There’s an argument for everyone doing the same! As part of their strategy to address this New World (dis)Order, investors should remain selective within their equity allocations, adaptive to changing market conditions and diversified within and across asset classes. Henry Cobbe Head of Research Source MaterialsComments are closed.
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