Trade Matters!

Tariffs and International Trade have dominated the headlines for a week since President Trump announced across-the-board tariffs for imported steel and aluminum. The primary effects of the proposed tariffs are minimal: UBS places the impact on aggregate inflation at less than 0.1%. However, the secondary effects on jobs, the markets, and the implications for trade policy go well beyond a tariff not likely to exceed $10 billion in a $20 trillion economy. It is quite possible that the ultimate reverberations of the tariffs could have a real impact on the trajectory of the economy, and by extension, the markets as well.

The steel industry currently employs about 140,000 workers in the US, a figure down massively from the 650,000 or so who worked in the industry in the early 1950s. The decline of steel production in the US is, as most things are in the economy, complicated. While the Europeans and Japanese embraced innovative and efficient techniques for steel-making in the 1950s, American mills still used open-hearth furnaces in a process effectively unchanged from the 1880s. And so it wasn’t just that American workers were paid more; due to productivity innovations, each furnace in Linz or Osaka could produce ten times as much steel per shift.

In the 21st century, Chinese steel companies, backed by government subsidies and a raft of unfair trade practices, became major players in world steel production. Even so, the US imports very little steel directly from China, President Trump’s frequent target for accusations of unfair trading practices. In fact, Canada ranks first on the list of countries from which we import steel while China is tenth. At the same time, US steel production has remained reasonably steady since the end of the Great Recession (though still down from pre-recession levels).

Source: tradingeconomics.com / World Steel Association

 

The bigger economic impact of disruptions in the supply and price of steel can be attributed to the widespread consumption of steel in the US. In construction and manufacturing, there are currently 6.5 million workers (conservative estimate) directly employed in steel-consuming industries. When the last round of tariffs was instituted in 2002, a study prepared for the Consuming Industries Trade Action Coalition (CITAC) found that 200,000 Americans lost their jobs at a cost of $4 billion in lost wages. The same researchers, Dr. Joseph Francois and Laura M. Baughman, found that the current tariffs will result in a net loss of 146,000 American jobs.
Source: tradepartnership.com

Such data might be easier to shrug off but for the fact that Francois and Baughman arrive at their estimates using exactly the same model the Department of Commerce used to argue the tariffs would increase US plant utilization to 80%.

Both the 2002 study and 2018 estimates do not take into account any retaliatory tariffs by other countries. While Chinese dumping and government subsidies have created oversupply in the world market, the proposed tariffs impact our allies the same as the Chinese. As such, the European Union, from whom we import 50% more steel than from China, has threatened to slap tariffs on $3.5 billion in US exports of other goods into the EU region. There is no word yet as to whether Canada, Brazil, South Korea, and Mexico, our largest steel trading partners, will take direct action.

To be sure, tariffs placed on $3.5 billion of goods will have a negligible direct impact on our $20 trillion economy. However, the proposed tariffs would directly affect the families of those American workers who produce those goods. Even if there is just a trade “skirmish” rather than an outright war, there will be clear casualties. And as often happens in war, the pain will be suffered by those with little to nothing to do with the causus belli.

Much of the rise in stock prices over the last twelve months has been driven by the narrative of “global synchronized growth”, meaning that most of the economies across the globe are experiencing positive growth at the same time. Yet stock prices have swooned in response to both the proposed tariffs and the resignation of President Trump’s top economic advisor, the staunchly pro-free trade Gary Cohn. The markets may be worried about the prospect of a full-blown trade war with one or more of our key trading partners. Such a war could result in rising costs (and falling profits) for US companies that rely on either the import or export markets (or both). For companies in the S&P 500, over 40% of revenues are derived from abroad. And even companies that get no revenue from outside the US could be hit by higher input costs for their products.

Another significant factor spurring markets forward has been the perception that the Trump administration had heretofore been pursuing a largely pro-growth agenda. These tariffs, along with projections for rapidly rising budget deficits of $1 trillion+, call into question the either the commitment to pro-growth policies or the sustainability of those policies.

We still see the economy as fundamentally sound, but we will not ignore increasing risks. I have said that it is our job to make sure our clients have a seat with the music stops in this bull market. We think the orchestra is only taking a long breath here, but we are making sure we have a hand close to the seat back to grab a chair if the dance doesn’t continue.