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What History Tells Us about Tariffs and the Threat of Trade War

Posted by Seton McAndrews | CFP®, Vice President Investments
June 20, 2018

Tariffs and Trade WarsThe Tariff Act of 1930, otherwise known as the Smoot-Hawley Tariff, was signed into law by President Herbert Hoover…even as nearly 1,000 economists warned of its dire consequences. The law slapped nearly 900 American duties on imported goods and was done in an effort to boost domestic spending and to protect American companies. Sound familiar?

While virtuous in its design, the outcome of the Smoot-Hawley tariffs was far from virtuous. Instead of protecting the US economy, the tariffs arguably helped fuel the Great Depression.

Back in 1930, European countries responded to the Smoot-Hawley tariffs by retaliating with tariffs of their own, creating an all-out trade war that produced no clear winners. The Great Depression left no part of the US economy unscathed.

Fast forward to 2018, and we find ourselves in a situation somewhat similar to the one we saw in 1930, with the US threatening – or outright imposing – tariffs on some of our biggest trading partners, in an effort to protect American companies. There is little doubt amongst economists that China does, indeed, have unfair advantages and strict requirements for American companies doing business there. Change is arguably needed. The question is, will we have to endure a trade war to get it?

To Tax, or Not to Tax?

Perhaps one of the most notable features of this trade dispute are not the tariffs themselves, but more the uncertainty over what the trade battle could ultimately look like. Over the course of the last few months, the Trump administration has threatened sizable tariffs, China has retaliated, both countries have backed off, then resumed threats, then backed off again, and so on and so forth. At the end of the day, no one knows what will happen.

Just recently, the Trump administration announced that United States would move ahead with its plan to levy 25% tariffs on $50 billion of imported Chinese goods. But this plan contradicts what Treasury Secretary Steve Mnuchin has said recently, that the tariffs would be ‘on hold’ as the two countries continued negotiations. In a statement, the White House said it would detail the final list of goods that will be subject to the tariffs by June 15, and the duties would be imposed shortly thereafter.

In addition to the tariffs, it appears that the Trump administration will also move forward with restrictions on Chinese investment, along with stronger export controls designed to limit Chinese access to American technology.

Again, these may be measures intended to deliver virtuous benefits to American businesses. But what will China’s retaliation look like? How far could the trade war go, and how could it affect the investment environment? Those are questions that could have critical answers coming in the next few weeks.

5 Reasons Tariffs May Matter More Today than at Any Time in History

Zacks Investment Research had an interesting take on why the stakes could be higher today than at any previous time in history. The reason is simple: the economy is more globally connected today than at any prior point in history. Trade arguably matters more now than it ever has.

Here are five key factors to keep in mind as the trade dispute unfolds:

  1. Global supply chains are far more sophisticated and intertwined today than they were thirty years ago.They also generally involve several more countries.
  2. The share of global exports as a percent of GDP is much higher today than it was 30 years ago.
  3. Interest rates today are very low relative to history, meaning that the Federal Reserve is missing a key tool in its toolbox if policymakers need to battle the negative effects of a trade war.
  4. Stock market valuations are high, potentially leaving stocks exposed to pronounced selling in response to a trade war.
  5. During the last major trade war between Japan and the US in the 1980’s, we were allies with Japan (during the Cold War). Today, the US and China are arguably closer to rivals than allies.

What Does Your Portfolio’s International Allocation Look Like?

As the trade dispute unfolds, it could take a toll on markets depending on how far the ‘trade war’ progresses. One could argue that the closer we inch to an actual trade war, the higher the risk of market volatility in response. For investors, it marks a time of heightened diligence, but does not necessarily mean a defensive posture is warranted.

As the process unfolds, it could make sense to revisit the international allocation of your portfolio, to see how well diversified you are and check your exposure to multi-national companies that might be most affected by a trade war. You can do this now by simply calling a Wealth Manager at 1-800-541-7774 or sending an email to wealth@wrapmanager.com, and we would be happy to discuss our views on the trade war further in addition to reviewing your current allocations.   

 

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