The Republican Party’s view on free trade between the Ronald Reagan and George W. Bush administrations was encapsulated by Larry Kudlow on CNBC: “We believe that free market capitalism is the best path to prosperity.”
President Trump’s views on trade are different. It appears that Trump views buying goods from China, Mexico, and Canada as going against his stated goal of “America First.” Recently, President Trump directed the administration to put tariffs on foreign steel. However, it will take some time to fully implement this policy (i.e., charges imposed on foreign-made goods imported into America). If the U.S. starts putting consistent charges on foreign goods, a trade war in earnest will begin, which will have far-reaching effects.
Foreign countries, in retaliation for these tariffs, will impose charges on our goods. Foreign politicians will happily engage in aggressive responses to American tariffs with tariffs of their own. Justin Trudeau, the Liberal Party prime minister of Canada, has called the tariffs “insulting and unacceptable.” Trudeau also said, “But we’re also putting a number of tariffs on consumer goods, finished products for which Canadians have easy alternatives.” In short, if we levy tariffs on Canada, they will escalate.
When Trump initially proposed tariffs earlier this year, China proposed a 25 percent tariff on American soybeans. Soybeans are mostly produced in Trump-supporting Midwestern states; hence, soybean tariffs would directly affect jobs in Trump’s base. Soybeans are unlikely to be the only product that the Chinese will embargo, but it shows they are thinking about a trade war.
Trade wars affect different parts of the economy in different ways. If they remain limited to steel and soybeans, U.S. steel will do better while soybean farmers will suffer. However, in a broad trade war, where we trade less in all goods due to tariffs, there are some effects we should expect. Many industries will be affected very differently: Businesses that sell goods overseas will have a hard time and business es whose competition comes from overseas will have an easier time. There will be three broad effects: pressure for more inflation, difficulty maintaining corporate profit margins, and a likely increase in employment.
Commoditized goods (e.g., undershirts) that are produced at rock-bottom prices in foreign countries will cost more to be produced in America, so prices for these goods will increase. This can drive inflation pressure. The Federal Reserve is willing and capable of fighting inflation; while this is not predicted to get out of hand, it could be higher than is preferable, causing the Fed to raise rates further.
Corporations will struggle to maintain their rate of profits. Large overseas supply chains keep corporate costs down and tariffs will affect those supply chains drastically. Whether they will pay for robots, U.S. workers, or both, companies will need to spend more money to produce goods in the U.S. to sell domestically.
A world where we trade less would likely cause more hiring of blue collar workers. This is why, historically, labor unions loved tariffs and stumped about unfair trade practices in foreign countries. However, in the early 20th century, when the U.S. had a lot of tariffs, factories employed large numbers of people. Now a factory is more often a small team of engineers working with robots. If the U.S. gets into a broad-based trade war where we raise tariffs on everything, it is unclear how much that will affect employment.
Simply talking isn’t going to move the needle. As long as it’s legal, businessmen are going to buy and sell goods across the world. In his first year in office, Donald Trump kept our trade policies the same, and cut taxes; simultaneously, the markets continued their ascent, which began in 2009. Insofar as our government actually puts tariffs into place, there can be massive ripples whose exact effects will be hard to predict. The S&P 500 reached a peak in January and has bounced around below that since then; should a full-blown trade war break out, it will be difficult to achieve that anytime soon.
Our president uses the rhetoric of political protectionism, but he also has a business background and high-level advisors who are in favor of free trade. Larry Kudlow is Trump’s top economic advisor. This is the same Larry Kudlow who spent much of his career loudly extolling the benefits of free markets on CNBC. A vast majority of corporate executives are for free trade and against tariffs. It will be interesting to see how far beyond rhetoric our president will choose to go.
By Moshe Kopolow
Moshe Kopolow is a registered investment advisor with. Advisory Services through Aquilant Advisors. Charles Schwab and Co. Inc. and Fidelity are the unaffiliated qualified custodians for advisory accounts of Aquilant Advisors.