What Impact Do Tariffs Have on the Economy

by: Edward J. Leach, CFP®, MBA

Just like in sports, there are always going to be winners and losers in business. The ability to evolve and adapt usually will dictate which side of the fence you land on. (See Kodak and Apple – one evolved and the other didn’t.)

The long-term impact of tariffs and trade wars are no different. There will certainly be industries, companies, or entire sectors that will be impacted – some will be winners and some will be losers. However, the overall impact on the broad economy is likely overblown and I will get to why in this article.

The Chicken Tax

First, a bit of a history lesson on the Chicken Tax imposed in 1964, which still has an impact today. Post World War II the European economy was improving – specifically Germany’s. During this time factory farming in the United States was booming and the United States became a leading exporter of frozen chicken – one of their “customers” being Germany. Well, the local German farmers didn’t appreciate the cheap frozen chicken being imported from the US as there was no way they could compete. As a result, Germany imposed a 50% tax on frozen chicken imports from the United States.

In retaliation, President Lyndon B. Johnson imposed a 25% tax on light trucks, and a number of other items such as potato starch, dextrin, and brandy. At that time foreign auto manufacturers like Volkswagen had some great pick-up trucks but were not able to export to the US as it was just too expensive.

Who won and who lost?

When was the last time you saw a pick-up truck that didn’t have the name Ford, GMC, or Chevy plastered all over it?

However, the Japanese automakers did seize an opportunity – they figured out it was better to build factories in the US and Mexico to build their products, which effectively got around the tariff. This is why you see Toyota, Honda, and Nissan pick-ups on the road today.

The point of this story is to simply illustrate things could change but trying to pick winners and losers – in this case specific certain automakers over the short term and long term can be difficult. When it comes to your investment dollars if you stay diversified across companies, industries, and sectors the probability is very high over the long term you will be a winner.

Trade Wars Unlikely to Take Down the Whole Economy

Gross Domestic Product, or GDP, is probably the best way to measure the health of a country’s economy. Gross Domestic Product is made up of the following components:

GDP = Personal Consumption Expenditures + Business Investment + Government Spending + (Exports – Imports)

The United States is a net importer of goods, meaning we import more than we export. In 2017, the total contribution to GDP of trade was -3%. Because our imports are greater than exports, net trade actually detracted from GDP.

2017 Gross Domestic Product.png

So, although the tariffs add up to quite a few billions of dollars, trade has a relatively small impact on the health of the economy. I would argue inflation, interest rates, currency exchange rates, and other macroeconomic factors at play have a much greater impact.

In comparison, the Chinese economy is not as reliant on trade as the media would make you believe. China is a net exporter of goods. In 2017, the total contribution to GDP of trade was 2%.

GDP.png

The stock market is typically a leading indicator of the health of the economy, which is why it makes it very hard to predict. Tariffs became a global concern back in January of this year, when trade tensions between the US and China first started to escalate. The chart below shows the S&P 500 year-to-date price return and highlights points in time where new tariffs were imposed. This picture speaks a thousand words, but I will keep it shorter than that. The effect of tariffs on the performance of the stock market has been exaggerated. For example, that big drop in late January/early February you see in the chart was not caused by tariffs on solar panels and washing machines, but instead a fear of rapidly rising inflation. So, while the headlines will blame trade tensions for the ups and downs of the market, there are other factors at play.

In addition, trying to predict the impact of tariffs on the performance of the stock market is nearly impossible. As evidenced by the S&P 500 year-to-date price return, there are times where stocks went up after “bad tariffs” were announced and times where stocks went down after “good deals” were announced. The markets generally do a good job of incorporating expectations into stock prices. Any news, good or bad, will have an impact if the outcome is materially different from those expectations.

SP 500 Price.png

Trade wars are good for headline writers and the 24-hour news cycle, but they are bad for business leaders who need to adapt and adjust their business practices on the fly to adjust to the new playing field. There will be winners and losers across companies, industries, and sectors across the global capital markets – but staying diversified will prove to be a winning strategy over the long term for investors as history as shown there are usually more winners then losers.