“Market Futures Fall As Investors Anticipate New Tariffs!”
“What Will Happen If Trade Tensions Escalate!?”
Chances are you’ve seen headlines like these over the past few months. The media can’t stop talking about tariffs and trade tensions and how they might harm the U.S. economy. But are tariffs really that bad? Is it true that we’re approaching a full-blown trade war with China?
In this piece, we hope to untangle reality from the what-ifs and shed some light on what changes, if any, you should make to your financial plan while the threat of tariffs and trade wars looms.
What’s a Tariff?
Let’s start with a simple definition: A tariff is a tax or duty imposed on goods imported from a foreign country. The importing business pays these tariffs to its home country’s government.
For example, say there was a tariff on diamonds. When U.S.-based jewelry maker Incredible Rings buys diamonds from South Africa to create a new pendant, they must pay an additional tax to the American government on top of the price of the diamonds.
Tariffs are usually created as a fixed percentage of the value of the imports, and in America they can be levied via an executive order, so they are easier to create than other types of regulation or legislation. That means the President could enact this so-called Diamond Tariff without the support of other government branches.
Can Tariffs Be Good?
If tariffs were wholly bad, they wouldn’t be used. Here are a few ways tariffs can be advantageous:
- Support Industries at Home – For instance, the steel and aluminum tariffs created in March 2019 were expected to help U.S steel and aluminum producers earn higher profits by making it harder for businesses to buy these products from foreign sellers.
- Create Government Revenue – Since tariffs are a type of tax, they help the government generate money.
- Address Unfair Practices – Tariffs can be used as a punishment against foreign countries, because they make it less desirable for businesses to purchase the good from foreign sellers. A country may enact a tariff to level the playing field when a foreign country is engaging in unfair trade policies.
- Use as Leverage During Negotiations – Because tariffs can have a negative impact on the export volumes of other countries, the threat of a tariff can be used to gain leverage during negotiations. President Trump threatened to impose a 5 percent tariff on all Mexican goods unless the country cooperated with his immigration requests. In June, Mexico quickly announced that it would take strong measures to reduce the flow of migrants in response to this threat.
- Easier to Collect – According to The Economist, tariffs are a good way for poorer countries to generate revenue, because they require very little infrastructure and are therefore much simpler to collect than sales tax.
What’s Bad About Tariffs?
Despite the above advantages, tariffs are generally discouraged for many reasons. Here are some of the very real fears and consequences expressed by economists, analysts and experts:
- Unseen Victims – As Walter Williams puts it, “when the government creates a benefit for one American, it is a virtual guarantee that it will come at the expense of another American — an unseen victim.” Companies who rely on the goods that are tariffed—say a jewelry store in our diamond tariff example—become less competitive and face higher costs. Which leads us to the next problem…
- Higher Prices for Consumers – Study after study proves that tariffs ultimately result in higher prices for consumers. According to Jacqueline Varas, Director of Immigration and Trade Policy at the American Action Forum, the 10% tariff on $200 billion worth of Chinese imports from September 2018 could cost consumers about $38 billion annually in terms of higher prices.
- Overall Trade Declines – As The Conversation puts it, the “overall volume of trade in the product between the countries involved decreases because the demand for and supply of the good falls.” This results in slower economic growth and can negatively impact the global economy.
- Bitterness Between Countries – In early June, the U.S. Chamber of Congress issued a joint statement from 140 business and agriculture associations to oppose unilateral tariffs on Mexico saying the policies make them “less competitive and undermin[e] efforts to negotiate strong trade deals in the future.” Tariffs can spoil past resolutions and leave a bitter taste in everyone’s mouths.
Potential for Trade Wars – When President Trump threatened to impose a tariff on Mexico, they quickly agreed to his demands. But that’s not always the case. As we have seen with China, many countries will respond to a tariff in kind. When both countries continue to up the ante, a trade war ensues.
So, Are We in a Trade War?
The threat of a trade war is arguably one of the greatest fears in today’s political and economic climate. While its definition is a bit subjective, a trade war is an economic conflict in which countries attempt to damage one another’s trade, often by using trade barriers such as tariffs or quota restrictions. As each country raises the stakes, the other responds in kind, both at the detriment to one another.
Depending on who you ask, we might already be experiencing a trade war. According to Susan Aaronson, a professor at George Washington University’s Elliott School of International Affairs, “when another country or countries start to retaliate, that’s when the effects can spread throughout the economy and globally.”
Yet Doug Irwin, an economist at Dartmouth who is one of the leading scholars of U.S. trade, explained that if the actions of other countries are proportionate, the current conflict would not meet his definition of a trade war.
Bruno Le Maire, France’s finance minister, had a dark take on the current trade climate: “I think all the G-20 people are aware that kind of situation would lead to an economic crisis, to a lack of growth and to a slowdown everywhere in the world.”
How to Avoid Playing the Lose-Lose Game
Many people consider tariffs a lose-lose situation, despite the few advantages tariffs may bring (particularly for a large country). But that doesn’t mean investors need to fear the threat of tariffs and trade wars. Working with a financial advisor to create a diversified portfolio that’s designed with your unique risk tolerance in mind could help ease that fear. The right financial plan is built with the market’s unpredictability in mind (e.g., reactions to a new tariff), yet still keeps long-term goals within reach.
Tariffs or not, the one thing we are certain of is that markets are unpredictable. You must remember that when it comes down to it, nobody knows whether tariffs will be imposed, who exactly they will harm or help, or how they will affect the economy.
After President Trump’s threat to enact a 5 percent tariff on all goods from Mexico, major U.S. stock indexes fell more than 1 percent and ended May down more than 6.5 percent, as noted by the Wall Street Journal. The following week, once trade tensions were avoided after Mexico agreed to Trump’s conditions, the stock market rose, having the strongest week for stocks since November. What a roller coaster and the perfect storm for an investor’s emotions to overcome reason!
Your financial plan should be built with your risk tolerance in mind so that short-term dips and falls in the market aren’t cause for concern. Our evidence-based financial plans are built to anticipate and withstand market risk.
According to Buckingham Strategic Wealth’s Director of Investment Strategy Kevin Grogan, “it may be helpful to recall that the stock market is forward-looking, so it already has incorporated its best guesses for how the current tariff situation will (and a lengthy trade war would) play out; this information is already reflected in prices.”
Lastly, ignore the noise. Speculation by experts, analysts and newscasters is just that—speculation. It can be tough to read hyperbolic headlines and fear instability in the market, but emotional investment decisions rarely work in investors’ favor. If you have questions about your portfolio or financial plan, reach out to your wealth advisor for more information.
Sources: The Truth About Tariffs