There has been a lot of concern about our foreign trade policy recently. We’ve all seen the US stock market’s reaction to the announcements of tariffs and trade restraints against China. But what about the larger implications for jobs, the economy, and your money?
On balance, global trade makes everyone better off. Trade lowers prices for domestic consumers and increases the choice and variety of goods available. But global trade isn’t free, no matter the branding. If foreign workers can produce goods cheaper than domestic workers, then production will move overseas. Domestic workers only benefit from the lower costs if they are not displaced, or if they are able to find another job. This has been a concern of workers for some time, even as business owners and investors have profited.
How does trade lower prices? For any given price of a good, domestic manufacturers will produce a given amount. But we live in a global marketplace, so if a good can be produced cheaper overseas, it will be imported at that lower cost. While this lowers the price of goods for consumers, it also undercuts domestic production. The imported goods are cheaper for domestic consumers, but at the cost of fewer domestic production jobs. This essentially has been Walmart’s business model: import the cheapest goods they can, from wherever they can get them, and sell them to U.S. consumers at the lowest possible price.
How do tariffs impact trade? A tariff is basically a tax that makes imported goods more expensive. This artificially raises the cost of imported goods, making domestic goods more competitive at the higher price. While this can lead to more domestic production (jobs), it also raises the price of the affected goods for consumers. In other words, inflation.
If tariffs can encourage domestic jobs, then why are they problematic? For one thing, our trading partners will not sit idly by while we tax their exports. The effect on their workers is that the goods they produce cost more, so demand falls and those foreign workers lose their jobs. Thus, the countries on which we impose tariffs will probably retaliate by imposing tariffs on our exports. So while some U.S. industries may benefit from tariffs, others will be hurt as our exports become more expensive. In the long run, everyone loses as prices rise and the global market for goods and services shrinks. There is a balance between protecting industries and hurting the economy with inflation. It is hard to get this balance right.
But don’t tariffs protect domestic jobs and allow industries to flourish? Maybe, but an industry without real competition stagnates because there is no incentive to improve. Think Detroit in the 60s and 70s. The U.S. auto industry’s products suffered until competition from Germany and Japan forced innovation, cost cutting and product improvements. Tariffs and trade barriers do protect domestic producers in the short run, but higher costs and inefficiencies outweigh those benefits in the long run. And that’s before considering retaliation.
The argument for tariffs on Chinese imports is that China’s aggressive and anti-competitive trade behavior of the past 30 plus years must be corrected. But tariffs and protectionism can cause more pain than they fix, and so should only be done with the support and agreement of our other allied trading partners. Never mind that picking a fight with China while we ask them for help solving the Korea puzzle seems to be a very poor negotiating strategy.
So why are investors freaking out about tariffs and potential trade wars? In short, uncertainty. The discussion above suggests higher costs and lower profits for some companies and industries. But investors don’t know who will benefit and who will be hurt, or how this will end. In addition, the “Goldilocks” economic scenario we currently enjoy, where economic growth is global and moderate (without overheating) relies heavily on global trade. So anything threatening that equilibrium adds uncertainty to investors’ outlook. Finally, expanding global trade has contributed to the relative global peace since World War II. Trade wars create additional stress, increasing geopolitical risks. All this added uncertainty causes volatility as investors try to guess at the impacts, winners and losers.
Investment volatility is nothing new, of course. In our recent article Market Volatility: It’s Back, we discuss investment volatility and the benefits of going through it. At Blankinship & Foster, we guide our clients not only through volatile investment markets, but through life’s ups and downs as well. To learn more about how our proven process simplifies your finances and helps you navigate life’s transitions, visit our website at www.bfadvisors.com or contact us to schedule a no cost consultation.