The first shots
of a global trade war were fired on Friday as U.S. President Donald Trump
announced a 25 percent levy on $50 billion of imports from China. The tariffs
focus on “industrially significant technology,” and intend to hurt
China for alleged theft of intellectual property rights. China responded within hours with a detailed list of
imports from the U.S. valued at $50 billion that it would impose a similar 25
percent tax on.
The financial
markets have largely taken the decisions in stride, probably due to some
estimates suggesting a negligible impact on economic growth, employment and
share prices. The fallacy in interpreting the immediate investor reaction is
that it misses the likely secondary and tertiary impact of the tariffs on suppliers of the affected items, the higher cost to users
and reduced demand for the affected items. Such an impact tends to occur gradually, and is likely to have a more profound
influence on share prices over time.
History
suggests that investors should be cautious about extrapolating the immediate reaction
of financial markets. The Smoot-Hawley tariff act passed in June 1930 is widely
considered to have been a factor in deepening the depression and causing
equities to plunge. However, the Dow Jones Industrial Average rose from that
June to August 1930 as investors believed initially that the tariffs would provide
a boost for American companies by deterring foreign competition. As late as
Oct. 15 that year, a euphoric Irving Fisher, the well-known Yale
University economist, declared that equities had reached a “permanently
high plateau.” The stock market crashed two weeks later. While
the tariffs were not the instigator of the drop in share prices,
they added to the bearish sentiment over time.
Permanently
High Plateau?
More recently,
President George W. Bush imposed tariffs ranging from 8 percent to 30 percent
on various steel products in March 2002 to last for three years. The levies were
canceled in December 2003. In addition to the fear of retaliation by the
European Union against American products including Florida oranges and
Harley-Davidson motorcycles, a respected study found that the 197,000 jobs lost in
steel-consuming industries exceeded the 187,500 people employed by the entire
steel industry. Equities fell from March 2002 to October 2002 and did not
regain their March 2002 levels until January 2004.
Lasting
Impact
The latest
skirmish has Chinese authorities targeting U.S. farm products, automobiles and
energy. Food, beverage and feed are a major U.S. export category and soybeans, the top product in this category, is being targeted.
Global giants such as Cargill Inc. and Archer-Daniels-Midland Co. dominate this
sector, and are likely to feel the pinch of the worsening global trade outlook.
China is the
world’s largest market for automobile producers, and General Motors Co.’s sales
of 4.04 million cars in China in 2017 substantially exceeded the 3 million cars
that it sold in the U.S. Automobile exporters will face not only the impact of
reduced Chinese demand for U.S.-made cars once the tariffs go into effect, but
would also have to pay more for imported steel on account of the new levies
to be imposed on purchases from Canada, Mexico and the EU.
Crude oil and
related products form the second-most important U.S. export category, and it is
also the fastest growing export sector. China has become a significant importer of U.S. crude, and has indicated that the
new levies would affect oil and other forms of energy purchased from the U.S.
The likelihood
that the tariffs would affect a wide range of U.S. companies in a number of
sectors stems from the fact that food, transportation and energy affect the
entire economy with consequences for the stock market. Second, Trump has
threatened to implement additional measures if the Chinese retaliate, and
equities could be affected by a vicious cycle of tit-for-tat action.
History
suggests that the harmful impact of tariffs affect equity prices over several
months, and retaliation by trade partners typically makes the correction worse.
And when the items targeted are widely used, the consequences are likely to be
felt by companies in a broad range of sectors that supply to the affected
companies, or consume their products.
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for the original article from Bloomberg.