U.S. President Donald Trump listens during a working session. (Photographer: T.J. Kirkpatrick/Bloomberg)

Tariffs: The Good Donald, the Bad Donald and the Ugly Market

(Bloomberg Gadfly) -- Call it the tariff tantrum.

The big question investors should be asking during the market's plunge this week is how could the threat of tariffs -- which would affect only 2 percent of all U.S. imports, representing just 0.2 percent of GDP -- cause stocks to lose more than $600 billion. The answer is that either tariffs will sock a bigger punch to the economy than most economists think, or it's about more than just tariffs.

Let's tackle the first part first. President Donald Trump has proposed import tariffs of 25 percent on steel and 10 percent on aluminum. U.S. imports of steel, aluminum and other similar metals equal about $40 billion a year. If the price of those imports all rose by 25 percent (and they wouldn't obviously), that would be an additional cost -- spread around the economy by increasing the cost of goods produced with those metals (think soda cans) -- of about $10 billion a year, which is a lot less than $600 billion. But that's not the end of it, of course.

Tariffs cause trade wars, and the assumption is that other countries will retaliate. That would slow U.S. exports. But even that's a relatively small part of the U.S. economy, about 12 percent, or $2.2 trillion, a year. Imagine if every other country that the U.S. exported to responded with a 25 percent tariff on all of its goods (not truly realistic), cutting demand by the same amount. Even that would result in a $550 billion economic hit, still less than the market drop, though the market is discounting the damage from a multiyear drop in exports, and the knock-on effects of a drop in exports of that size would crimp the rest of the economy. So in that case perhaps the market drop should be far bigger. But again, that's not a likely outcome. The steel and aluminum tariffs are mostly aimed at China, which accounted for just $130 billion in exports last year. A 25 percent import tariff across the board from China, which itself is still highly unlikely, would still be only about $32 billion.

Macroeconomics are far more complex than that. Tariffs shift demand -- that's the point -- and can influence prices substantially. Sum it all up, and Michael Gapen, an economist at Barclays, says the steel and aluminum tariffs could knock 0.2 percent off of GDP and raise prices by 0.1 percentage points. That's a potential $40 billion hit to U.S. GDP, still less than $600 billion, even if it were to continue for a decade.

The market, as is often said, is not the economy, and the large public companies that make up the S&P 500 Index  generate more of their income overseas than the economy as a whole. So it's reasonable to conclude that the recent slump is about more than just tariffs.

Ever since the president was elected, investors have had to weigh which Trump they would get. The good Donald, who pushes for market-boosting regulation and tax cuts, or the bad one, who clamors for economy-dampening tariffs, walls and isolationism. Investors have bet on the first version and been rewarded with a tax cut. The market has soared by trillions of dollars in the past year and a half, more than can be explained by Trump's policy changes alone. Now they are experiencing the flip side. That's sure to take a bite out of the Trump premium the market has created.

Furthermore, inflation has been one of the biggest investor worries of late. Tariffs, which increase prices, feed right into those fears, possibly leading to both slower growth and higher interest rates. And with stocks near record highs, even small economic concerns can do a lot of market damage, as recent history can attest.

When you push the idea, as Trump has, that a rise in the stock market indicates economic improvement, you have to live with the opposite: That a drop in the market means something is wrong with the economy. Trump keeps a close eye on the market, and part of his calculus, to the extent he has given it any thought, could be that tax cuts and other pro-market policy moves are enough to keep investors happy, even with tariff talk. If not, and stocks continue to tumble, it could be enough to change his mind on tariffs. More than anything, Donald likes to look good more than he likes a fight. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

©2018 Bloomberg L.P.

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