History's Not on the Market's Side in a Trade WarBloombergOpinion
(Bloomberg Opinion) -- 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 October 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.
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.
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 cons their products.
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