Monday, April 9, 2018

New U.S. tariffs have lots of bark and unknown bite

Photo: Canva
By Taylor Graff,
Guest Columnist 

During the past century, trade barriers around the globe have declined substantially, coinciding with a considerable increase in global trade. Politicians will debate the winners and losers from this but multinational corporations have benefitted tremendously from free trade. However, popular sentiment for globalization has recently soured in many countries and the trend may be reversing. In many ways, President Donald Trump’s election may be viewed as a byproduct of this trend and his recent actions on trade have caused financial markets to reevaluate the future of trade policy.

For most major economies, trade with the United States as a percent of gross domestic product is small enough that U.S. tariffs alone are unlikely to derail the global economy. However, aggressive retaliation to tariffs and a broader trade war represent a risk to the global economy and an even more significant risk to multinational corporations which dominate the global equity market. Highlighting the risk of rising trade barriers, companies in the S&P 500 Index generate nearly half of their revenues outside the U.S.

What comes next? There are two historical examples that may provide context. First, in 2002 the George W. Bush administration enacted similar steel tariffs to those recently announced. In response, several nations initiated a case in the World Trade Organization and proposed severe retaliatory tariffs. After the WTO ruled against the U.S. 20 months later, the Bush administration rescinded the tariffs rather than face significant retaliatory trade action. 

Conversely, in 1930 Herbert Hoover's administration struggled in combatting the onset of the Great Depression. They enacted large and wide-ranging tariffs aimed at bolstering domestic industries. Other nations followed with their own tariffs on goods from the U.S. and other countries; these hurt U.S. exporters and led to a global trade war. The ensuing contraction in global trade deepened the economic downturn, rather than ameliorating it.

These examples demonstrate how other nations’ reactions can determine how this event ultimately impacts the economy and financial markets. We see three potential outcomes: 

1.  Retaliation Against the U.S.: International responses may be limited to targeting the United States. Corporations heavily exporting from and importing into the U.S. would feel the significant impact and the U.S. economy would feel pain. The magnitude would depend on the severity and breadth of the retaliation.
2.  Negotiating:  International trading partners may decide it is wiser to negotiate rather than retaliate in response to these actions. We have already seen South Korea renegotiate their free trade agreement with the U.S. Depending on the outcome of these negotiations, this could benefit the economy and multinational corporations.
3.  Trade War:  Nationalist political factions around the world may be emboldened to take similar actions leading to a trade war that substantially reduces global trade. The global marketplace is far more expansive than it was in 1930. Global trade is approximately 60 percent of global GDP today vs. approximately 9 percent in 1930, so the potential impact could be very significant.

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Overall, it is too early to determine the impact this may have, but it introduces significant uncertainty into global markets. 

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Brown Advisory or TEXPERS.

Taylor Graff
About the Author
Taylor Graff is the head of asset allocation research at Brown Advisory. He leads the asset allocation research effort within the Investment Solutions Group, a team responsible for conducting primary statistical, market and economic research as well as research on external managers. Additionally, Graff develops asset allocation strategies for balanced clients and works directly with clients as a portfolio manager. Prior to joining Brown Advisory, he was the head of research at Cavanaugh Capital Management, where he conducted investment research and developed quantitative modeling applications for asset allocation and fixed income strategies.

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