Aside from the Kavanaugh nomination and Hurricane Florence, the news lately has been dominated by ‘tit for tat’ on the trade front. Meanwhile, the stock market powers ahead. What gives? Isn’t it important to our economy if traded goods are more expensive and supply chains are disrupted? Won’t stocks eventually ‘wake up’ and fall because of trade policies?
To lay the groundwork, understanding how trade affects the US economy is critical. Our economy is actually relatively closed. About 12% of US GDP is associated with exports while imports make up another 15%. (Compare this to Germany, where 40% of GDP is exports; in Japan, it’s 17%.) The net of these two is a component of GDP calculation, and since the 1990s, we’ve run deficits consistently. If the US dollar were not the primary currency of trade, the US would have undergone an economic adjustment long ago to account for these persistent deficits, likely taking the form of a lower currency value, inflation, a difficult job market, or all of the above and then some. However, the station of the US currency is significant in this calculus, so we must think of this issue as the world is, rather than what it might be. As it is, we import capital to accommodate our consumption and we do not experience the kinds of dislocations that smaller less developed countries do.
A substantial portion of our goods and services are made and consumed in the US. The Chinese import US goods only to the tune of about 0.7% of our GDP. Exports from China to the US are about 4.1% of its GDP; when considering the effect of this number in China, remember that it does not capture local benefits from plant utilization in China by American manufacturers, such as employed Chinese workers.
Our two major trading partners are Canada and Mexico. There, NAFTA is in renegotiation. But despite tariffs, trade with Canada increased in the last few months, and Canada’s trade deficit narrowed. Through July, 2018, we were importing more from Mexico than in the last several years for the same period. Thus far, it’s pretty difficult to see any material impact on the economies in North America from trade talks.
At the consumer and industrial level, metals tariffs, much ballyhooed, have resulted in higher aluminum prices in the US for certain, but steel prices have barely budged. Stainless prices are up, but are at 61% of early 2012 values. Nickel alloy is at 82% of 2012 values. Lumber, nearly constantly subject to tariffs, has fallen in price dramatically since January. Soybeans, hit by Chinese tariffs, are down in price, but the other side of that coin is that consumers benefit from lower soy prices. At General Motors, costs of steel are on track to increase by $1 billion this fiscal year. But that’s 0.6% of GM’s latest annual revenue number. Looking at its cost of goods sold quarter over quarter for June, excluding depreciation and amortization, the number was DOWN, not up. The company’s conference call indicated that it was finding places to save even while bearing higher materials costs.
Meanwhile over in China, a decline in the yuan is ameliorating tariff impacts on the consumer. Ditto the Canadian dollar and the Mexican peso. So while taxes in the form of a tariff makes goods coming to the US cost more, the decline in source country currency values can offset that tax.
Tariffs are also happening in the context of a strong US economy where the Fed is still somewhat accommodative. Consequently, consumer demand has only grown stronger this summer. Of course, the threat of higher prices on imported goods may be front-loading demand into this quarter; time will tell. We tend to believe that strong employment bears the larger responsibility for solid demand figures.
Supply chain disruption is another common complaint around tariffs. But supply chains have been building in flexibility for years, in order to deal with wars, natural disasters, and of course, financial disruptions like tariffs. Companies can and do switch suppliers from country to country. It does take time, but it’s not impossible. We think GM, which should be particularly vulnerable to tariffs, is showing the results of supply chain maneuvers that will neutralize the effects of tariffs to a large extent. The much publicized plight of soybean farmers is overdone. There are only two major producers of soybeans in the world, and we are one of them. Our crop will be sold to countries that do not tariff it, and next spring, farmers can once again make a choice to plant grasses or corn instead of the bean.
That said, the latest round of tariffs does pose a threat on one front, and that’s inflation. The first set of goods taxed were business to business items, while this next round is nearly all consumer goods. We’re going to pay more at WalMart, no question about it. The effects of higher prices will probably become evident around the holiday season, but with tariffs so far set at just 10%, it remains to be seen how much of that will pass through.
We have discussed many of the commonly publicized negatives surrounding tariffs. But it’s conceivable that there will be positives. These might include manufacturing moving to the US; better trade agreements that then cause tariffs to be cancelled; or increased sales at US firms that become more competitive with imported goods. The Wall Street Journal wrote a story recently on Allen Edmonds, which makes shoes in the US and always has. Pricey, yes, but they last forever and the company will virtually rebuild your old pairs multiple times at no charge. This kind of service and product is overlooked in the US, but perhaps no more.
Considering all the possible points of pain from tariffs, our conclusion is that given their current extent, the effect on the US economy will be mild, with more extreme well-publicized disruptions here and there. Should the trade war worsen, we’ll have to revisit the subject, but for now, we conclude that the market is right to look past trade talk.