As it is told by the usual “unnamed sources”, the President started last Thursday in a foul mood. He had just lost his confidant, Hope Hicks, who, a day after testifying before the House Intelligence Committee, decided that the job wasn’t worth the candle of stonewalling and perhaps even going down with the White House in the Russian investigation. He had also heard that his son-in-law, Jared Kushner, was not going to get top secret security clearance due to his constantly amending his application to the point that the conflicts between his public role and his corporate one became increasingly hard to explain. Finally, he was hearing increasing rumors that the Mueller investigation was getting closer to the Oval Office. Like most politicians in a similar situation, he chose to create a distraction.
Specifically, he issued an order, via tweet, to tax foreign steel 25 percent of its invoice price as a tariff, and aluminum 10 percent. No matter that our largest providers are such countries as Canada, Great Britain, Mexico, and Brazil, all allies (or were before this came about.) The tariffs were issued to target China, never mind that China is not among the top three in providing this country either metal. The tariffs are to take effect this week, assuming the Departments of State, Commerce, and Defense can become conversant in them, as all did not find out about the tariffs until other countries did.
Foreign relations are one of the few areas the president can act without the consent of Congress. President Trump has decided to make the most of it. His threatened tariffs on steel and aluminum, along with his protracted effort to re-negotiate the North American Free Trade Agreement (NAFTA) in good faith, seems to portend to a policy not so much as “America First” as “America Alone”.
The idea that this (or any) country can go at it alone in an interconnected world is not just baffling, it is economically counter-productive. The whole concept of international trade is based on the philosophy of comparative advantage. If, say, one country made a good, say textiles, cheaper than another, it would stand to reason that the former country should make textiles, and the consumers of the latter country should benefit from lower prices accrued as a result.
Trump’s world is dominated by Youngstown, Ohio, Janesville, Wisconsin, Harrisburg, Pennsylvania, and other areas that suffered as production was shifted abroad. This is the base of his support. These areas suffer from high unemployment, as workers were taken out of historically inter-generational career job tracks to be offered jobs with less prestige, benefits, and wages, and only after schooling. The people felt too old to be retrained and too angry to be moved to other areas of economic promise. They also felt overlooked by both political parties. To them, Trump is the first politician to recognize and respect them in a long time. Given that Trump’s polls only in the area of 35-40 percent, he cannot afford to lose this base, given his ambition for a second term. Thus the talk of tariffs.
Trump’s problems start when you consider how many companies depend on foreign steel and aluminum to keep prices down and compete both domestically and internationally. For every job potentially saved and created by these tariffs, there are around 90 jobs in the U.S. that depend on cheap foreign metals to compete. Further, we are not factoring in the potential adverse jobs effect of retaliatory tariffs from the countries affected, which could lead to additional job losses. To assume other countries will not counter with tariffs of their own is naïve. Finally, no company in its right mind will add domestic capacity and jobs to the steel and aluminum industry until they are convinced the demand would not disappear with another stroke of a pen.
Even Trump’s Defense Secretary James Mattis does not see a reason for the tariffs, as our allies have enough steel and aluminum capacity to furnish our defense needs. Thus the need to do this to protect a strategic industry does not get a second.
At a recent dinner, Trump extolled the virtues of operating a government in chaos, saying that it suited his personality. That may be the case, but for many supporters who voted for him to cut taxes and reduce regulation, the idea of economic trade wars was not what they signed on for. If the chaos gets out of hand, Trump’s personality may not be enough to contain it. Like the monster created by Dr. Frankenstein, chaos cannot be contained without structure and understanding, both of which are in short supply.
In 1930, when the stock market crash began to impact international trade, Congress passed the Smoot-Hawley Tariff Act, which slapped tariffs on a number of goods. This led to the “beggar-thy-neighbor” trade policies, where countries would raise tariffs on a complementary products, in a tit-for-tat that got out of hand. The result was the Great Depression, which was not reversed until after World War II. It is hoped that Trump acts before things get further out of hand. Given his affinity for chaos, no one is holding their breath.
Before the tariff spat, which seemed to spontaneously occur last week, the economy was looking very good. It still is, going by government statistics.
There is some weakness in auto sales, which can be chalked up to tighter credit and winter weather. Pent-up demand is more prevalent in housing. There has been some disappointment that corporate tax cuts and reparations of foreign profits have not resulted in more capital spending, but with population growth now slowed to 0.3 percent per year without immigration, and export markets problematic due to the talk about tariffs, companies are using their extra cash to raise dividends and buy back stock. By process of elimination, this is the most prudent thing to do, if not the most economically desirable.
The new chair of the Federal Reserve set the market back by talking about four rate increases this year instead of three. This was not so much a change of policy as an affirmation of the growth of the current economy, and the inevitable result of higher interest rates that follow.
What few people seem to be focusing on is the continuation of the shrinking of the Fed balance sheet to the tune of $110 billion per quarter. Since the policy was put in place last fall, it has attracted little attention, which suits the Fed just fine. It is currently being offset by the inflow of profits from abroad to the US. Such flows are one-off events and will taper off in the second half of the year.
If the tariffs stick, expect higher inflation. It will come from both the higher cost of steel and aluminum, as well as whatever tariffs are leveled in retaliation. While the impact is difficult at this point to quantify, it has put an upward bias in any forecasting.
The Stock Market
Stocks reacted negatively to the news of potential tariffs. Establishment Republicans who voted for Trump to reduce taxes did not bargain on a trade war.
At this point, cooler heads may yet prevail. If not, look for more revisions in both company and economic forecasting, to say nothing of the stock market.
Warren M. Barnett, CFA
March 5, 2018