PMC Weekly Review - March 16, 2018

A Macro View: “A Tale of Two Tariffs"

The newly imposed tariffs on steel and aluminum that were enacted last week did not receive the warm welcome that President Trump had hoped for. Close trade partners, specifically Canada and Mexico, began lining up to seek exemptions from the tariffs, and European Union (EU) nations warned of a looming trade war. As many know, trade wars are not a good thing for capital markets , and many economists argue that the last significant tariffs, imposed by the US with the Tariff Act of 1930 (more commonly known as the Smoot-Hawley Tariff Act), were a significant contributor to the Great Depression. Doomsday enthusiasts might argue that the recently imposed tariffs could have a similar effect, potentially derailing the nearly decade-long bull market. But before drawing any parallels between the newly imposed tariffs and the Smoot-Hawley Tariff Act, it is important to understand the similarities and differences in the economic backdrop of both time periods.

The first point to understand is the magnitude of the tariffs being imposed. The Smoot-Hawley Tariff Act followed the lead of the 1922 Fordney-McCumber Act and aimed to boost by 40% the previously imposed tariffs on about 900 imported goods. The tariffs that President Trump imposed are currently on only two goods—steel and aluminum. Second, the US is the largest importer of steel in the world, but it accounts for only 5% of the 1.7 trillion metric tons that are produced annually. Also, Canada and Mexico, the first two nations exempted, are integral to steel imports: Canada exports nearly 90% of the steel that it produces to the US, whereas Mexico sends almost 75% of its production. The implementation of the tariffs and subsequent exemption of the two countries seem more to be bargaining chips in the continuing North American Free Trade Agreement (NAFTA) negotiations, rather than the first shots fired in a looming trade war.

The US economy as a whole is almost completely unrecognizable now from what is was in the 1930s. The US did not have the robust and diversified economy that it has today, and it was more agrarian-based. Farmworkers (both owners and laborers) accounted for about 21% of the labor force, which is a far cry from the 1.5% of agricultural workers in 2016 (the latest figures available). The tariffs that were raised due to Smoot-Hawley largely affected the agricultural industry, and because it was a larger part of the economy, the effects were exacerbated. Steel and aluminum, on the other hand, accounted for only 2% of US imports in 2017. The changing nature of the US economy and its expansion into and creation of a variety of new job sectors suggest that more narrowly focused tariffs should not have the resounding effect they had leading up to the Great Depression.

One commonality between then and now, however, is a rise in protectionist sentiment. When Smoot-Hawley was first introduced, it enacted tariffs in an attempt to protect American farmers, who had been ravaged by the Dust Bowl, from a rise in foreign agricultural imports. Unfortunately, by the time the bill went through the legislative process and was actually signed into law by President Hoover, the scope of the bill widened to include tariffs on industrial goods. Similarly, President Trump, beginning with the cancellation of the Trans Pacific Partnership, the subsequent ongoing renegotiations of NAFTA, and the much maligned introduction of steel and aluminum tariffs, has signaled he is putting “America First.”

Although the newly implemented tariffs pale in comparison to those enacted in the run-up to the Great Depression, it is still hard to predict how they will affect the US economy. Although their effects have yet to be quantified, most economists agree they ultimately will prove to be a burden on global growth and offset some of the economic benefits of the President’s recent tax reform. The US economy is clearly more robust and diversified now, but rising protectionism could be a catalyst that expands the focus of the tariffs and kicks off a trade war that ultimately would likely be bad for consumers and the entire global economy. Most mainstream economists accept the axiom of free trade, but there is little doubt that we are entering a time when that will be tested. 

Brandon Rick 
Associate Investment Analyst

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