Wild Week for Trade Produces Tame Result

Over the last several days, a seeming barrage of tariffs and counter-tariffs, threats and retorts, announcements and (we guess) counter-announcements between the US and other countries have seemingly whipped financial media into a trade frenzy. Coverage almost universally characterizes the back-and-forth as a trade war—now a global one. The World Bank piled on, issuing a report on Tuesday warning escalation could sink global trade on par with its fall during the financial crisis.^[i] Doomsayers are having a field day. But the moves that sparked this furor don’t live up to the hype, in our view, and a full-blown trade war with the power to end this bull market remains a distant hypothetical.

Let’s take a short (but scenic) walk down Trade Memory Lane, starting 10 days ago. On May 29, the Trump administration announced it planned to slap previously threatened tariffs on $50 billion worth of Chinese goods, with the final list due on June 15. (These same tariffs were supposedly canceled, according to Treasury Secretary Steve Mnuchin eight days prior.) But Tuesday, everyone’s favorite “unnamed sources” claimed China offered to buy almost $70 billion more US goods—narrowing the US’s trade deficit with China, a Trump administration goal—if the US doesn’t impose the aforementioned tariffs. Maybe this sways US negotiators, maybe not. Two days later, the Commerce Department announced a settlement with Chinese smartphone company ZTE over its violation of US sanctions on Iran and North Korea. ZTE will pay a $1 billion fine and let US regulators monitor its operations from within. In exchange (and on condition of good behavior), ZTE will escape a seven-year ban on doing business with American suppliers. While this may resolve one dispute, it shows the US flexing its trade policy muscles. And the saga may not be over, as Congress swiftly introduced a bill to block the deal. Meanwhile, trade negotiations with American allies soured. Last Thursday, the US removed exemptions on steel and aluminum tariffs for Canada, Mexico and the EU, ending their two-month reprieve following the tariffs’ inception in April. Responses were rapid. Canada immediately announced “dollar-for-dollar” tariffs of 10 – 25% on up to $12.8 billion worth of imported American steel, aluminum and other goods.^[ii] Mexico followed on Tuesday with 15 – 25% tariffs on about $3 billion worth of assorted American products like pork, cheese and bourbon. That same day, Larry Kudlow (the President’s chief economic adviser) suggested the Administration may prefer killing NAFTA and replacing it with bilateral deals with Canada and Mexico (a comment Trump more or less echoed Friday).

The action-packed week continued Wednesday, when the EU announced it is planning 25% levies on $3.4 billion of to-be-determined American imports. These (and the Canadian duties) would take effect July 1. Stateside, a Republican senator introduced a bill requiring Congressional approval for any tariffs proposed on national security grounds, including those imposed in the last two years (e.g., the steel and aluminum levies). It isn’t clear how the bill will fare—a similar one introduced in early 2017 stalled in committee.

After the dust settled, however, the global trade landscape looked very much same. With the EU, Canada and Mexico losing their exemptions, US tariffs now apply to about $40 billion worth of its steel and aluminum imports (86% of the total), up from $17.5 billion. Given tariff rates of 25% and 10%, respectively, their maximum impact is on the order of $7.5 billion. Same goes for the EU, Canada and Mexico’s retaliatory measures: They combine to hit $19.2 billion worth of US goods, but their ultimate effect is in the $2.5 – $4.8 billion range. Toss in the bottom-line impact of all tariffs currently enacted or threatened, and we are looking at $58.24 billion, tops. This works out to 0.1% of the affected countries’ total 2016 GDP—and even this is a high estimate, as these tariffs are mostly (and often purposely) easy to skirt.^[iii] We aren’t saying they are (or would be) painless—many producers could suffer from higher input costs, potentially canceling projects or laying off workers as a result. Concerns about possible future tariffs could also complicate planning—one reason businesses generally don’t appreciate policy uncertainty. But the global economy is vast and markets are callous. It takes way more than this to risk recession or threaten stocks.

Projecting disaster from these measures requires wild speculation. Take the World Bank report’s dire scenario of a 2008-size drop in trade: The calculation presumes countries worldwide jack up import tariffs (presumably on all goods) to the maximum permitted under WTO rules. This is fanciful. For starters, a trade malaise didn’t cause the 2008 crisis—it was a symptom. The culprit was a misguided accounting rule that wiped $2 trillion from bank balance sheets, choking credit and money supply while a haphazard government response spread panic. Setting that aside, protectionism on the scale the WTO imagines would be bad, true, but it is miles and miles from where we stand now. Present tariffs target niche industries and aren’t at all global. Responses to US measures have mostly been “dollar-for-dollar,” not escalating or geographically far-reaching. And whether ill-advised or not, the Trump administration seems to be employing tariffs to pressure other countries to lower their barriers to US exports. Freer trade wouldn’t be an outlandish outcome—and throwing your hands up and pretending to walk away is one of the tactics so famously outlined in The Art of the Deal. So while more tit-for-tat tariffs and associated chatter could spark trade war howls, we believe investors should try to keep perspective. Scaling always helps. We remain watchful for meaningful escalation, but presuming this is inevitable (or already here) is a fallacy.

[i] And that, the World Bank says, is using “conservative estimates.”

[ii] Including, in a shock to many Canadians, American-made maple syrup.

[iii] Source: World Bank, as of 6/7/2018. Nominal GDP for the US, the EU, China, Canada and Mexico in 2016 (the latest figures available).