“Trade war” is an ugly term. And the result of prolonged sparring between economic powers slapping tariffs on each other figures to be ugly. Fortunately, that’s not the end game investors should expect.
The escalating trade war between the U.S. and China has strangled the stock market since early March, when President Donald Trump announced his intention to slap new taxes on imported steel and aluminum.
Many American companies and several foreign trading partners voiced their immediate disapproval. China responded by announcing a policy to add tariffs on 106 U.S. products.
The stock market’s hyper-volatility in the past five weeks is a justified reaction. In one sense, the downside to a trade war between the two largest economies on the planet is potentially massive.
If foreign products imported to the U.S. become more expensive, that cost gets passed on to consumers or absorbed by the industries producing them. The result is either higher prices to buy things or less revenue for global corporations, which leads to lower stock prices.
That said, there’s a reason most of us think of colonial times and high school history class when we hear the word “tariffs.” It’s an outdated strategy with a history of failure.
In a now-famous scene from “Ferris Bueller’s Day Off,” actor Ben Stein’s character reminded us what happened after Congress passed the Hawley-Smoot Tariff Act in 1930. Did it work? Anyone? … Anyone? … It did not work and the U.S. sank deeper into the Great Depression.
With a few minor exceptions, the U.S. government has rarely used tariffs in the 90 years since. Hindering free trade leads to a diminished exchange of goods and services. It means smaller markets and higher costs. Tariffs may help U.S. steel manufacturers, but harm its farmers. As the stock market has shown us, it also means more volatility.
Our president may be stubborn but he’s not stupid. A strong economy since his election is Trump’s biggest win as a politician. Tariffs are a means to an end. And the end he has in sight is a renegotiation of America’s existing trade deal with China. Both Trump and Chinese President Xi Jinping have already shown a willingness to soften their rhetoric. They understand a trade war has no real winners.
Investors would be wise to come to the same realization. Volatility will remain elevated in the meantime, but profitability is likely to prevail. Short-term pain will lead to long-term gains.
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