Yesterday, President Trump announced sweeping new tariffs on imports from many of our trading partners. Thus, Trump’s tariffs spark global selloff in stock markets around the world and increase the risk of recession. How bad could it get? How long will it last?
In the past few years, stocks have risen substantially. The recent tariff announcement will change that – at least for the short term. Global stock markets are reacting negatively to the added tariffs. How long it will last is unknown, but for perspective, stocks should not fall nearly as much as they did during the 2008 recession. Even so, back then, stock markets recovered all losses within 3-4 years after reaching a bottom in March 2009. Thus, the lesson is don’t panic. This too shall pass. Even so, there is much more to the story.
While there will be positive benefits in the future, investors will experience short-term disruptions. Before I get into the arguments for and against the Trump tariffs, let’s look at how the economies of the United States and China differ. This is an important point to understand.
America Versus China: Two Opposite Economies
The U.S. is the wealthiest nation on the planet and is the largest consumer-based economy. Seventy percent of U.S. economic growth (GDP) is derived from consumer spending. In short, if U.S. consumers continue to spend, our economy will do well. Because of this the world wants to sell their products to America.
Conversely, China is the largest export-driven economy and is highly dependent on selling its products to the rest of the world, especially to the United States. Other countries – those without a consumer-based economy, have watched the Chinese model over the years and have tried to copy it. In short, many foreign nations survive by exporting products to the world. This increased greatly during and after Covid as many companies in the U.S. began to source their materials from countries other than China. This hurt China while helping other countries.
One more important point is that the U.S. government has been spending far beyond its means. This excessive spending, combined with a shortfall in supply, contributed to very high inflation. In short, the U.S. was propping up its economy by infusing more and more money into the economy. This resulted in historically high budget deficits, causing our national debt to rise to its current level of $36.6 trillion.
Again, for perspective, even though we will experience some pain now, the pain would’ve been much worse if we would’ve maintained the status quo. Thus, something needed to be done to avoid a more dire economic scenario in the future. That’s not to say what Trump is doing is ideal, but reducing the size of the federal government is needed, even though the method has its faults. Now, here’s the argument for and against tariffs.
The Argument for Tariffs
For decades, the playing field has not been level. By that I mean the U.S. has imported much more than it has exported. As we have bought more than we have sold, we have had a trade deficit for many years. Some of this is expected as the American economy is the largest consumer-based economy. Now, the Trump administration wants to force other countries to reduce their tariffs on U.S. goods, which would help U.S. businesses sell more to the rest of the world and strengthen America’s economy. He also wants to bring manufacturing back to the U.S., which is why the UAW and other unions support these tariffs. However, it takes 3-5 years for a company to either begin, or add to, manufacturing their products here in America. That’s a long lead time. Thus, the question is: How long will American’s tolerate the pain?
The Argument Against Tariffs
Tariffs add to the price of imported goods. Will inflation rise as a result? Yes, to some extent. However, it’s important to understand that the added tariffs – at least in some cases, will be partially absorbed by manufacturers, distributors, retail outlets, and finally, the U.S. consumer. Additionally, it’s possible the Chinese government will subsidize China-based exporters to help offset some of the added costs.
Are tariffs a good idea in general? The U.S. added sweeping tariffs under President Hoover, which were designed to help farmers. Most economists believe the Smoot-Hawley Tariff Act of 1930 prolonged the depression and even made it worse. The difference is that the U.S. had a trade surplus then, while it has a trade deficit now. Tariffs are never a good idea when you have a trade surplus. Interestingly, Trump’s recent announcement imposes a 10% tariff on the United Kingdom, a country with which we have a trade surplus. Thus, not all of Trump’s tariffs seem to make sense.
Is There a Plan to Minimize the Pain?
To combat the negative economic fallout in the U.S., Trump plans to reduce regulations, something many experts say became too restrictive under the Biden administration. Deregulating is straight from the Ronald Reagan playbook and will help U.S. businesses. In addition, Trump plans to lower taxes, including making his 2017 tax cuts permanent. I wrote about this in an article entitled, “Who Benefited Most From Trump’s Tax Cuts? The Answer May Surprise You.” Less regulation and lower taxes will help offset the short-term pain for U.S. consumers. It’s impossible to say if this relief will be enough.
The Risk of Recession
The recent tariffs have raised the risk of recession, especially if it lasts for a while. Why? The new tariffs will reduce the amount of global economic activity, which could easily cause a recession in many foreign countries that depend on exports for economic growth. Even though the risk of recession is heightened, it may not be as bad in the U.S. provided the American consumer continues to spend. However, if consumers reduce spending in a meaningful way, the U.S. could also experience a recession.
That brings me to a very important point. Our view of the financial markets and economy is largely influenced by where we get our news. Those who watch CNN exclusively, for example, have been told that our democracy is about to end. CNN wants to do everything possible to stop the Trump agenda.
Those who watch FOX News exclusively will not hear the same dire scenarios. They will also not receive unbiased news as FOX slants right. Even this morning, in the wake of the recent tariff announcement, CNN has been on the attack while FOX is defending Trump. While both make good arguments, neither provides the complete story. This is likely because each knows the demographic of its viewers and plays to it. Remember, it’s all about viewership, which results in more ad revenue.
While I have been watching CNN and FOX for years, for financial news, I trust CNBC. CNBC is very much in the middle of the political spectrum and is the least biased of the three.
What to Expect
While no one can say with any certainty what will happen, we can say there will be some short-term pain for investors. It will also create a rare buying opportunity for patient investors as stock prices decline. I would not suggest buying stocks quite yet as this situation will likely persist. Again, it is impossible to say how long it will last.
Stay tuned for more.
Read the full article here
