Dear Clients & Friends,
The Tariff War has taken center stage as of late, so we thought we’d discuss why economists and financial professionals have become so concerned. Before we begin, I want to remind everyone that our opinion on the matter is focused exclusively on the financial impact of these decisions and was formed without partisan preference. Additionally, though the following description may cast a bad light on the current circumstances, it’s important to recognize that tariffs sometimes work. Tariffs are usually expected to sting a little in the short term while working to improve long-term conditions. And we are at MORWM are certainly long-term thinkers.
First, a primer on tariffs:
Tariffs are a tax placed on imported goods in order to make the price of domestic goods more attractive, or to make the price of goods imported from a specific country less attractive. Imagine that the United Democracy of Morland (MOR-land ;-) puts a 25% tariff on yo-yos made in The Republic of Killeen. One of three results is likely to occur:
The added cost to import foreign yo-yos causes a decline in profits for the importers.
The added cost to import the foreign yo-yos causes the importers to stock fewer yo-yos from Killeenland and stock more yo-yos from another country, even if the cost of the other yo-yos is higher (before the tariffs are considered).
The added cost to import the yo-yos will be passed on to the consumer by raising the price that the consumer pays.
In all three cases, either the profits fall for the importers, or the price goes up for the consumers. This is the short term “sting” that I mentioned above. On the other hand, all three cases should cause a decrease in demand for yo-yos made in Killeenland. Hopefully, this would encourage President Amy of Killeenland to consider long-term policy that is fairer for Morland. If all goes well, then new policy would be established, the tariffs would be removed, and everyone is better off in the long run.
I hope that the primer helped. We will now move on to our concerns about the tariff war between America and China.
Two quick points before we get into the meat of our discussion. First, China does not pay the tariffs that America places on goods. We do. The American importers are the people who feel the short-term pain. Secondly, although the White House is advertising that tariffs collected from China are making the stock market go up, that is simply not how tariffs work. Again, we are not collecting tariffs from China, and more importantly, the tariffs collected are certainly not being invested in the stock market!
Several aspects of this trade war have not been receiving widespread media attention. First, when one country imposes tariffs on another country’s goods, usually the opposing country retaliates - as China has. For example, China’s retaliatory tariffs have greatly affected American soybean farmers. Due to these retaliatory tariffs, soybeans are now too expensive for China to import. As a result, China is now buying triple the amount of soybeans from Russia that they normally would, at the expense of soybean farmers here in the States. The New York Times reports that soybean exports are down 26%. And that’s just one example in the agricultural sector.
The Wall Street Journal reported that The 7th Circuit Court of Appeals, which covers a region that includes Illinois, Indiana and Wisconsin, received twice as many bankruptcy filings in 2018 as it did in 2008, during the height of the Great Recession. The 8th Circuit Court of Appeals, which includes Iowa, Minnesota, Missouri, Arkansas, Nebraska and both Dakotas, saw a 96 percent increase in bankruptcy filings last year compared to 2008. Those are staggering statistics.
Another problem is China’s retaliatory sale of US Treasuries. Within the past few days, China has dumped $20 billion of US Treasuries into the open market. This is very alarming and could have dramatic effects. If US Treasuries are unloaded into the public market, an oversupply of Treasuries could be created. A resulting supply/demand imbalance may cause the price of Treasuries to fall. Without getting too scientific, when the price of Treasuries fall, their interest rates go up. When this happens, all interest rates go up, including mortgage rates, lines of credit, business loans, education loans, car loans, etc, etc. In addition, this move by China weakens the US currency which makes all foreign more expensive for American consumers.
Unfortunately, we can’t retaliate against this strategy because the US is FAR more in debt to China than China is to the US (China owns $1.2 trillion worth of US debt in the form of Treasuries and other types of loans).
The third relevant concern is that US companies seem to have paused on strategic planning and business investment because the climate is so unclear. This will likely be temporary, but can cause a very significant reduction in business spending and GDP in the short run. In addition, the largest US companies who spend the most money and employ the most people are the most likely to suffer from these conditions.
Our foremost concern is actually quite simple: China appears to be in a much, much, much better position to navigate this “war.” In addition, we are not convinced that those in charge truly understand the mechanics of why China is in a better position to win this war. Not to mention that these tariffs are a tax on the American consumer. For those of you who hope for tax relief, bear in mind that tariffs are indeed another consumption tax, plain and simple.
Let me re-iterate that our belief here at MORWM is not necessarily that tariffs are always a bad idea. Well, they usually are, but not always. Sometimes you have to spend money to make money. Sometimes we need to spend money to protect our own interests. In fact, here’s a far-fetched, yet interesting take:
A) We add tariffs to Chinese imports, making them more expensive for US consumers.
B) China retaliates by selling Treasuries and devaluing our currency, which makes Chinese imports even more expensive for US consumers.
C) Because our currency is devalued and our products are cheap in comparison, Chinese consumers start buying more American goods.
D) We buy less from China, they buy more from us, and the century-old trade imbalance is neutralized.
This is far-fetched indeed, but possible.
Now, let’s look at the bright side, because you all know that we like to end on a positive note. Many agree that China has been playing dirty in the field of global commerce for a long time. If we are successful, the US could exit this battle with better and fairer trade policies. Again, far fetched but possible.
With that, we wish everyone a wonderful weekend.
-The economics geeks at MORWM
Matthew Ramer, AIF® Principal, Financial Advisor MOR Wealth Management, LLC
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