A Short Look at Tariffs and How They Affect Us

Over the past twelve months, trade wars and tariffs have been the major story on the business channels and the consequential uncertainty has plagued small business owners, CEO’s and economists.

I was invited to speak at the Pac Rim meeting in Sacramento on May 9 and the Monday before the meeting the Administration announced $300 Billion dollars in tariffs on China and sent an armada of war ships barreling toward Iran. A month later there was a threat of tariffs on Mexico, our largest trading partner, and India, the world’s fastest growing economy. It is becoming increasing more difficult to make predictions about our future direction given the uncertainty we deal with almost every single day.

We know, due to the size of our consumer market, that “trade wars are easy to win.” American consumers are an indomitable force, unlike any other in the world, the U.S. consumer market is a $13 trillion dollar behemoth. America has the largest consumer economy on the planet and as a result we set the global agenda for trade. So yes, trade wars are easy to win economically but not politically. U.S. Presidents face reelection every four years, China has a dictator.

Let me take you back to the last big trade war that began with the passage of the Smoot-Hawley Tariff Act of 1930. It was passed in an attempt to protect American businesses and farmers from foreign goods being imported into the U.S. The legislation was based on an idea of “America First” and after the stock market crashed in 1929, talk of protectionism gained strength. Economists wanted nothing to do with this plan and 1000 of them urged Hoover to veto the Act, however he signed it into law on June 17, 1930.

It signaled that the U.S. was now moving toward isolationism and the Act prompted foreign governments to retaliate by putting tariffs on American goods. It set off a trade war that sparked a global slowdown, exacerbated the U.S. depression of 1929 and reduced global trade.

Nearly a century later, we find our world in a similar place. There have been tariffs set on Canada, Mexico, China, the Eurozone and others that are now having an outsized impact in a much more interconnected world than one that existed in the 1930’s. I think the administration’s calculus assumes that the extremely powerful American economy isn’t dependent on a worldwide economic marketplace. That would be a bad assumption, we are in the late stages of the longest recovery in U.S. history, and the economy is waiting for something like a trade war to set it adrift.

Consider this, tariffs have devastated soy bean farmers, China has found new suppliers for this crop, many of our farms have been forced into bankruptcy and this is having a reverse multiplier effect on the farm industry. For example, farm equipment manufactures like John Deere are struggling, Chemical companies like Dow/DuPont have reported lower revenues and trucking companies that deliver produce are reeling.

This scenario duplicates itself in other industries as supply chains are irretrievably broken, costs have skyrocketed over the past year and revenue moves in a negative direction despite an American economy that is still showing strength.

Also equally important, China does not pay for tariffs, it is a tax paid for by the importers who bring product into our country. American companies pay the tariffs that eventually get passed on to consumers.

When I look deep into my crystal ball, our economic future is uncertain due in part to Tariffs and this is what I am seeing:

The yield curve inverted again on March 22, 2019 and as I send this article off on July 7, 2009 the 10 year Treasury note is still lower than the 3 month T-bill, an inversion for more than 30 days has been a strong predictor of future recessions.

There is a global slowdown in manufacturing, the May PMI report missed Wall Street estimates by a wide margin and is has now been down for the past six months. Also, the sentiment index for manufacturers was the lowest we have seen in nine years.

Copper prices are down 9% over the past month, another negative sign

Credit use is now at an all-time high, including personal and corporate credit. Also the U.S. deficit and debt have reached historic highs.

It has been over a year since the trade disputes began and as I have continued to speak to groups nationwide, I keep getting the same question, “when will the trade war end”? Here is what happened at the June G 20 meeting in Osaka. Trump made the decision to drop restrictions on Huawei Technologies and postpone the tariffs he threatened to impose on $300 billion of Chinese imports. Xi agreed to buy American soybeans, although this is has not been worked out as of this writing.

I believe that this signals the end of the trade war as Trump has given into China’s tariff demands and pulled the sanctions on Huawei, even though this technology company is considered a national threat to our military and other national interests.

The initial goal was to fundamentally change America’s trade relationship with the Chinese government especially as it has to do with the theft of intellectual property. Economically we had the advantage but politically Zi knew that the upcoming election was on Trump’s mind.  Zi also knew that tariffs were becoming disadvantageous to the administration and they did not want to  further damage the support the President was getting from farmers, and others affected by tariffs.

So where are we now, the June jobs report beat expectations and came in at 224,000, overcoming the 75,000 jobs produced in May 2019.  This is good news for the economy but bad news for the stock market. Here’s why, with the high number of jobs created beating expectations in June, it means the economy is in good shape so the  Federal Reserve has no reason to cut interest rates.

However, much of the increase in the Dow during June can be attributed to the Fed’s possibly planning an interest rate cut in July.

The Fed should only cut interest rates if there is high unemployment, inflation above 2% or a potential recession in the forecast. If Lawrence Powell is trying to save his job by taking this action and juice the stock market, the Fed is doomed.

Peter Boockvar, the chief investment officer at Bleakley Advisory Group said it best, “Tariffs can be thrown around as an economic bomb for anything now.” While Mr. Boockvar makes a great point about the devolution of tariffs being used for purposes other than economic threats, my biggest concern is how these actions are affecting small businesses and their supply chains. A real tariff compromise over the next quarter would restore confidence and remove the uncertainty that has been plaguing our economy.

So stay positive about the possible outcomes, the American economy is in good shape for now with unemployment at 3.7%, and the first quarter GDP coming in at 3.1%. The stock market had a great June but is now dependent of the results of Q2 earnings and the Fed.

We will know more the future of our economy when the second quarter GDP numbers come out in August.