In today’s political and economic climate, it can feel like one wrong move will leave our economy adrift with no hope of return. But putting our feelings of uncertainty aside, how would a full-blown trade war actually affect the U.S. economy and stock markets?
For a little background, trade tariffs are taxes on a product made abroad. By taxing the items coming into the country, people may be less likely to buy them as they become more expensive. The hope is that people will buy cheaper local products instead. A trade war exists when countries try to damage each other’s trade by imposing tariffs (taxes) on each other’s products.
The Trump administration first proposed tariffs on China in March of this year to correct what were deemed unfair trading practices, massive trade deficits and retribution for stealing intellectual property. The U.S. has a substantial trade deficit with China, which reached an estimated $375 billion in 2017. U.S. exports to China were only $130 billion while imports from China were $506 billion.
In recent weeks, the U.S. has announced a second round of tariffs, which would take effect later this summer and into fall. This prompted China to respond with its own set of tariffs on U.S. exports to China. The “tit-for-tat” moves by each country have raised tensions between the world’s two largest economies and increased speculation on the possible economic impacts.
“A trade spat turning into a trade war could wreak havoc on global supply chains and have negative implications for growth, inflation, productivity and real incomes.” (Liz Ann Sonders, Chief Investment Strategist, Charles Schwab & Co., Inc. March 2018.)
A global trade war can make it more difficult for companies to operate and compete in the global economy. Countries like China can retaliate through tariffs, boycotts on certain goods or other measures like delaying approvals on future investments and extra customs inspections on U.S. goods. This could force companies to pass the increasing cost of business onto consumers. The latest round of proposed tariffs could hit consumers more directly as it’s aimed at popular products like cell phones, clothing and toys.
“But there are risks; in fact, CNBC reported in late June that two-thirds of CFOs have expressed concerns that U.S. trade policies will hurt their companies over the next six months. If the implementation and threats of tariffs continue to escalate, there is an increased risk that capital expenditures will be postponed and merger-and-acquisition activity dampened — potential detriments to both financials and technology sectors. For now, though, both consumers and businesses remain optimistic.” (Schwab Newsroom, July 2018.)
As a general rule, the stock market doesn’t like uncertainty. While the U.S. economy is still running strong, an escalation into a full-blown trade war would likely have a trickle-down effect by driving up market volatility in the short term.
We’ve seen the ramifications of this already in 2018. This volatility in the stock market would likely continue until both sides can come to some sort of an agreement. Ideally, a resolution will be reached so that an all-out trade war can be avoided. Companies will then have a clearer understanding of the landscape they are operating in and can adjust their business strategy for the long term. This bodes well for markets. Until then, it’s difficult for companies to plan for the unknown and one can anticipate continued market turbulence.
While sadly we don’t have a crystal ball, history tends to point towards the markets recovering well in the long run and, as is often the case, the uncertainty is instead due to the back and forth actions of both nations.
Linde Carroll, CFP, is an investment consultant at the Vancouver-based investment management and financial planning firm Sustainable Wealth Management. She can be reached at firstname.lastname@example.org.