October 2018 Market Insights

    Neal G. Davis, CFA
    Senior Portfolio Manager & Research Analyst

    There has been considerable amount of negative press from the Trump administration with respect to our trade deficit with the world, particularly China. Last year, the U.S. imported significantly more than it exported. This resulted in a trade deficit of $568 billion, $375 billion of which was with China alone. To some, such a large trade imbalance might appear alarming. However, most economists agree trade deficits can have a positive impact on an economy, while other negative aspects related to jobs are often overstated. In response, the U.S. has imposed massive tariffs to curb the growing trade gap. While the tariffs were levied with good intentions, they were largely unnecessary and have their own unintended consequences that can impact consumers and U.S. businesses.

    The Balance of Trade

    A country’s balance of trade is the total value of its exports less the total value of its imports for a given period. If a country imports more than it exports, then it has a trade deficit. Conversely, if a country exports more than it imports, then it has a trade surplus.

    Benefits of a Trade Deficit

    The U.S. has a robust consumer-based economy in which we import countless goods from foreign nations. The resulting trade deficit can be beneficial to the U.S. in the following ways:

    • • Purchasing goods more cheaply from foreign countries, like China, raises the standard of living of all U.S. citizens.
    • • Buying inexpensive goods affords us with more discretionary income to be allocated elsewhere.
    • • A trade deficit can confirm that consumers are optimistic about the economy and willing to spend their hard-earned dollars. Historically, trade deficits widen during periods of economic expansion.
    • • As our trading partners accumulate U.S. dollars from the purchase of their imports, they regularly reinvest proceeds back into the U.S. economy. This can take place in the form of purchases of U.S. Treasuries (results in lower interest rates), real estate, equity markets or business investment.
    Trade Deficit and Jobs

    Jobs will flow into low-cost countries where products are manufactured to satisfy consumer demand. Yet, a greater number of jobs have been created in the U.S. to make up the shortfall. The U.S. has replaced manufacturing jobs with higher-paying services jobs which now represent roughly 80% of the U.S. economy. The job creation is apparent in unemployment data which stands at a multi-decade low of 3.7%.
    Additionally, with no barriers to trade, jobs are created by direct foreign investment into the U.S. Foreign businesses can freely invest their capital within the U.S., such as Toyota manufacturing plants or foreign banks, thus creating job openings.
    Lastly, it is not practical to suggest that foreign manufacturing jobs should suddenly return to the U.S. There would not be enough skilled workers to fill those jobs. This can be substantiated by the number of job postings already outpacing the number of job-seekers.

    Tariffs

    A tariff is a tax or duty to be paid on a type of import or export. To bolster manufacturing in the U.S. and reduce global trade deficits, the U.S. placed a 25% tariff on steel and a 10% tariff on aluminum earlier this year. However, most of the steel and aluminum purchased by the U.S. comes from Canada and Europe. In effect, the tariffs implemented by the current administration on steel and aluminum targeted our allies and trading partners, rather than countries we intended to punish, such as China.
    More recently, new rounds of tariffs were placed on $250 billion of Chinese goods, or roughly half of all imports into the U.S. The tariffs imposed targeted farm equipment, steel, aluminum, medical supplies and other goods. The tariffs on Chinese goods are set at 10% now with the expectation that they will rise to 25% by January 1st if there is no resolution on trade. Naturally, China responded with their own round of tit-for-tat tariffs on farm products, whiskey, autos, salmon, cigars and other goods. The situation could escalate further, as Trump has promised to pose a tariff on virtually all Chinese exports if the trade dispute cannot be resolved.

    Impact on Individuals and Businesses

    Certain industries, such as steel and aluminum, have greatly benefited from the addition of tariffs. The tariffs have allowed companies to level the playing field by making foreign steel and aluminum more expensive. The result gives American companies a competitive edge in the marketplace.
    While tariffs benefit some, a greater proportion of businesses and individuals are impacted negatively. Many companies use steel, aluminum, or other products levied with tariffs somewhere in their supply chain. Large corporations, concerned with maximizing profit margins, will pass most of the additional costs along to the consumer to protect their bottom line. There will be some lag time before we notice the price increases, but analysts note that we could start to see higher prices around the holiday season.
    Lastly, corporations that are unable to pass higher prices along to consumers will look for other means to reduce costs, such as reducing their number of employees. Those industries that have been targeted, such as auto, fishing and farming may be impacted.
    Final Thoughts
    The tariffs levied were an approach to combat our trade deficit, which may not really be a problem for our economy. Markets and the stocks of specific industries will continue to fluctuate as new policies on trade are discussed and implemented; but tariffs alone are unlikely to send the overall economy into a tailspin. Given time, the U.S. will hopefully be able to establish fair and open trade agreements where goods and services can trade freely across country lines. The result would better serve the U.S. and all countries involved.

    RISKS AND IMPORTANT CONSIDERATIONS
    Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.