Investment Insights from 1825 – Trade tariffs
Thomas Watts | March 15, 2019
The information in this blog or any response to comments should not be regarded as financial advice. If you are unsure of any of the terminology used you should seek financial advice. Remember that the value of investments can go down as well as up, and could be worth less than what was paid in. The information is based on our understanding in March 2019.
Many an educated man has theorised on the certainties of life, each of them reaching the same conclusion. It was Daniel Defoe, author of Robinson Crusoe and, later, statesman and polymath, Benjamin Franklin, who both determined that “Nothing can be said to be certain, except death and taxes.” Over the centuries such a sentiment has certainly been proven correct in terms of that most contentious of issues, trade. As long as there have been goods and services flowing between nations, you can be sure there have been taxes levied on them.
With growing trade tensions between the US and China having plagued financial markets during 2018, investors have found recent solace in the more accommodative tone struck between the two nations of late. It seems that President Trump has undergone a transformation of almost Kafkaesque proportions, going from being a “tariff man” in December 2018 to letting a deadline “slide” if an agreement is within sight by March.
Although duties imposed on foreign imports are meant to protect domestic manufacturers and producers, most economists agree that no one really benefits from trade tariffs, not economically anyway. Even those who see Trump’s actions from a political perspective may concede that, whilst it may capture the nationalist vote, the economy is still, ultimately, likely to suffer. A coalition of US businesses recently released figures showing that Trump’s tariffs and the uncertainty they have caused amongst consumers, cost American businesses on average $1.4bn a month. Although the impact differs from region to region, heavily industrialised states such as Michigan saw their tariff costs triple in August 2018 from a year earlier. Protectionism and taxing foreign imports are not a new phenomenon however, especially stateside, with many of the President’s predecessors having laid the groundwork for how the current president reacts to the threat of cheap imports.
Reed Smoot and Willis Hawley may not go down in the annals of interwar political history but their much overlooked legacy has become increasingly pertinent of late. As the US economy entered the first stages of the Great Depression in late 1929, the feeling, stateside, was that America must come first, with the protection of US jobs and farming from foreign competition to be paramount. The incumbent President, Herbert Hoover, had comfortably won the race for the White House on a nationalist ticket, with promises of assistance for beleaguered US farmers, struggling to compete with cheaper foreign imports.
Smoot, a Senator from Utah, and Oregon Representative Hawley, had just the tonic for the President. Shortly after Hoover came to power, the Smoot-Hawley Act was passed. Seeking to increase tariffs on agricultural and industrial imports alike, the bill saw little opposition, with Hoover later even expanding the act to include about 20,000 extra products, covering various sectors. However, those on Wall Street were horrified by the news. In 1930, 1,028 economists sent a signed petition to urge the president to veto the legislation, with automobile magnate, Henry Ford, even calling the bill “economic stupidity”. Investment banking behemoth, JP Morgan’s Chief Executive, Thomas Lamont agreed, admitting he “almost went down on his knees to beg Herbert Hoover to veto the asinine Smoot-Hawley tariff.”
Their reservations were well founded. Almost immediately after the tariffs were introduced, Canada and other major economies retaliated with duties of their own. History has not been kind to the Hoover administration, with both economists and historians reaching a broad consensus that Smoot-Hawley actually helped to exacerbate the Great Depression, rather than aid the US’s economic position. Whilst America’s dependence on imports did fall over subsequent years, the retaliatory measures introduced by other countries led to a 61% dip in exports during 1933 alone.
A year earlier, with the US in the grips of economic depression, farmers’ and workers’ conditions had only deteriorated further despite Smoot and Hawley’s promises, with the two subsequently losing their seats during the next election.
This isn’t to say that trade tariffs are a purely American phenomenon; even we Brits have employed the tactic to protect our economic interests over the years. Back in the days of the empire, during the late 18th century, the British had found smuggling opium (up to 4,000 chests weighing 170 lbs) from India into China a year, an extremely lucrative business. China had become a major market for poppy tears, with 12 million of its population becoming addicts, devastating its larger coastal cities where the drug was rife. In 1839, dependency had become so bad, the Chinese Emperor even sent a letter to Queen Victoria calling for a halt to the import of opium; he was swiftly ignored. Countering this disregard from the British, he subsequently issued an edict ordering the seizure of all the opium in Canton, including that held by foreign governments.
The British reacted with military force, taking Hong Kong for their own and compelling China to open up its ports to all foreign merchants as well as exempting all import duties. Forcing China to start accepting foreign goods, tariff free, severely weakened the oriental powerhouse and the Qing Dynasty. China had enjoyed its status as the largest economy in the world for centuries up until the first half of the 1800s, but within a couple of decades after the end of the Opium wars, China’s share of global GDP had roughly halved, whilst the British Empire went on to become the largest in history, engulfing a quarter of all global trade.
Trade wars and the use of tariffs, it seems, are as old as the concept of trade itself. From opium to oranges, governments have always pursued ways to protect their own domestic goods whilst simultaneously making their exports more appetising to foreign buyers.
So where does that leave us now? Since his inauguration, Donald Trump has threatened trade wars with numerous countries and trading pacts, citing the imbalances to the detriment of the American people. This is a message that clearly resonates with his core ‘Make America Great Again’ supporters. However, his priority from day one has always been the trading terms with China which he sees as the biggest injustice. Last year the US imposed 10% tariffs on a range of Chinese exports which was due to increase to 25% at the beginning of March.
President Trump, however, delayed this increment, citing progress in negotiations with China. This plays into the theme of Trump’s other core goal – a second term in office. He has already begun to initiate his campaign for re-election and one of the fundamental pillars of what he deems to be his key deliverables to the American people is strong stock market returns. Every high the S&P500 index reached was met with a tweet from the President hailing how his policies and administration have driven these returns. The President is now deeply linked to the fortunes of the stock markets, whatever his actual impact.
Against this backdrop, it’s unlikely that President Trump would sanction the increment to tariffs imposed on China, to 25%, given the expected negative effect this would have on markets. It is likely, instead, that after protracted negotiations, a future trade policy is agreed, which he can hail as a victory only he could deliver to the American people. This would give him a boost with his core supporters once more, whilst also taking away some of the uncertainty which has been overshadowing markets for some time.
Either way, expect a tweet at the end of it!