Trade Wars Are Bad, And Nobody Wins

Trade Wars are Bad

  • Wars are sometimes well intentioned (war on drugs), occasionally necessary (World War II), but seldom good and more or less never easy to win
  • Even if you do win, the longer term implications are often more problematic than you thought
  • One obvious point about tariffs is that the entire purpose is to raise prices
  • If prices for steel and aluminum do not rise, there will be no US jobs created or saved by US based steel and aluminum companies
  • While US companies would certainly benefit from a pricing advantage relative to their foreign competitors, I believe this is very unlikely to lead to a meaningful increase in domestic production any time soon
  • With current levels at or above the average for the last decade, any material additional capacity that exists today may be antiquated and inefficient, and unlikely to be brought online
    • New capacity, and any resultant new jobs that come out of that capacity, would take significant time to come to pass, and it is hard to see that companies would be confident that the announced tariffs will be long lasting enough to justify new investment beyond what they already had planned
  • New investment today would not likely come on line after until the 2020 election

Trade Wars are Not Easy to Win

  • On the other hand, it is not hard to imagine that jobs could easily be lost
  • There are hugely more US workers involved in making the products that use steel and aluminum than there are US workers directly in those sectors, and these tariffs and the resulting higher domestic prices for steel and aluminum relative to prices in the rest of the world suddenly make the US a less attractive place to manufacture anything which use those inputs
  • US economy is large and diversified, and manufacturing is not a large percentage of total jobs, so these tariffs in particular are unlikely to have an outsized effect on overall economic growth
  • But at the margin, the tariffs would have to be expected to increase US inflation, decrease growth, and decrease our export competitiveness. And this ignores the impact of retaliatory measures by US trade partners
  • The real danger is that we see an escalation into a full-blown trade war. Given the rise of economic nationalism and increasing numbers of populist leaders with a shaky grasp of economics around the world, the likelihood of entering a trade war that is in no one’s best interest seems higher than should make one comfortable
    • Such a trade war would be a profound retreat from the globalization trend we have seen over the last 30 years
  • It can take years for companies to build out their global supply chains. With the stroke of a pen, political leaders can make those supply chains instantly far more expensive
    • But this does not make the process of building the domestic capability to replace foreign suppliers happen overnight
    • Such onshoring would take time, and frankly would not likely be possible in a lot of cases
    • In the meantime, widespread tariffs would mean large price rises
    • Those price increases, in all likelihood, would force the hand of the Federal Reserve to raise rates more aggressively than is currently planned, without any corresponding positive such as would come from an unexpectedly strong economy
  • One of the most striking features of investors today is their apparent willingness to look far into the future in assessing the value of investments. Whether this is in the form of high valuations for currently unprofitable but fast growing companies, or real estate and infrastructure investments priced with extremely long payback periods, investors today seem serenely convinced that they can predict what the future will look like
  • Global trade war could cause investors to shorten their time horizons, which is a negative for long duration risky assets such as equities

GMO: Trade wars are bad, and nobody wins, March 2018

Image Source: Axios