Trade deficits occur due to comparative advantage. For whatever reason, one party can produce a product at a lower cost than its trading partner. Maybe wages are lower in the producing country. Maybe one party has a surplus of natural resources the other needs. Maybe climate allows one country to produce what another cannot. There is no evil in the aforementioned situations. On the other hand, trade deficits mean that money flows out, a subtraction from GDP. Thus, our GDP would be higher if we didn’t have trade deficits.
Some countries try to skirt the natural forces of economic nature by using tariffs, subsidizing production costs, stealing intellectual property, etc. in order to protect its own producers and give them competitive advantages. China may be the biggest villain. Such problems need to be addressed. But tariffs are a tax. While they can help to rebalance trade, they come at a cost.
It’s a canard to suggest that the rest of the world is taking advantage of us resulting in trade imbalances. While some may subsidize manufacturers or use tariffs to rebalance trade to their benefit, the U.S., because it has one of the highest standards of living in the world, will almost always have higher wage rates and higher costs to produce goods. It also needs to import commodities that can’t be produced in sufficient quantities at home ranging from energy to rare earth materials to coffee beans. The U.S. hasn’t had a goods trade surplus for 50 years.
If there was a master plan to bring over 70 nations to the negotiating table to make refinements in trade to our benefit, it worked. Even if one didn’t like the parade of conflicting tariff announcements over the last several weeks, one can argue that the reaction to negotiate wouldn’t have occurred if we sent “pretty please” letters to every nation around the world.
But while a basic goal of such a plan may have worked, the tumult led to a series of undesirable consequence culminating in the sharp selloff in the bond and currency markets, actions that ultimately forced the White House to modify its stance. A 90-day pause isn’t a solution although some negotiations can be completed within 3 months. Most of the ire so far has been directed at China, a country that thinks in years and decades, not days and weeks. Talks with China will begin within 90 days but a final solution by early summer may be unrealistic.
The reactions among American consumers and businesses range from shock to anger to confusion. Consumer confidence has been shaken and managements have deferred capital spending waiting for tariff related clarity. Postponements certainly aren’t a recipe for clarity. Lower consumer confidence and less capital spending are a clear recipe for an economic slowdown.
The House is now in recess. Over 430 members of Congress can now go home and get an earful for the next two weeks. Maybe they will come back to Washington and decide they have a governance role to play. As the tariff situation unfolds further, steps are moving forward to cut taxes and streamline discretionary spending potentially offsetting some of the economic harm of tariffs. Even that raises confusion. We constantly see images of Musk raising a chain saw symbolizing the pace of spending cuts but any savings achieved to date are merely a partial offset to rising interest, Social Security and Medicare costs. Expansion of the annual budget deficit seem inevitable, at least in the short run.
Meanwhile, it’s now officially earnings season. Some managements will offer earnings guidance while others will step back. Earnings in general for the first quarter will be good and consumer spending in April will be strong as buyers look to clean out pre-tariff inventory. But the outlook today for May and June is gloomy. It seems the only certainty about tariffs is that the way they will look like in a few weeks will be different than how they stack up today.
That was highlighted with an exclamation point this weekend. After markets closed Friday, it was revealed that the escalating reciprocal tariffs applied to a host of technology products manufactured in China, from iPhones to semiconductor capital equipment, will be waived for now. But on the Sunday news shows, Commerce Secretary Lutnick noted this reprieve wasn’t permanent and sectoral tariffs on semiconductors were coming. President Trump promised more details today. The roller coaster ride continues.
Trying to reorient a world trade structure that has been in place for more than 50 years in 90 days was always going to be gut wrenching and chaotic. Furthermore, we have no idea whether the new world order is going to generate beneficial change. Will companies reshore manufacturing here with tariff protection that may only be temporary? Will foreign-based companies move production to our shores? Even, if for instance, an Asian auto manufacturer builds an assembly plant here using foreign parts, will they be granted tariff relief that would make such a project economically viable? Commerce Secretary Lutnick talks of millions and millions ready to assemble smart phones. Really? Only about 12 million Americans today work within the manufacturing sector and maybe only half of them actually work in the plants themselves. And even if there are a few million who might take such jobs, at what cost, given that the tariffs will be a financial burden on the rest of the country?
The answers today are unknown as are the ultimate consequences of these policy shifts. One needs to look at markets as well as changing economic data for answers. By markets, I mean not just the stock market, but bond, currency and commodity markets as well. As Trump’s draconian stance of tariffs that probably peaked on April 2 moderate, hopefully markets will react favorably. But that assumes no recession and modest or negligible impact on long-term inflation expectations. That might be a big ask.
Trump was elected in the belief that he would control our borders, reduce inflation, improve manufacturing, and reduce the size of government. He moved with haste while he had maximum political capital. Some will applaud the speed of his actions while others focus on the mistakes made by haste. The proof will be in the state of the economy over the months ahead. Tariffs are the hardest part of the package to swallow, the most expensive. I would expect volatility to remain high at least over the next several weeks. For now, that is chasing money out of the U.S. to safer havens. Witness the dollar’s ongoing decline. Dollar weakness might actually be a help to reported corporate earnings but the coinciding flight of capital is going to suppress investment in the U.S., Trump’s primary goal.
Even with the temporary tariff relief offered over the past two weeks, the level of tariffs in place will result in a tax increase of hundreds of billions of dollars, a tax importers, exporters, and consumers will have to share. The extra money you spend to buy an avocado or a new car is money you won’t spend elsewhere. It’s hard to be positive on markets now until we can see hints of blue skies on the horizon once tariff policy is “finalized”. As companies report earnings over the next few weeks, it will be hard to see optimism, acknowledging that daily market moves will be impacted by daily tariff missives from the White House either raising of lowering barriers.
Today, Academy Award winner Adrian Brody is 52. Actress Julie Christie turns 85.
James M. Meyer, CFA 610-260-2220