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The Good, The Bad And The Ugly Of Trade Wars

The good, the bad and the ugly of trade wars

I can already see you thinking “what the hell does a trade war have to do with personal finance?!” It’s because it impacts every one of us. This has become even more obvious for us retail investors with the biggest indices giving away recent gains. The Dow, for example, is down 5% from its recent top.
It gives us ample opportunities to buy but because of the recent drops and “scary” headlines, some might become sheep that follow the herd while it’s actually time to become a wolf and devour some stock.

That’s why I want to talk about this trade war. What it exactly is and means for the global economy.

After President Trump signed an executive order that places a 25% and 10% tariff on steel and aluminum respectively in early 2018, many feared it would be the start of a global trade war. Unfortunately, these fears were grounded and with a new round of tariffs, it doesn’t look like things are going to cool down any time soon.
While President Trump makes trade wars sound good, are they actually bad as many others say, and how ugly can it (still) get, now that we are in a new round of throwing punches?

The executive order

The executive order that President Donald Trump signed in 2018, imposes a tariff of 25% on all steel and 10% on all aluminum coming into the U.S. You could consider it the start of the full-blown trade war that is raging now because it was on basic commodities. That said, the US applied the first round of tariffs to Solar panels and washing machine imports.

The neighbors Canada and Mexico received exemptions and a new deal called the United States–Mexico–Canada Agreement (USMCA) got made. They complete the deal, but Canada nor Mexico hasn’t ratified it because of the tariffs are still in place for other goods.

After this order, and the following tariffs which got doubled for Turkey, on 10 August 2018, further escalation followed.
Trump ordered the creation of a list of 200 billion worth of goods to get a tariff of 10% which got raised to 20% and put into effect recently.

Aside from these tariffs, another battle is in the making. This time cars are being targeted. The auto tariffs would mainly target allies such as Japan, Germany, and South Korea.

What is a trade war?

A trade war as described by the business dictionary:

A conflict between two or more nations regarding trade tariffs on each other. This type of conflict usually arises because the nations involved are trying to improve imports or exports for its own country. Trade wars have the potential of increasing the costs of certain imports if the nations involved refuse to make a compromise.

In other words, this fits perfectly with what is happening now. The imposing of tariffs or additional taxes on imported goods is nothing new though. Just this January, the U.S. did this for solar panels and washing machines. Europe too has increased tariffs, on solar panels and steel from China. But one tariff increase is not the other. The WTO system has “safeguards” that allows tariffs such as these under two conditions. These are:

  1. “A product is being imported into its territory in such increased quantities, absolute or relative to domestic production, and under such conditions, as to cause or threaten to cause serious injury to the domestic industry that produces like or directly competitive products.”
  2.  “Safeguard measures shall be applied to a product being imported irrespective of its source.”

What Trump did was unseen. He calls on national security to introduce import duties. In the eyes of the EU, the tariffs were an economic safeguard measure in disguise, not a national security measure. Since the WTO College of Commissioners endorsed this on the 6th of June, the EU used these safeguards to impose tariffs on €2.8 billion in goods.

Retaliation from the rest of the world

The EU already implemented a tariff on a list of 100(+) U.S. products worth €2.8 billion ($3.46 billion) on which it applied a 25 percent tariff. This list of American goods did not come out of thin air. Europe chose these products to hurt Trump and his supporters in the U.S. as much as possible.
The choice for a tax on Harley-Davidson engines, for example, is no coincidence: the factory is in Wisconsin, the home state of Paul Ryan. Bourbon whiskey is also on the list. That product comes from Kentucky, the home of Mitch Mc-Connell, the fraction leader of the Republicans in the Senate. Orange juice is a processed agricultural product that is mainly produced in Florida, traditionally a so-called swing state where Democrats and Republicans each have very few elections.

Believe it or not, it’s not the first time, the US pulled this. The list that leaked yesterday is reminiscent of 2002. During George W. Bush’s stay in the White House, he also decided to increase import tariffs on steel.

China’s foreign minister, Wang Yi, vowed a “justified and necessary response” to any efforts to incite a trade war. China followed through and following in the EU’s footsteps it also imposed tariff’s of their own on July 6th, 2018. $50 billion of US imported goods gets targetted with a 25 percent tariff. Goods such as mineral fuels, some consumer goods, and medical equipment are hit.

Canada retaliated by applying a 25 percent tariff on steel, while the remaining products such as aluminum and agricultural and food products are hit at a 10 percent rate.

Turkey also implemented tariffs after the US doubled down on their rates for Turkish steel and aluminum.

Can a trade war actually be good?

Not really, at least if history is an indicator of success or failure. When George W. Bush tried to save the steel industry in 2002 by raising tariffs on select steel products, U.S. gross domestic product declined by $30.4 million, according to the U.S. International Trade Commission [ref]https://www.usitc.gov/publications/safeguards/3632/pub3632_vol3_all.pdf[/ref]. More jobs were lost than saved. The states he sought to help suffered instead. As a result, the tariffs were overturned.

After the US put in place tariffs on steel an aluminum subsidies had to be provided for US farmers. Steel factories did see a jump in profits but barely any new jobs were created.

US steel tariffs impact on jobs
US steel tariffs impact on jobs

How ugly it can get

The Smoot-Hawley Act passed by Congress in 1930 is a prime example of how ugly it can get. It’s often blamed for the deepening of the Great Depression.

The law increased U.S. tariffs by an average of 20 percent. The taxes originally were proposed to protect American farmers. Unfortunately, many other industries lobbied for and won similar protections. As demand collapsed, countries scrambled to maintain their gold reserves by devaluing their currencies or imposing even more trade barriers. Global trade completely plummeted.

In conclusion, what is unfolding now might still only be the beginning. Most people are using the word trade war now, and with both Europe and China retaliating, the word “war” fits this trade conflict perfectly. Things can get even uglier.

With the end of the trade war far from being over and multiple countries in the world adding oil to the fire, the stock market is obviously nervous and most indices are dropping on any news regarding this trade war. Time will tell who are the victors of this war and which countries will need years to lick their wounds.

If you are interested in an extensive timeline of the trade war (with sources) I recommend you check out piie.com. They have an interactive timeline and a concise pdf.

Sources:

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Mr. FightToFIRE

Writer at Fight To FIRE
I'm the owner and the main writer of FightToFIRE, a personal finance blog focussing on Financial Independence and Retiring Early. During the regular working hours, I'm a developer for a major financial institution in Belgium. During my off-hours, I write. do some weight lifting and other stuff to keep me healthy and fit.
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