By: Matt Dodson and Molly Mann
Donald Trump’s “Make America Great Again” campaign enticed the middle class, inspired the politically frustrated, and arguably served as the deciding factor in his presidential victory. His campaign focused on many important issues, specifically, foreign policy. An aspect of Trump’s strict foreign policy could likely come to fruition as he has recently announced a 25 percent tariff on steel and 10 percent tariff on aluminum. (cnbc.com)
Tariffs, taxes levied on imported goods typically intended to discourage imports and raise government revenue, can prove healthy for the economy in the short term by decreasing trade deficits, improving domestic competition, and lifting the economy overall. In our previous blog, we discussed net exports and noticed a slight increase in net exports during periods of economic recession. However, in the long term, tariffs could damage the economy by ignoring the principles of specialization. For instance, several years ago our population worked in steel mills providing materials for production, but now more Americans attend college and work higher paying jobs. The changing workforce now earns larger paychecks, but must sacrifice some of that income to pay off their past tuition and debt. Coinciding with the evolving job market and rising student debt, Trump could face challenges in attempting to resurge the steel industry if these jobs do not provide incomes to cover the costs of living and rising education costs.
Overall, the looming threat of Trump’s tariffs leads to volatility in the financial markets due to speculation of economic uncertainty. Although the market has fluctuated drastically based on Trump’s previous actions, it always recovers. However, this situation may mean different for the market. Trump’s original announcement caused equities to fall, such as the Dow closing 420 points lower earlier in the week. Granted, financial markets such as the Dow or the NASDAQ change drastically on a day to day basis and cannot serve as direct predictors of implementations of future policy. Nevertheless, the Dow closed 336.7 points higher on Monday with Caterpillar, a company which relies on steel and aluminum, contributing to the gains with a 3.2 percent rise.(cnbc.com) These fluctuations and market responses speak towards the global uncertainty and disagreement towards Trump’s propositions, however, the Caterpillar trades Monday appear as an optimistic response to the previous week.
Trump is not the first one to try to enforce a steel tariff. George W. Bush also unsuccessfully attempted to implement major steel tariffs in March 2002, but excluded Mexico, Canada, and some developing countries (to avoid penalties). Bush’s foreign policy received major push back from European and Asian countries, who proposed retaliatory tariffs of their own, eventually leading to discussions at the World Trade Organization (WTO). In late 2003, the WTO decided that the tariff violated trade agreements and authorized billions of dollars' worth of sanctions. The WTO sanctions, international turmoil, and market downslide led to the United States’ withdrawal of the tariffs, more than a year prior to their scheduled termination, in December 2003. (zerohedge.com)
The graph featured above shows the impact of the Bush steel tariffs on the financial markets, the US Dollar, and yield rates. The S&P 500, the value of the US Dollar, and 10-Year bond yields saw a sharp decline beginning in March 2002, when the tariffs began, and continuing throughout the remainder of the year. The downtrend could be expected because the tariffs, seen as a bad thing for the economy, led to an increase in negative speculation causing the US Dollar to depreciate. The depreciation of the dollar adds to inflation increasing the likelihood of bonds defaulting causing yield rates to decrease. If Trump’s policy officially goes through, it may face a similar fate with already decreasing markets and future decreases in bond yields and the US dollar.
Currently, Trump’s tariffs face a significantly different economic climate than the recessions of Bush’s time in the early 2000s which could cause the current tariffs to fare better than the ones of the past. Additionally, there could also be an even greater negative effect because countries including Canada and Mexico currently would face the repercussions from the tariffs. The renegotiations of NAFTA in the coming weeks could change these terms. (cnbc.com) Considering Trump's unpredictable tendencies, the potential tariffs may serve as a negotiation tactic to create a better NAFTA deal. As Trump’s plans fully come to light, it will be interesting to see the possible resulting trade-war and whether Trump’s proposal produces a different economic result than Bush’s did 15 years earlier.