What Tariffs Do (and Don’t Do) for the Stock Market

 

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President Trump recently announced a trade tariff imposed on steel and aluminum imports aimed primarily at China. It places a 25% tariff on steel and a 10% tariff on aluminum, which is designed to combat the US trade deficit and protect domestic steel and aluminum production.

However, steel companies immediately tanked following the announcement, while other nations voiced their concerns over the tariffs and the effect it will have on other industries and trade agreements. But there’s a bigger issue involved with tariffs that isn’t so obvious — and its effect could have lasting consequences on the US economy and stock market.

The role of the tariff

Tariffs are designed to protect domestic industries which may be suffering due to a foreign competitor. In theory, if competition is strong enough, it could impact the domestic workforce and lead to layoffs and increased unemployment. Tariffs are also used as a type of trade weapon. For example, if a country unfairly taxes or places a tariff on one country’s exported goods, they might turn around and place a retaliatory tariff on that country’s goods.

One of the issues Trump brought up when signing the steel and aluminum tariff into law was the trade deficit of the US. As of 2017, the total US trade deficit stood at $566 billion. It imported around $2.89 trillion in goods and only exported $2.33 trillion. But this deficit is one of the most misunderstood economic terms.

A trade deficit is not a real deficit in terms of money. The US doesn’t actually lose money. It just means the US imports more goods than it exports. But part of the reason actually has to do with the value of the US dollar. Because the dollar is used as a global standard and has been slowly growing stronger over the past several years, it makes US manufactured goods more expensive relative to other countries’ currencies.

A strong domestic currency goes hand in hand with a weaker manufacturing base and export industry. Some countries thrive with the opposite situation – having a weak domestic currency but relying heavily on a strong export industry and manufacturing base.

Unfortunately, a tariff artificially alters this natural supply and demand in the global marketplace. As a result, US manufacturers may be better protected, but the costs for steel and aluminum will increase. And that price increase will likely get passed along to the consumer.

Final thoughts

At face value, tariffs aren’t generally perceived as a positive thing. Based on the stock market’s reaction to the latest trade tariff, investors are likely finding themselves agreeing with that sentiment. While Trump’s tariff was designed to help the US steel and aluminum industry, it might end up doing more harm than good, with higher prices getting passed along to other goods and services and ultimately costing the US economy more than simply allowing the trade deficit to continue.