President Trump on Thursday, March 1, announced that he intends to impose a 25% tariff on all steel imports and 10% on all aluminum imports. Equity markets hated the announcement – the Dow Jones Industrial Average fell about 500 points immediately after the news. I don’t like it, either. Let me explain why I think these tariffs may be harmful to the economy.
Steel and Aluminum
The can is only a small percentage of the cost of a six-pack of beer, so beer (and soda) drinkers probably won’t notice much of a price increase, nor will demand suffer much.
The larger issue is with steel. Every construction project uses steel. The cost of President Trump’s proposed multi-trillion dollar infrastructure bill just went up. The debt financing that will need to be raised in conjunction with the new infrastructure just got more expensive, meaning they will have to pay higher interest rates to place the debt. The cost of autos just went up. The cost of tractors and other farm equipment used to plant and harvest your food just went up. Even if the steel is made in the US, its price just went up. Everyone will pay more for stuff, especially big stuff, because steel became more expensive. Maybe some jobs will be saved in steel plants, but others may be lost in other sectors, and there will be a cost to everyone else in the US.
At the same time, the US Unemployment Rate is 4.1%. This is not historically low, but it is lower than it has been in many years. Traditional Economics teaches that tariffs aren’t typically a good idea, but if a tariff is to be imposed, it should correspond with high unemployment in the target sector, not low unemployment. The timing of this new tariff thus doesn’t make economic sense.
When Unemployment has been this low in the past, wages have tended to rise. A Wall Street Journal article today by Greg Ip shows how the sub-4% Unemployment rate of the late 1960’s led to higher inflation into the 1970’s. So far, wage growth has not been strong. Could this new tariff be the tipping point?
What I am getting at is that the real danger with the new steel and aluminum tariff is that it could lead to higher inflation, which the stock and bond markets don’t want to see. Other factors out there also could point to inflation, including the following:
- Higher interest rates, which spooked the markets in late January and early February. 10-Year Treasury rates moved from the low-to-mid 2%’s up to just under 3%, and are now at 2.82%.
- The new tax law is bullish, especially for corporations. As they grow, they will need to hire new people in the 4.1% Unemployment environment, which means wages could go up.
- The Dollar Index fell over 10% during 2017, meaning that imported goods cost 10% more in US Dollar terms. Treasury Secretary Mnuchin has stated his desire for a “weaker Dollar”, although he retracted his statement to some degree. The current Administration is not unhappy with the lower Dollar Index. One way to look at it is the 10% lower Dollar plus the 25% steel tariff means that imported steel will now cost 35% more than it did at the start of 2017.
- Now we have this new Tariff.
Perhaps this Administration wants higher inflation. Their actions, achieved and stated, point in that direction. High inflation didn’t work for the Nixon Administration, and, if it transpires this way, it won’t work for the Trump Administration. There are a lot of countervailing forces that could inhibit inflation – the economy and the workforce is much more global now than it was during Nixon, and capital allocation through financial markets are more quick to react. President Trump himself touts stock market performance as a proxy for the popularity of his own policies, so he may change course if the markets tell him that he’s wrong. I don’t know if we will eventually see higher inflation, at least at a level north of 2%, but I do strongly believe that tariffs hurt a lot more than they help and they can lead to higher overall inflation.