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US tariffs: The opening shots of a trade war?

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The tariffs were protested by virtually every major US economist, as well as significant players in the industries they were supposedly meant to protect. A high profile investment banker acting as economic advisor to the president was a particularly vocal opponent. But in June 1930, Herbert Hoover signed the Smoot-Hawley Tariff Act into law, raising the rates on 890 different import duties just as the world was tumbling into the Great Depression.
 
Viewed through this lens, the news that the White House intends to place tariffs of 25% on steel imports and 10% on aluminium seems rather less dramatic. In any case, in spite of its unfortunate timing, few economists seriously think that the Smoot-Hawley Act was a major cause of the Depression. Gary Cohn, the former Goldman Sachs president and COO who last week resigned from his position as director of the US National Economic Council in protest against the tariffs, can thus take comfort from the fact that he probably hasn’t presided over an international disaster. Nevertheless, the US president is making a grave policy error which could potentially have major ramifications both at home and abroad.
 
First is the risk that, insignificant though these tariffs seem at a first glance (steel and aluminium together amount to only 2% of US imports), history will view them as the opening shots of a much more damaging trade war. Quite aside from the fact that such economic conflicts tend to harm all participants, it is not even clear that this one would be waged against the ‘correct’ adversary. To date, the president’s protectionist remarks have largely been directed at China, with whom the US has a trade deficit that he regards as synonymous with ‘losing’. Yet the US imports barely any steel from China, preferring to obtain it from allies including the EU, Canada, and South Korea.
 
Predictably, the EU therefore responded to the news by threatening to introduce its own tariffs on politically sensitive US exports, from bourbon to Harley Davidsons. Not to be outdone, President Trump has already retaliated by suggesting that this might be met with further tariffs on cars, for which US imports from the EU totalled €38 billion in 2016. The exaggerated machismo and posturing is as tiresome as it is worrying for those industries affected – if only about as surprising as EC President Jean-Claude Juncker’s blustering proclamation that “we can do stupid too”.
 
More disturbing is the fresh impetus the tariffs give to the global trend for equating the preservation of national character with closed borders and restricted markets. The president’s justification, that he is protecting an industry on grounds of national security, is so widely believed to be a fabrication as to make a mockery of World Trade Organisation (WTO) rules. Thomas Lamont, the JP Morgan partner and economic advisor to Herbert Hoover who failed to convince the president to veto the “asinine” 1930 act, later described how “that Act intensified nationalism all over the world”. In 2018, the world is hardly in need of a further push in that direction.
 
What does all this mean for the financial markets? One immediate consequence is that the outlook for countries seeking to ‘go it alone’ just became a little more bleak. The UK economy might be the sixth largest in the world, but it is an order of magnitude away from those of the US, the EU, and China. If the latter three come to blows over trading terms, there is a realistic possibility of industries that are important to the UK being treated as collateral damage. If this restricts the ability of the Bank of England to follow through on current expectations and raise interest rates more than it does the Federal Reserve and European Central Bank, the value of sterling could have a long way to fall.
 
Looking beyond the UK, though, there is a more fundamental concern. In 1930, the Smoot-Hawley Act may not have caused the Great Depression, but it certainly helped to sour international relations. As a result, attempts by the global community to deliver a coordinated response were hamstrung before they had begun. The last great financial crisis is not yet fully behind us, but already one does not have to look far to find hints of what might trigger the next one. That the fallout from the 2008 crisis was not an even greater catastrophe is significantly down to cooperation between different countries’ central banks, policymakers, and politicians. If protectionist measures and nationalist politics prevent them from doing so next time, the outcome could be much worse.

All views expressed here are the Author’s own and are based on information available at the time of writing

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