Tariffs – how it plays out
US tariffs are putting the global economy and investment markets into a spin. What are tariffs, why are they used, and how do they affect the economy and daily living?
Tariffs are effectively a tax levied on imported goods. They are implemented to protect domestic industries from cheaper imported competition. Tariffs generally lead to higher prices and an increase in inflation.
Trump has imposed tariffs on 70% of US imported goods across most countries at varying levels. His reasoning is to encourage US consumers to buy more American-made goods, increase the amount of tax raised and boost US investments. Although this may sound appealing for Americans, what are the real consequences?
Trump’s playbook vs inflation and high debt
When Trump announced the new “sky-high” tariffs on 2nd April (Liberation Day) world markets plunged with the S&P 500 index declining by 12%.
Investors were shocked, because simply put, high tariffs are bad for economies. They are inflationary and generally suppress economic growth. For centuries, economists have bemoaned tariffs as being harmful.
Trump spoke of balancing US trade with countries, so imports would match exports. The US has an annual trade deficit (imports exceed exports) of $920bn, or 4% of GDP. He associated this deficit with being “robbed” by other countries, which is illogical. A trade deficit is not necessarily bad, especially for the US where Services comprise 70% of GDP.
The first real benefit of a Trump tariff is to provide himself with “bargaining chips,” as evidenced by Chinese tariffs starting at 145% and, a month later, being reduced to 30%, with the likelihood that they will decline further. In addition, for Mexico and Canada, tariffs are touted as a way to stop illegal drugs and immigrants from reaching the US.
Another Trump-flaunted benefit is that tariffs will generate some much-needed higher tax revenue to help control the US’s ballooning debt.
Suggestions of massive new foreign investments are unlikely, in our opinion, as they require decade-long commitments well past Trump’s presidency.
Trump will use tariffs to negotiate favourable transactions for the US, but the catch is that the US cannot afford high tariffs, as they are inflationary and will restrict lower interest rates, which the US desperately needs, given its $35 trillion debt at 120% of GDP.
This high debt will be in the spotlight in the second half of the year when the US government needs to refinance $9 trillion of it. This will likely be at a far higher interest rate than where it was initially issued during COVID at near-zero rates.
Currently, the average tariffs on imported US goods are 15%, which is expected to add 2% to inflation and reduce imports by 15%. This will restrict interest rate cuts, and the market predicts a 40% probability of a recession.
US interest rates forecast: before and after tariffs
A political fallout is also gaining momentum, with 64% of Americans believing Trump is not focused enough on lowering prices, and 55% dissatisfied that he is too focused on tariffs. In Trump’s first term, tariffs only increased by 1.6% on average.
Our Outlook on Tariffs
We believe US tariffs will be reduced further during the year to dampen inflation and support interest rate cuts. Currently, the market is predicting US interest rate cuts between 0.5% and 1% this year. These cuts are critical for refinancing the $9 trillion debt, and this should be supportive of equity markets.
A Brief History of Tariffs
Tariffs have been around since the 16th century and have been implemented for two main reasons:
- A more effective way to collect taxes
- To protect domestic production from foreign competition
However, as far back as the 19th century, economists were dismissing tariffs as harmful to an economy. They advocated that if each nation applied its scarce resources to activities that gave them a competitive advantage and then traded, all countries would become wealthier.
In the 1840s, Britain implemented the idea of “free trade,” but it had a slow take-up by other countries. When World War I broke out in 1914, government expenditure spiked. Tariffs increased to source more taxes, eventually leading to a tariff war that decimated global trade and contributed to the start of the Great Depression. In 1933, US tariffs averaged 20%.
Post-World War II, international trade was encouraged with lower tariffs and easier access to markets. By the 1990s, the trend toward free trade had accelerated and was a component of strong global economic growth until 2007, the start of the financial crisis.
US Tariffs: Negligible Impact on South Africa
Exports comprise 30% of South Africa’s GDP, with the US contributing 9%, or just 2.7% of GDP. Of these exports, most are metals, which are exempt from tariffs. Therefore, with a revised tariff rate of 10%, their effect on South Africa is negligible.
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