Advisor Voices: Certain Uncertainty
16 May 2019
A dozen years ago or so, when I worked for a major investment consultant, one of my colleagues criticized an investment team for not knowing what they did not know. I had to think about this for a long time, because how can you know something that you do not know? This notion has come back to me recently when thinking about the trade situation with China, because the eventual outcome is something I know that I do not know.
President Trump’s May 5th increase in tariffs from 10% to 25% on $200 billion of goods came as a surprise to the markets, which had rallied considerably this year. The rally was, in part, due to optimism around a trade agreement. Those hopes were further dashed on May 13th, as China retaliated with tariffs as high as 25% on $60 billion in U.S. goods, sending global markets lower. Both sides have seemingly dug in their feet, with the U.S. saying it could impose a 25% tariff on the remaining $325 billion in Chinese exports.
The trade war has been a popular issue among voters/consumers. However, the first $50 billion in tariffs did not directly affect consumer goods. The next $200 billion, which were first taxed at 10%, affected only 31% of consumer goods. Not only will consumers start to feel the effects of tariffs now that those will be taxed at 25%, but more than half of the remaining exports are consumer goods. How popular will tariffs be with voters when they go toy shopping this holiday season?
Source: Peterson Institute of International Economics
So what are the potential outcomes? One outcome could have the two sides take a step back, allowing Donald Trump and Xi Jinping to have a productive conversation at the G-20 meeting on June 28th. Another option could see trade negotiations continue to drag on or the trade war become more permanent. The later outcome would certainly be more damaging to China in terms of its effect on GDP since exports to the U.S. are more significant than our exports to them. However, higher tariffs will mean higher prices for U.S. consumers, which could affect spending and increase inflation. With uncertainty around consumer demand and supply chains, businesses may not invest as much in their companies, which could slow growth.
So what is certain? The trade wars have contributed to slower global growth and escalating them will only dampen global GDP further. The Chinese government has a long-term view (Xi has no term limits) and the ability to provide economic stimulus, while politicians in the U.S. will want their voters happy with the 2020 election year coming up. Neither side wants to appear to bend or see their economy break. Hopefully, the more optimistic outcome will prevail and the second half of the year can be trade-tension free. Will it? I am certain that I do not know.
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