Tariffs Can Pose Problems When Used as a Revenue Source

It’s difficult to put a positive spin on the tariff-for-tariff battle going on between the United States and China. However, U.S. President Donald Trump made an attempt to do so by saying that tariffs could be a potent revenue source for the U.S.

However, market analysts beg to differ with that notion.

“I have always been quite pessimistic on the possibility of the US achieving a meaningful trade agreement with China,” wrote Kristina Hooper, Chief Global Market Strategist at Invesco. “I have worried about the negative impact of tariffs and the potential that China can retaliate against the US in a meaningful way. In addition, I have always believed there is a misguided concern by the US over trade deficits.”

Last Friday, President Trump’s administration agreed to increase tariffs from 10 percent to 25 percent on $200 billion worth of Chinese goods. In return, China responded this week with raising tariffs on roughly $60 billion worth of U.S. goods.

Where do the markets go from here?

Hooper posited that one of three things could happen with the imposition of tariffs:

  • “Companies will be unable to pass the cost onto its customers. The company’s profits would be reduced. For public companies, this would negatively impact earnings and could therefore impact stock prices.
  • A company passes the cost of tariffs to their customers (as, for example, Apple has suggested it would do) and consumers pay more for the same item. This means that, all else being equal, they have less money left to spend on other goods or services.
  • A company tries to pass the cost of tariffs to their customers, but there is demand destruction as consumers cut back their purchases. Traditionally economists have largely discussed demand destruction in the context of energy. For example, if the Organization of the Petroleum Exporting Countries (OPEC) lowers production, thereby increasing oil prices, consumers may reduce their driving and thereby their consumption of oil, creating demand destruction. In the case of the current trade wars, we have already begun seeing demand destruction in an industry that was one of the first to experience the imposition of tariffs at the start of 2018: washing machines. The same fate could befall other items, including other “big ticket” purchases such as autos, if tariffs are applied to them.”

As for what the markets hold for the future, Hooper expects more volatility. With that increased volatility comes a flight to safe-haven assets, which could favor bonds and currencies like the Japanese yen.

“Looking ahead, we should expect continued volatility in both equities and fixed income,” Hooper wrote. “My base case is a resumption in negotiations, episodic flare ups in tensions, markets moved by both positive and negative news flow, and no meaningful deal reached any time soon. In the near term, I wouldn’t be surprised to see a continued flight to safety favoring US Treasuries and yen, and stocks selling off — although at a certain point I expect bargain hunting to begin.”

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