Investors with a global perspective are holding their breath. This week, the President of the United States imposed a new tariff on both Steel and Aluminum being imported into the U.S.
The investors now wait anxiously to see if the tariff will strengthen the U.S. economy or start a global trade war.
Market reaction was swift. The Dow dropped 420 points on the news and world markets also sold off on the news. However for the rest of the investors around the globe, this is sign of a potentially market destabilizing trade war between the U.S. and major partners across the world. To get some perspective we’ll examine the potential effect a trade war could have for the broader economy, and the specific markets we are interested in.
Short Term Gain – Long Term Pain
There were some immediate winners in the aftermath of this week’s announcement. U.S. Steel (NYSE:X), the venerable stalwart of the old economy saw its shares rise by six per cent. Other manufacturers of similar products saw a bump as well. The increase in share price survived a selloff the next morning, but have settled much higher than historical values.
The broader market reaction however, clearly illustrates most investors and institutions see this as a very risky, if not dangerous move for the U.S. For one thing, trade wars can spiral out of control very quickly and severely damage nation-state economies. In an effort to protect the U.S. economy and encourage domestic spending, President Herbert Hoover passed the Smoot-Howley Tariff in 1930. Unfortunately, Hoover’s Tariff ignited a global trade war which which is considered one of the factors that led to the Great Depression.
Pandora’s Box – Could it be made of Steel and Aluminum?
Canada is actually the single largest exporter of steel to the U.S.; Canada is also the single largest importer of U.S. steel. Canada imports 2.5x as much steel from the U.S. than all other major exporters put together, including China. In fact, on balance, the U.S. actually has a significant trade advantage.
This happens because the North American Free Trade Agreement (NAFTA) helped mitigate the real challenge of the steel logistics, which is geography. The vastness of North American geography and the transportation bottlenecks in the Rocky Mountains make North/South trade far easier than East/West. Therefore it’s far easier to ship steel from Los Angeles to Vancouver than it is to ship from Vancouver to Calgary. It’s also far easier to transport steel from Florida to Toronto, than to ship it from Pittsburgh to San Francisco.
In practice this means auto plants in Ontario, Canada import steel from the U.S. turn it into car parts, and send some back to the U.S. for assembly, some to Mexico and some is kept for the plants in Canada.
If a project in the Pacific Northwest states need steel, and west coast production capacity is full, they will often import it from Vancouver which is far easier than shipping overland or through the Panama Canal.
Additionally, various types of steel are used for various types of steel products. For example, a particular type of vanadium steel is needed to make rebar for a very specific part of a bridge.
That formulation may only be manufactured by a handful of smelters, and if the North American plant that can make the rebar is located in Canada, then prior to the new tariff, it would have been more cost efficient to import the steel from Canada.
Impact on Consumer Goods
Finally, if anyone is under the illusion the Canadian, European and Pan-Asian governments are not seriously looking at retaliatory action, they need to face reality. These governments will probably protect their economies, and the collateral damage is hard to anticipate.
Even in a simple eye-for-an-eye scenario, the short-term bump from increased tariffs could result in higher costs of consumer goods imported into the United States.
For example, the new aluminum tariff is already expected to raise the price of Apple goods such as the iPhone, iPad and Mac Computer lines, as they all have significant aluminum parts and/or enclosures. The Apple scenario is a perfect example of the Law of Unintended Consequences. Trying to “help” American manufacturing is now going to make the price of goods you see at the mall more expensive.
In the next article we’ll dive a little more into how a trade war could have surprising impacts on Cannabis, Cryptocurrency, and Biotech.
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