Trade War Economics And How It Affects Investors

How a US and China trade war affects investors

In a trade war, everybody loses. Let's look at trade war economics and how it affects investors.

Think about what happens during the final minutes of a tense basketball game. The front row stands up because they are both nervous and excited. Because they block the view of the second row patrons, the second row all stand up. Pretty soon, the entire stadium of viewers is standing up, making them no better off than if they all sat down.

A trade war is when a nation imposes tariffs or quotas on imports and foreign countries retaliate with similar forms of trade protectionism. As it escalates, a trade war reduces international trade, and therefore GDP growth.

In the short run, a trade war may help protect a domestic industry's profits and save or even create jobs. But in the long run, a trade war costs jobs and depresses economic growth for all countries involved. It also triggers inflation when tariffs increase the prices of imports.

The Last Major Trade War In History

The last major trade war occurred with the 1930 Smoot-Hawley Tariff. It increased 900 import tariffs by an average of 40 to 48 percent.

Smoot-Hawley was designed to support U.S. farmers who had been ravaged by the Dust Bowl. But it also raised food prices for Americans who were already suffering from the Great Depression. Other countries retaliated with their own tariffs.

The trade war worsened life for all Americans who were already suffering through the Great Depression. And then one of the greatest tragedies of all happened: World War II in from Sept 1, 1939 – September 2, 1945. An estimated 50 – 85 million people died during this time period.

When people are hurting economically, terrible things tend to ensue.

The US Trade War With Everyone

On March 8, 2018, President Trump announced a 25 percent tariff on steel imports and a 10 percent tariff on aluminum.

America is the world's largest steel importer. Trump believes the tariffs would protect the 147,000 workers in the U.S. steel and aluminum industries.

Unfortunately, tariffs could end up hurting up to 20 million workers in U.S. industries that import steel. We are talking about helping a few only to end up hurting 150X more people. Clearly, something is seriously wrong with Trump's logic.

About one-third of the 100 million tons of steel used each year by American business is imported, while imports account for more than 90% of the 5.5 million tons of aluminum used by U.S. companies.

Given the new tariffs, all the major steel and aluminum exporters to the US complained, including allies such as Canada, India, and Mexico.

Here are the US industries that get the hurt the most by new tariffs.

How A US Trade War Affects Investors: US Trading Partners

Auto and Aerospace Industries

In the aerospace industry, about 2.5 million U.S. jobs depend on both steel and aluminum imports.

The increased cost of individual parts could create “a cascading effect that has fairly significant impacts on our industry’s global competitiveness,” Remy Nathan, vice president of international affairs at the Aerospace Industries Association told NPR.

The auto industry, which supports more than 7 million American jobs, would get hit. The industry is already facing sales declines in the U.S., will also be especially impacted.

Manufacturing and Construction Industries

About 17 million Americans work in industries that use domestic steel — 6.9 million in manufacturing and 10.1 million in construction, according to the Bureau of Economic Analysis.

The increased cost of these materials will affect the manufacturing of everything from appliances to beer cans. As a result, there will likely be fewer goods made in the U.S. and fewer workers hired to produce them.

The higher price of steel will also impact the construction industry, which uses the material for beams, and the oil and utility industries, which rely on steel pipelines to build the energy infrastructure that serves American consumers.

We are already seeing weakness in the expensive coastal city housing market since 1Q2018, as higher mortgage rates have taken the wind out housing demand. Inventory is clearly rising, causing further softening of prices. If the cost to construct new housing continues to increase, housing will become even more unaffordable to the US consumer.

National housing supply chart

The head of the U.S. Chamber of Commerce said Trump's trade war could cost 2.6 million U.S. jobs. He included the effects of Trump dumping NAFTA.

Trade War With The European Union

Trump initially delayed the tariff against the EU until June 1, 2018. He wanted the U.S. ally to cut its 10 percent tariff on U.S. autos. He also asked the EU to set quotas on its steel exports.

But on May 31, 2018, Trump announced the tariff would be imposed on Canada, Mexico, and the EU. The U.S. Aluminum Association said the move will disrupt “supply chains that more than 97 percent of U.S. aluminum industry jobs rely upon.”

On June 21, Germany proposed an end to the EU's 10 percent tax on U.S. auto imports. In return, Trump must drop imposing a 25 percent tax on European auto imports. There is already a 25 percent U.S. tariff on light trucks.

On June 22, the EU imposed tariffs on $3.2 billion of American products. It targeted imports that will impact Trump’s political base. Examples of these taxable imports are bourbon, motorcycles, and orange juice.

On July 25, 2018, the EU and the United States agreed to hold off on any new tariffs, reassess the steel and aluminum tariffs, and work toward zero tariffs on non-auto industrial goods. The EU agreed to import more U.S. liquified natural gas and soybeans. That would reduce its reliance on Russian LNG and help out American farmers who have lost the Chinese market due to the trade war.

Bottom line: A trade war with the EU escalated quickly, but de-escalated just as quickly. Trump played chicken and won to gain some concessions.

How a US trade war affects investors: US and EU Trading Partnerships

U.S. Trade War With China

The biggest trade war the US has really is with China, the world's #1 exporter. China has had a longstanding history of stealing U.S. intellectual property and dumping cheap goods into the U.S. economy.

On May 4, 2018, the Trump administration presented China with five demands. It asked China to:

  • End subsidies to tech companies.
  • Stop stealing U.S. intellectual property.
  • Cut tariffs on U.S. goods by 2020.
  • Open China to more U.S. investment.
  • Reduce the trade deficit by $200 billion by 2020.

China's trade surplus with the U.S. is huge, and seems to only grow bigger. With the largest hoard of US treasuries and assets, China will simply recycle these assets and buy more US companies and real estate, something the Trump administration wants to protect.

US Trade War With China So Far

Trump has focused on protecting industries in the heartland of America, where real estate is ripe for purchase given the lower valuations and higher net rental yields. Foreigners have already bought up many prime properties in expensive coastal cities such as New York, San Francisco, and Los Angeles.

It would be wise for Americans to realize the trend of foreigners buying US real estate, and getting ahead of the curve by buying prime heartland real estate through real estate crowdfunding platforms such as Fundrise.

Fundrise is my favorite real estate crowdfunding platform. I personally have invested $810,000 in real estate crowdfunding so far. Institutional real estate demand has heated up post-pandemic. I want to buy as much real estate as possible before foreign institutional real estate demand comes and buys up our property again!

Once foreigners have finished buying up coastal city real estate, they will start targeting prime heartland real estate in cities such as Austin, Houston, Dallas, Salt Lake, and Memphis.

China's Cheap Labor: A Competitive Advantage

The emergence of China as an international powerhouse since the 1980s has really created a threat for the US economy. Once the capital markets and trade opened up in China, cheap Chinese made goods started to flood the market and put developed market products under huge financial strain.

In 2017, the United States exported $130 billion to China. The three largest export categories are aircraft at $16 billion; soybeans, $12 billion; and automobiles, $11 billion. U.S. imports from China were $506 billion, or 40X more. In 2018, the figures are going to be even more staggering.

With China now as the world's number one exporter, it is only logical for other export nations to either work together with China, or try and protect their industries.

China's GDP per capita is only about $6,000 compared to $40,000 in the US. With such a huge cost difference advantage, it is an inevitability that China will continue to dominate global trade.

Bottom line: China's Xi will stay in power longer than Trump will stay in power. Xi knows his economy must continue to grow at a robust pace to take care of his 1.2 billion people. China is a much tougher customer to play chicken with. As a result, a trade negotiation will take longer. However, one glimmer of hope for US negotiations is that China's stock market is down much worse than the S&P 500 since the trade war began.

US Trade Goods With China

How A Trade War Affects Investors

As a US consumer, expect the following big three items to become more expensive due to import tariffs:

  • Automobiles / Motorcycles
  • Computers
  • Housing

As an investors, expect the following:

  • Continued stock market volatility until a trade agreement can be made with China and the US. There needs to be a meeting of the middle, as US did with Canada, the EU, and Mexico.
  • A crisis of confidence that leads to a recession if no trade war agreement is made.
  • Unemployment rises as companies need to cut costs.
  • Ultimately, a financial crisis where stocks sell-off more than 20% and the real estate market gets crushed as nobody wants to invest any longer.

A trade war is a self-inflicted wound created by power-hungry politicians who are looking to protect their constituents. It's logical that Trump wants to protect the heartland of America who voted him into office. Unfortunately, helping a few ends up hurting the many.

As an investor seeking financial freedom, it's important to be aware of how damaging a trade war can be to your net worth. With rising interest rates, valuations in the stock market and real estate market in the top quintile in history, and uncertainty with international trade, it's best to be more conservative than aggressive in the coming years.

After such a good run in the economy, capital preservation is the key. The last thing you want to do is give up all your gains.

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