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The Realities of Tariffs

10/14/2019 6:00 am EST


Daniel Gramza

President, Gramza Capital Management, Inc.

When President Trump proposed placing a 10% tariff on an additional $300 billion worth of Chinese goods by Sept. 1, it brought back concerns over an expanding trade war. Here Dan Gramza’s discusses tariffs. 

It must be kept in mind that this is not the first time a U.S. president has used tariffs. William McKinley, who later became president, got his Tariff Act of 1890 passed, which increased the average tariff on imports to almost 50%. 

Trade tariffs were used after World War I and in the late 1920s. Ronald Reagan, Bill Clinton, George W. Bush, Barack Obama imposed trade tariffs with what appears to be no appreciable result, though not nearly to the extent of the current Administration.

Theoretically the biggest beneficiaries of tariffs will be the nations and producers that are not involved in the tariffs because of potential increase in demand for their products that do not have the tariffs to overcome. This increase in demand for those products could also have an impact on the demand for that country’s currency as other countries’ consumers sell their local currency to buy the currency of the country whose products they are purchasing. The expectation is that the currency of the product producing country would rise.

The potential losers would be the producers that utilize products that have tariffs in the production of their products. This could not only decrease demand for those products but also for the currency of that country and therefore the expectation would be that country’s currency could fall.

President Trump promised in the 2016 campaign to get tough with trading partners whose “unfair” policies, in his view, have caused huge trade imbalances at the sacrifice of U.S. jobs. For every $5 of Chinese goods that the United States buys, China buys $1 of U.S. goods. 

One of the problems for China is the government wants Chinese to buy Chinese made products, not those products from another country to provide jobs and help fuel their economy. This would change if they open their doors to more trading with other countries.

Although the Chinese GDP for the fourth quarter of 2018 was at 6.6%, the slowest pace since 1990, it is still double the 3.2% for the global GDP estimate. China’s economy contributes about one third of global growth. We must keep in mind that China’s economy has a very heavy debt load and its ability to make payments depends on rapid growth to generate the profits and tax revenues needed to make those payments. Slower growth would mean it will be difficult to stop the increasing government, corporate and household debt load.

The Chinese government is also concerned about the social implications of the slowing economy and is establishing targeted stimulus measures, decreasing taxes, increasing infrastructure investment, decreasing bank reserves and stimulating sales of cars and appliances in an effort to maintain growth objectives. 

However, more important than the tariffs is how the president deals with the Chinese typical practice of investing in U.S. companies to steal technology. They have a history of lifting technology from U.S. companies that invest in China and penetrating U.S. data networks. Most analysts see this as a much bigger threat than the trade balance, which many view as harmless. The main challenge now is the settlement of properly dealing with intellectual property (IP). This has not been solved. Many countries are watching to see how the United States and China reach a conclusion on trade and IP because the outcome will have an impact on how these countries will trade with China.

Currencies and foreign exchange rates are a good barometer of capital flowing into or out of a country. Attractive product pricing, solid economic growth, high interest rates and an increasing stock market are some of the reasons the demand for a country’s currency will increase and raise the price of that currency.

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