Trump Plays with Trade Fire

By: Peter_Schiff

With his announcement last week of broad tariffs on imported steel and aluminum, President Trump launched what could be the first salvo of an all-out global trade war. Seemingly itching for a fight, he gleefully tweeted that "Trade wars are good, and easy to win." It seems like Trump thinks the conflict will play out much like Ronald Reagan's 1983 week-long invasion of Grenada rather than the more telling quagmires that unfolded in Vietnam, Afghanistan and Iraq. He's wrong.

Apart from overestimating America's bargaining position, Trump and his supporters grossly misunderstand the nature of international trade and how Americans have benefited from a system that has allowed us to continually consume foreign goods on credit. While this "benefit" has also placed a cost on domestic industries, I don't believe that Trump has any idea how a trade war can reduce current American living standards.

As justification for his surprise offensive, Trump likes to highlight how America's gargantuan annual trade deficit (which has grown to more than $600 billion during his presidency) is simply the yardstick by which "stupid" American trade policies are subsidizing foreign economies. In his mind tariffs are just a means to take back what we have foolishly given away. As Trump explained via Twitter " When we are down $100 billion with a certain country and they get cute, don't trade anymore - we win big." But does a country with a trade deficit really subsidize the country with the surplus? Or is it the other way around?

Let's suppose you keep chickens at home, and your neighbor has a cow. Everyday you trade a half dozen eggs for a quart of milk. This is the nature of trade. You offer something that you have in abundance (that other people don't) for something that someone else has in abundance (that you don't). But let's suppose you eat a few of your chickens and your egg production drops to four per day. You continue to get your quart of milk, but everyday your neighbor adds two eggs to the account that you owe. Theoretically, you will one day owe your neighbor a whole bunch of eggs. But, in the meantime, does that two-egg deficit represent a benefit to you or your neighbor? Remember your neighbor still has to deliver the same amount of milk for less of a current payoff. He MAY get that deferred compensation down the road, but he's not getting it now. And with every egg you go into the hole, the greater the chances that your neighbor may ultimately get stiffed.

Who is likely to be worse off if this trade were to suddenly stop? Remember, you are not the only potential trading partner available to your neighbor. Maybe the house across the street will give him six eggs for his milk?

The eggs/milk deficit that you have with your neighbor allows you to consume more than your production capacity would typically allow. While this is a definite benefit to you now, it does dissuade you from making the sacrifices necessary to increase your egg production. Your own industry atrophies while your neighbor's doesn't. But so what? You still get all the milk you need.

The point of an economy is to maximize consumption. Since goods cannot be consumed that have not been produced, it goes without saying that production is a necessary precondition to consuming. But, if given the choice, most people would be happy to outsource the production to someone else and concentrate solely on the consumption. But in the real world such an arrangement is untenable over the long term.

Of course your milk/eggs trade arrangement will be a problem if your neighbor cuts off your credit and demands full payment. Then you are stuck with a big debt, reduced egg production, and no milk. But, for America, that day has yet to come. For now, our trading partners are happy to take our debt rather than our goods. But if Trump starts making more unreasonable demands, they may not be so willing.

It's helpful to remember that a tariff is essentially a tax that will be paid by domestic consumers. It's not like American producers will keep prices where they are and simply manufacture more steel to make up for the lost imports. Instead, prices will likely rise to almost the same level as the taxed imported products. Profits at American steel companies will increase, but production probably won't.

The manufacturers will know that the artificial political barrier protecting them could be removed at any time. Will they take the risk in investing in plant and equipment capacity when they know that removal of the tariffs would instantly eliminate their advantages and expose them to losses? Given the thin support that such tariffs will have beyond the narrow steel industry, it's safe to assume that current manufacturers will stand pat and use the extra profits to issue dividends and buy back shares. To a lesser extent, they may increase wages for the nation's 140,000 steel workers. But this industry-specific benefit will come at a great cost to the overall economy.

Raising the cost of steel would also raise the cost of every American product manufactured with steel. Right now the discussion is focused on beer cans, with people arguing about how many cents per soup can the tariffs will add. But this is just the tip of the iceberg. The real impact will be seen for metal-intensive items that are manufactured both here and abroad.

While the Trump tariffs will directly raise the price of imported steel (and indirectly the price of domestic steel), it does nothing about the price of goods made FROM steel. So a domestic manufacturer of home appliances, such as Whirlpool, will have to pay more for steel used to make a refrigerator. But its foreign competitors will be able make refrigerators with untaxed steel and then ship the finished product to the U.S. without facing a tariff. This will give the foreign firm a competitive advantage over Whirlpool both at home and abroad. Whirlpool will shed profits and may shed workers. So whatever advantages are given to steel manufacturers will be paid for by companies and workers that use steel. The problem for Trump is that there are only 140,000 domestic workers in the steel-making industry, but more than six million workers in industries that make stuff FROM steel. (American Iron & Steel Institute)

Trump's gambit is also politically ham-fisted. He likes to say that his tariffs are aimed at bad actors like China. But that country is far down the list of steel exporters to America. The move really hits our close allies first, particularly Canada, a country that accounts for 16% of our steel imports, according to a December 2017 report from the Dept. of Commerce. But 50% of U.S. steel exports GO to Canada. Total cross-border trade between the U.S. and Canada in 2016 came in at more than $600 billion annually, according to the Office of the U.S. Trade Representative. That's a very big applecart to push over for a comparatively small gain.

Potentially even more dangerous is the way the tariffs will be implemented. By absurdly claiming that they are being done in the interest of "national security" rather than economic advantage, the Trump administration is inviting embarrassing losses at the World Trade Organization, which combined with a rapidly deteriorating diplomatic environment could further isolate the U.S economically.

The big problem is where it all ends. Already major voices in the European Union (particularly from Germany) have threatened retaliatory tariffs on politically and symbolically sensitive American exports like bourbon, blue jeans, and Harley-Davidson motorcycles. Trump has threatened to tax European cars, if the EU follows through on those threats. Given the personalities involved, and the national pride at stake, it's not hard to see that this tit-for-tat could escalate quickly and lead to a full-blown trade war on multiple fronts.

But this is not a war we can win. A decline in imports will force us to rely on our own production to meet all of our consumption. But we no longer make large categories of products that we consume. Even if we were to be able to ramp up production quickly, American consumers would be looking at much higher prices. With plenty of indications that inflation is already starting to percolate, now is not a time to go out looking for more.

But most concerning is the likelihood that a large decline in trade translates into a diminished international appetite for U.S. dollars. With government borrowing about to surpass $1 trillion annually (even while the Federal Reserve itself is set to begin selling more than $600 billion annually in Treasury bonds) we will need to find lots of buyers for U.S. dollars for years to come. If a trade war discourages those buyers, the dollar will fall and interest rates will rise even faster. But it could get much worse than that. If a recession forces the Federal Reserve into another round of quantitative easing, we will desperately need foreigners to show up at our bond auctions. If they don't we will lose the ability to export our inflation, and all the excess liquidity will remain at home, where it will push up prices on the limited domestic supply of goods and services. This means even higher prices for American consumers, many of which will also be unemployed. The combination of rising unemployment and inflation will be bad politics for Trump, as it will allow democrats to use the "misery index" to defeat him in 2020 much as Ronald Reagan used it to defeat one-term Democratic Jimmy Carter forty years earlier.

Let's hope that Trump's bluster on trade is just a negotiating tactic. Maybe he's crazy like a fox, and his threats will produce a favorable outcome for the U.S. But given his international unpopularity, and how quickly world leaders have mobilized for war, I wouldn't count on it. More likely his blunders on trade will simply move our day of economic reckoning that much closer.

Read the original article at Euro Pacific Capital

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube.

The commentary below is from Peter Schiff, CEO of Euro Pacific Capital and author of the The Real Crash: America's Coming Bankruptcy. Please feel free to excerpt what you like with proper attribution. To speak with Peter, please contact Andrew Schiff at 203-662-9700 ex. 135 or aschiff@europac.net.

Regards,
Peter Schiff

Euro Pacific Capital
http://www.europac.net/

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.