Why Trump’s protectionism is bad news

Why Trump’s protectionism is bad news

The ‘P’ word is back. With a vengeance. Protectionism.

Donald Trump said last week that he would impose a 25% tariff (i.e. extra tax) on steel imports into the US as well as a 10% charge on aluminium. And the decision has already cost the President the services of his economic adviser Gary Cohn, a former investment banker with the sort of experience the White House really needs.

The apparent aim of the tariffs is to protect American jobs.

In fact, it might have the opposite effect. Retaliation and trade wars could soon follow. This looks like another major hurdle for financial markets to face…

Trump’s not all bad

Just mention the word Trump and many people go straight into complete frenzy.

I have to admit that I’m not amongst them. Some of what the US President says does make sense. For example, he can see the potential benefits of more nuclear power in curbing carbon emissions and climate change. What’s more, like it or not, he was democratically elected in a well-stablished electoral process. So for the moment at least, he’s the man in charge.

And at first glance, there’s some apparent logic in the President’s latest actions. Trump won the election by promising blue-collar voters in Mid-western steel-producing states that he’d get tough on imports. Now he’s carrying that through.

For years, China in particular – a country with so much production capacity – has been blamed for ‘dumping’ steel and aluminium in the US at prices below the cost of production. Indeed, China has been accused of promoting its exports unfairly through subsidies, tax advantages and currency manipulation. Trump claims this has cost the American steel industry hundreds of thousands of jobs.

Hence the latest protectionist tariffs.

Sure, it’s not the first time the US has gone down this path.

In the early-1990s, almost all flat-panel displays used in US-made laptops were imported, mainly from Japan. American flat-panel display firms complained to the Commerce Department that Japanese firms were selling displays at ‘less than fair value’. The US International Trade Commission imposed a 63% tariff on the import of flat-panel displays.

But tariffs are a mistake

This time, though, Mr Trump may have gone too far in slapping on his tariffs.

Even if they’re a negotiating ploy, they’re a slap in the face for globalism, in which the interests of the entire world are placed above those of individual nations. (OK, globalism, like democracy, isn’t perfect. But it’s still better than the alternatives). “To be fair, the US is the least protectionist large economy in the world and singling it out might seem hypocritical, especially by the more protectionist nations”, says Amit Kapoor for Millenium Post. “However, there’s…no economic logic behind the move. There are no economic gains to be made, even by the US, through higher tariffs. Moreover, the costs for the US and the world far outweigh the benefits that can be gained from them”.

By removing competition, ‘protected’ industries may be able to pay higher wages for a while. But in the short term they’re just as likely to make more profit as give employees extra. Further out, lower pay is actually more likely.

“Protectionist trade policy is structured on creating scarcity”, says International University of Geneva finance and economics lecturer Frank Hollenbeck for the Mises Institute. “Trade restrictions do not increase the amount of capital but force a diversion of capital. Because the protectionist country would need less specialisation, capital would be dispersed more widely and hence wages would be lower than they otherwise would be”.

The immediate effect of raised tariffs is likely to be higher US steel and aluminium prices. That’s because manufacturers can’t expand their capacity overnight. If that leads to lower consumption, though, jobs in these industries will be lost anyway.

In any case, China has been cutting its steel overcapacity, says Kapoor: “to put things in perspective, the US imported less than a million tonnes of steel last year. Therefore, US tariffs would hardly affect the US economy. Instead, Trump will end up hurting his closest global allies in Canada, South Korea, Japan and the EU”.

Further, protecting American industry from ‘unfair’ competition is much tougher than Donald Trump and other protectionists believe. If restrictions are put on all Chinese steel components, we’ll soon see trade wars where everybody loses.

As economist Richard Baldwin has said, imposing tariffs is like building a wall in the middle of the factory floor that only decreases the efficiency of production and benefits no market.

Competition is good

In contrast, global trade and competition are generally good all round.

We all want to be better off. So we shouldn’t really care about what China does. The more the Chinese subsidise their industries, the more cheap goods and services – and high-paying jobs – we gain in the West. That’s because we can divert capital from steel/textile manufacture into making more money elsewhere.

“In a competitive environment where abundance is the norm, high pay must come from high productivity”, says Hollenbeck. “In order to command high pay, a worker must produce valuable goods or services. Competition promotes abundance while enabling income and wealth equality. The best US policy, or that of any country, is the elimination of all barriers to imports. This can be done unilaterally. Abundance should always be preferred to scarcity.”

That’s all bang on the money.

The negotiators currently debating the post-Brexit customs environment could take some good advice here (no, I’m not expecting that they will, it would require too much common sense from all those self-serving politicians).

But the main message for financial markets is clear. Protectionism is bad news. It creates big uncertainties. It could spread and develop into worldwide trade wars. They might get very messy. The downside risks for already over-extended stock and bond markets have just got a lot bigger. It’s time to hold ‘safe-haven’ gold.

And here’s how financial expert Jim Rickards thinks you should play the gold markets in 2018.