Tag: trade deficit
Asset Allocation Bi-Weekly – Let’s Talk About Tariffs! (November 11, 2024)
by the Asset Allocation Committee | PDF
In recent years, tariffs have made a surprising comeback. Once widely condemned as a relic of the protectionist past, tariffs reemerged in 2016 as a policy tool against China and are now being considered for implementation on goods from all other countries. Populists tend to believe that these tariffs can be used to address a range of domestic economic issues, including persistent trade and fiscal deficits. They also generally believe that by leveling the playing field for domestic industries, tariffs can ultimately boost living standards for American households.
Under the new proposal, the US would impose a blanket tariff of 10% to 20% on all imports, with additional tariffs of 60% to 100% on goods from China. This would significantly increase the US’s average tariff rate to its highest level in nearly eight decades. The primary goal would be to protect US manufacturers and incentivize foreign companies to shift factory operations to the US, thereby creating domestic jobs. Furthermore, proponents believe that the increased tariff revenue could help reduce the US federal budget deficit. This proposed strategy has resonated with a substantial portion of the American electorate.
Despite its popularity with certain segments of the population, the proposal has faced significant opposition as it contradicts conventional economic wisdom. A tariff is a tax imposed on imported goods. Typically, it is levied as an ad valorem tax, which means it is calculated as a percentage of a good’s value. For instance, if the tariff rate were 10%, then importing a car valued at $10,000 would require paying a tariff of $1,000.
The potential increase in import costs has raised concerns about the proposal’s impact on price inflation. While businesses initially bear the cost of import tariffs, they can often pass a significant portion of this cost onto consumers in the form of higher prices. This economic phenomenon, known as tariff pass-through, is particularly prevalent for goods where businesses have significant pricing power. However, the extent to which tariffs can contribute to inflation and impact the overall economy varies.
When US consumers and businesses purchase foreign goods by paying in dollars, the foreign seller typically will exchange the greenbacks received for their own currency in the foreign exchange market. Therefore, increased US demand for foreign goods should lead to increased demand for foreign currencies, which in turn could weaken the US dollar. However, foreign countries often recycle their dollar holdings back into the US economy, in which case the foreign inflow can paradoxically buoy the dollar and widen the US trade deficit, or at least limit the dollar depreciation and the narrowing of the deficit.
For a flat tariff to successfully reduce trade and fiscal deficits without exacerbating inflation, the US would need to transition from a consumption-driven economy to an export-oriented one. US consumers would need to scale back their demand for tariff-laden imports and/or US producers would need to increase their exports. This shift would require the US to reduce its reliance on borrowing and become a net lender to the global economy. By increasing exports, the US could offset the negative impacts of tariffs and strengthen its economic position. Countries, like China, have achieved this transformation by implementing policies that encourage saving and discourage consumption, often at the expense of social safety nets.
The US dollar’s dominance as the global reserve currency could hinder an export-led growth strategy. Historically, large US trade deficits have supported the dollar’s role as other countries have relied on it for international transactions. To shift this dynamic, the US might need to diminish the dollar’s appeal. This could involve implementing capital controls, as many developing countries do, in order to restrict cross-border capital flows. Alternatively, the US could sacrifice monetary policy autonomy, either by pegging the dollar to another currency or by joining a currency union with other nations.
Because we don’t expect the US to make all the necessary adjustments to become more export-oriented, we believe that potential tariffs could induce foreign countries to devalue their currencies to offset the impact of the tax levy. Accommodative monetary policy could make this possible. This scenario would benefit US companies with limited foreign revenue, such as small and mid-cap companies, as their revenues would likely remain unaffected by currency depreciation. However, this could negatively impact US exporters that rely on foreign sales as the price of their goods could become less competitive.
Asset Allocation Bi-Weekly – #69 “The U.S. Trade Deficit and Global Prices” (Posted 2/22/22)
Asset Allocation Bi-Weekly – The U.S. Trade Deficit and Global Prices (February 22 2022)
by the Asset Allocation Committee | PDF
When Democrats passed the CARES Act in January 2021, it was viewed initially as a political achievement. Polling from Politico/Morning Consult showed 75% of registered voters supported the bill three months after its passing. Meanwhile, Democrats began touting President Biden as the next Franklin D. Roosevelt. The legislation was so popular that the politicians who voted against the package started taking credit for it. However, the bill may have had an unintended consequence. The fiscal stimulus injected new money before the global economy was ready to absorb it. While domestic firms were sitting on low inventory, the pandemic prevented foreign firms from operating at full capacity. Thus, American desire for goods led to a rise in global inflation as firms could not provide the necessary supply to offset the demand created by the newly injected stimulus. Additionally, the trade deficit rose to an all-time high, as excessive demand led to an increased need for imports. In this report, we discuss how the CARES Act contributed to the widening deficit and a rise in goods inflation. We will also explain how we expect countries will seek to reverse some of the bill’s impact and conclude with possible market ramifications.
Following the passage of the CARES Act, Americans struggled to find places to spend their extra money. Because of pandemic-related restrictions, the availability of services was severely limited. In the first few months of 2021, restaurants hosted fewer guests, airlines offered fewer flights, and sporting events were, for the most part, uncrowded. With limited entertainment and travel options, consumers spent the bulk of their new money on durable goods. Last year, purchases of motor vehicles and recreational goods surged to levels not seen in the pre-pandemic era.
Robust spending in the first quarter of 2021 caught many firms off guard. In the previous year, when the U.S. went into lockdown, firms liquidated their inventories, believing the pandemic recession would be long-lasting. Rental car companies were particularly active because the lack of travel meant they would have to hold vehicles, a depreciating asset, on their balance sheets for an unforeseen length of time. Thus, these firms were motivated to sell their vehicles. The activity was so noticeable in 2020 that the U.S. recorded its first trade surplus in Auto Vehicle Parts and Engines since the Great Financial Crisis. The lack of available inventory carried by firms due to this selling activity contributed heavily to demand pressures seen in the following year.
Although consumers contributed to the jump in demand in Q1 2021, consumption data in March suggests firms also ramped up spending. Going into the Spring season, higher vaccination rates encouraged states to ease COVID-related restrictions. Consequently, firms expecting a travel rush, particularly in the Leisure and Hospitality industry, boosted spending on equipment and labor. This spending likely drove the rebound in durable goods from a lull in February to its highest level of the year in March. The aforementioned rental car agencies were big spenders during that time. The lack of available cars forced these companies to purchase used cars, something they typically try to avoid. Automobile consumption accounted for almost half of the total spending on durable goods in March. As a result, the price for new and used cars skyrocketed in 2021 and is currently one of the primary contributors to inflation.
While the U.S. was stimulating its economy, the rest of the world was still reeling from the pandemic. The difference in outcomes was likely related to the successful development and disbursement of COVID-19 vaccines. At the start of 2021, Americans found it relatively easy to sign-up and receive their first jab. Meanwhile, Europe found it difficult to distribute vaccines, Asian populations were vaccine-hesitant, and African countries struggled to even obtain vaccines. The emergence of the Delta variant made matters even worse. The new variant led to a surge in cases and severely hampered the efforts of countries to reopen their economies. Shipments were being delayed because ports were closing, and arbitrary quarantines resulted in constant labor shortages, and in some cases, factory closures. These pandemic-related disruptions meant foreign suppliers could not produce at levels sufficient to satisfy the U.S. demand for foreign goods. It had a negative impact on the global economy.
The combination of a lack of global production capacity and strong demand from the U.S. for inventories put upward pressure on the prices of goods and services around the world. The most noticeable rise in prices came from materials as demand for industrial supplies climbed sharply. Natural gas, steel, and crude oil were in exceptionally high demand because companies needed raw materials to ramp up production. Global demand for materials was so strong that the U.S. recorded its largest trade deficit for industrial supplies in at least 20 years, despite traditionally being a net exporter for that commodity group. Firms began looking at alternative sources for inputs, in some cases placing multiple orders with different vendors. In other cases, they were shipping inputs via airfreight as opposed to through ships. These orders may at least partially explain why firms, with the exception of automakers, are currently holding elevated inventory levels. Thus, much of the rise in the U.S. deficit for goods can be attributed to firms receiving multiple orders of the same goods from different suppliers.
U.S. demand for foreign goods may have pushed global prices upwards, but it will probably take a global effort to contain those price hikes. To combat rising worldwide inflation, we suspect that central banks across the world will start to tighten monetary policy. The rise in interest rates should relieve some of the demand pressure for goods and take some of the wind out of inflation. However, the primary driver of disinflation will likely come from countries easing pandemic restrictions and allowing firms to operate at full capacity. In the meantime, we think that conditions favor equities in the financial sector and commodities. Higher interest rates should make it easier for financial institutions to increase margins without taking much risk, and persistent demand for raw materials will probably continue to support commodity prices throughout 2022.