Considering the Steel and Aluminum Tariffs

After weeks of speculation, it is official: President Trump announced he will sign an order next week to slap a 25% tariff on global steel imports and 10% on aluminum, acting on the Commerce Department’s recent recommendation. Steelmakers are thrilled. Companies that use steel, like automakers, aren’t so happy about the prospect of higher costs. More broadly, market observers worry this is the opening salvo in a global trade war, especially with America’s trading partners already chattering about retaliation. The S&P 500, meanwhile, fell 1.3% Thursday—the third straight drop of greater than 1%—and many pinned the volatility on trade tensions.^[i] Considering sweeping protectionism has a history of hurting markets, we can see why folks may be nervous. But when confronted with any seemingly negative development, it is important to consider the context and the likelihood it snowballs into something large enough to lop a few trillion off GDP. So the key question today is, what is the likelihood these tariffs trigger a full-scale global trade war on par with the early 1930s? In our view, recent history and current political considerations suggest it is lower than most seem to think.

On their own, we don’t think steel and aluminum tariffs are enough to cause a global recession. In 2016—the most recent year we have data for—global steel production totaled 1,629.6 million tons. The US imported just 30.9 million. So based on some rough back-of-the-envelope math, the steel tariff hits just 1.9% of global steel production. And that is if no countries are excluded and all steel types are targeted, both things the administration hasn’t specified yet. While the administration says the tariffs are primarily aimed at China, that nation exported just 108.1 million of the 808.4 million tons it produced. Of those exports, only 2.4 million tons went to NAFTA nations (the World Steel Organization doesn’t provide a detailed country breakdown, so NAFTA is the closest proxy for the US). It is difficult to envision this causing a hard landing in the world’s second-largest economy, particularly considering the Chinese have been trying to slow output for years, sensing an oversupplied global market. As for aluminum, according to the US Census Bureau, America imported about $16.2 billion worth of bauxite and aluminum in 2017—less than 1% of 2017 GDP.

Trade wars involve sweeping tariffs across large swaths of the global economy and can have crippling economic effects. The Tariff Act of 1930—aka Smoot-Hawley—sparked the last full-blown trade war. The Act imposed nearly 900 tariffs across most sectors and had a dramatic impact on trade. US imports declined over 40% within two years, major trading partners retaliated and global trade fell 66% (from $5.3 billion in 1929 to $1.8 billion in 1933), likely exacerbating the Great Depression. Tariffs targeting one or two industries don’t have sufficient scope to have such a deleterious effect.[ii]

Granted, these aren’t the only tariffs the Trump administration has adopted. Last November, they imposed tariffs on Canadian lumber. They also targeted Canadian aerospace imports in October 2017, but they lifted the tariffs in January 2018 once the International Trade Commission (ITC) decided the imported planes weren’t harming the US. In January, they added tariffs on solar panels and washing machines. President Trump has even talked about imposing a “reciprocal tax” where the US would hit countries with tariffs at the same rates they levy on US goods and services, though others in the administration have stated there is no formal proposal for such a tax at this time. So far, none of these have invited sweeping blowback—just the tit-for-tat typical of the last 20-plus years. Canadian Prime Minister Justin Trudeau considered banning US coal exports and spoke of targeting certain industries in Oregon, home to Senator Wyden, one of the biggest proponents of lumber tariffs. In a similar vein, the EU is reportedly mulling tariffs on Harley-Davidson motorcycles—headquartered in House Speaker Paul Ryan’s home state, Wisconsin. Kentucky bourbon, produced in Senate Majority Leader Mitch McConnell’s home state, is also in their sights. Both are traditional symbols of the U-S-of-A, but economic lifeblood they are not. Nor is sorghum, presently targeted by China’s Ministry of Commerce. Meanwhile, South Korea is going the diplomatic route, challenging the tariffs at the World Trade Organization (WTO).

This all seems fairly consistent with trade tiffs under past presidents. Targeted tariffs are unfortunate but routine and haven’t caused trade wars or sunk stocks. The Obama administration slapped tariffs on tires, solar panels and … wait for it … steel (Twice, actually). China hit back at tire tariffs by imposing tariffs on US autos. They also added levies to polysilicon from the US, a component in solar panels, in response to the solar tariffs. But that was it—no sweeping trade war. Similarly, President Bush imposed steel tariffs in 2002. Within a month, the EU threatened to retaliate with tariffs on motorcycles, textiles and orange juice. In December 2003, the US lifted the tariffs after the WTO ruled them illegal. Now, 2002 wasn’t a particularly great year for stocks, causing some to draw parallels with today, but in our view, that had a lot more to do with the continuation of the dot-com bear and the post-Enron implementation of the well-intended-yet-awful Sarbanes-Oxley Act. The sectors that did the worst—Tech, Utilities and Telecom—have little to do with steel and their underperformance predates tariff implementation.

All that said, it is true tariffs create winners and losers. Researchers estimate higher steel prices caused about 200,000 American job losses in 2002. Many—including some Congressional leaders and members of the Trump administration—argue the downstream negative impact on the auto and other steel-consuming industries will outweigh any potential benefits the tariffs would bring to US aluminum and steel producers. Much of that depends on the specifics of the forthcoming tariffs. Aluminum gets less attention, but we reckon the beer industry won’t love the higher cost of cans. Aerospace firms likely won’t be happy either. Companies in the Consumer Discretionary and Industrials sectors could face higher costs, pressuring earnings and forcing cutbacks, including layoffs. However, it usually takes more than cost pressures in one or two sectors to cause a recession. We don’t mean to dismiss the personal impact any of this can have on workers and small business owners, but markets are callous, and at times like this, we think investors are best off thinking like markets.

Another consideration: There is no guarantee the tariffs stick around long. Political pressure from other industries could drive the administration to water the measures down. Other countries could mimic South Korea and challenge them at the WTO, arguing the Trump administration is using national security as a cover for protectionism. For those who doubt that agency’s efficacy, it is worth noting the WTO just ruled a Chinese tariff on US chickens illegal, and China terminated the tariff on Tuesday. Even if they survive, we believe the economic impact is likely limited and odds of a broader trade war remote. Trade jitters may keep hitting sentiment for a while, but in the longer term, stocks should move on and keep weighing the many positive fundamentals at work globally.