The world has gotten a lot crazier over the last couple of weeks. North Korea has launched more missiles after a temporary lull. They were not inter-continental types which is a good thing. Venezuela is in chaos and they are a major oil exporting country. Someone launched a drone strike against an oil pumping station in Saudi Arabia and we just deployed an aircraft carrier battle group near Iran. Washington is in total grid lock. All concerns, yet not the biggest things shaking financial markets.
There was great optimism that we were close to negotiating a new trade agreement with China. We are the two largest economies in the world. In 2018, we exported $180 billion of goods to them, which represented about 0.9% of our GDP. We imported $559 billion from them. This is roughly 4.6% of their GDP. The population of China is more than three times as many people as we have.
Two major elements of the trade dispute are we do not have access to sell all of their people and they often ignore our patents and trademarks. They knock off inventions from America and cost our companies lots of money. Their government also subsidizes products from their manufactures making it harder for American companies to compete both at home and overseas.
This trade war started last July when the President put tariffs on $34 billion of Chinese goods. Tariffs are surcharges that companies place on imported goods to punish another company or protect domestic industry from imports. Tariffs have been around in some form since the passage of the Smoot-Hawley Tariff bill in 1929. Some tariffs are always in place and some are used to try and gain a short term advantage.
The stock market was very optimist about the possible deal with China. It could have had a big impact on American business if it was a strong agreement. It would have opened new markets and made the playing field more level. When the trade deal became questionable, the stock market had a big reaction. Success had been priced into market valuations.
Tariffs do increase cost to consumers in many cases. Someone has to pay the higher prices. Higher prices lead to increased inflation. Inflation when it rises too fast causes the FED to raise interest rates. We have seen what happens to market valuations every time there is a hint that the FED will increase interest rates.
Historically, tariffs have been negative for the stock market. This started way back with the first tariffs. Almost 70 years later George W Bush put some tariffs on steel and lumber to try and protect American interest. The S&P lost more than $2 trillion of market capitalization. This was several thousands of points. It did not recover until after those tariffs were removed.
As with everything in today’s complicated world economy, one change affects many other things. China is a major buyer of our government bonds. If they would refuse to buy more or dump their current holdings, that could affect our interest rates and the value of the dollar in world markets. This would help some industries and hurt others.
Right now, the dollar is the international reserve currency for the world. This means trade is valued with our money. If things become too disruptive there could be a move to the yuan to replace the dollar. The yuan is China currency.
This current crisis brings us back to a point we have discussed before. Do not take on more risk than is right for your timeline and tolerance level. Do not automatically assume that things will just keep getting better. Markets do not only move in one direction.