Challenges in global trading: The game with tariffs

The trade war between the US and China has fueled the rumor mill and is creating growing uncertainty. Historically speaking, trade tariffs are not a new instrument. But what is behind the current US tariffs? And how should investors handle the situation?

Consequences of tariffs can be unpredictable

When British King William levied steep tariffs on French wine imports in 1689 with the intention to raise demand for domestic alcoholic drinks, he did not expect the effect on his country in the succeeding years. British consumers shifted as planned their demand from French wine to domestic spirits – especially gin. As a consequence, crime statistics worsened and the number of addicts throughout the country rose.

What we have learned from King William’s action is that trade interventions mostly have unexpected impacts, even more in today’s globalized world, where the “domino effect” can reach wider and last longer.

Trade war between the US and China

To put it simple, trade tensions are often a reaction to trade imbalances and perspectives – one side offers something that the other side wants. Introducing the first round of tariffs in March this year, the US imposed import tariffs on steel and aluminum on different countries including China covering around USD 2bn to increase protection for domestic producers.

China responded swiftly with tariffs on 128 US-products such as fruits, wine and pork amounting to USD 3bn. A second round of tariffs could affect different areas on both sides and respectively cover a trade volume of around 50 billion US dollars. US Imports amount to nearly four times of the volume of what China imports from the States.


Overview of the second round of tariffs

Source: Peterson Institute for International Economics, The Economist

President Bush already failed on tariffs

Back in 2002/2003, in response to US President Bush’s 30% import tariffs on steel, China and the EU were aiming for taxes on goods either produced in republican dominated, or so called swing states, where democrats and republican voters’ share was equally distributed. Goods in scope included fabrics and textiles from Carolina, bourbon and motorcycles from Tennessee and Kentucky as well as oranges from Florida. President Bush revoked the steel tariffs after almost two years in place.

In retrospective, the expected positive effect on the steel industry was accompanied by negative collateral effects, underscoring the importance of the “domino effect”: A government report from the US International Trade Commission in 2003 concludes that the employment gains in factories producing raw steel did not compensate for job losses in industries, such as companies that use raw steel for car parts and appliances.

It seems that the Achilles’ heels when it comes to tariffs are goods which influence the re-election results of the current political party and its president.

What influence does the trade war have on the markets?

First of all, we need to keep in mind that imports and exports are only one part of the Gross Domestic Product (GDP) of a country. Goods account for 80% of global trading, however, the contribution to global GDP is only 12%.

And amidst the tariff discussion liberal steps are often forgotten: Donald Trump’s statement that he would like to conclude the renegotiations of the North American Free Trade Agreement (NAFTA) is a positive sign and awakes hope for further regional or bilateral negotiations. This supports the view of our Credit Suisse experts that reciprocal trade terms are one major goal and the assertive Donald Trump rhetoric is more a negotiating tactic.

We remain committed to global equities

However, finding new trading partners in a globalized world is not a difficult task nowadays. It seems to be no coincidence that the EU and Mexico have agreed this April on a new free trade agreement. As a conclusion, we do not expect escalations of trade tensions. This is reflected in our positive view on global equities.

In Europe, we have a preference for domestically exposed, less trade tariff dependent smaller capitalized companies. Furthermore, we prefer sectors exposed to growth such as Information Technology (IT) and Financials regardless of their international exposure. To mitigate the risk of a rise in protectionist rhetoric, we include Telecoms, a domestic defensive while we are cautious on Consumer Staples and Industrials. These recommendations should be considered in a portfolio context, as a broad diversification is the best investment strategy.