Tariffs and Trade Wars: Part 2

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Jun 14, 2018 2:30:23 PM

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tariffs and trade warsIn part 1 of this series, we discussed how, overall, tariffs can create localized benefits (e.g., helping a particular industry), but they do so by imposing higher costs on the rest of the economy. We also discussed the wider implications—primarily that when a country imposes tariffs, there is a real possibility that other countries will retaliate. This leads to a vicious circle that leaves everyone worse off. Economically, tariffs don’t make a lot of sense.

The politics

Politically, however, tariffs do make sense—as we are seeing. The reason is that while trade offers significant economic benefits, it can and has imposed real costs.

Here in the U.S., millions of jobs have been lost abroad, and those workers are paying for the faster economic growth that trade brings. Given those costs—and they are real—why do we let this happen? Beyond those costs (even if we conclude they are justified), shouldn’t we drive the hardest bargain we can when we cut deals?

This is the present administration’s position, and it has a great deal of fact and logic behind it. What is not included, however, and what has historically justified the current system is the bigger picture.

The bigger picture

To set the stage, we have to go back to the aftermath of World War II. Except for the U.S., pretty much the whole world was in ruins. The only other major powercommunist Russiawas on the prowl, looking to take over these ruined, destitute nations.

To prevent that scenario, the U.S. did a number of things. The Marshall Plan, which rebuilt Europe, was a major step. But even more so was what was called the Bretton Woods system, named after the resort where the negotiations took place. Briefly, the deal was that the U.S. would buy everything that other countries sent us and protect the global trading system. In return, the U.S. got to run things pretty much as it wished.

This arrangement cost money—a lot of money. But at the time, the U.S. was rich enough to afford it. Plus, the costs were more than offset by the benefits, including saving Europe and Asia from communism and incidentally protecting the U.S. from a larger Russian threat; opening markets worldwide to U.S. goods, even if on a more limited basis; and making the U.S. dollar the world reserve currency. It was a bargain, in fact, gaining control over most of the world in exchange for helping them get rich.

Move on 50 years, and those once devastated countries are now rich themselves. Other countries (e.g., China) have signed on to the U.S.-led system in order to get rich. And we continue to run the world. The world trade system is still U.S. centric, the dollar is the uncontested reserve currency, and the U.S. Navy protects trade around the world and dominates the oceans. We got rich as well over that time period. And—this is critical—there was no major world war for about the longest time ever in history. Under U.S. leadership and subsidy, the world was rich and peaceful for an entire lifetime.

This is the justification for the current system of open trade underwritten and subsidized by the U.S.: peace, wealth, and control for the U.S., as well as peace and wealth for the rest of the world. This is what has kept the system going for so long.

Times have changed

Now, however, the situation is changing. The U.S. is still rich, but other countries are rich, too. There is no systemic global threat like the Soviet Union. The justification for the U.S. to pay for leadership on the one hand and to have that leadership on the other seems to have eroded. Things really are different than they were when the system was set up. As such, it certainly isn’t crazy to say the system has to change as well, to recognize those changed circumstances. One way to do that is to reconsider what a better system would look like.

Would a changed system be better for the U.S.?

Here in the U.S., the administration is doing just that and seems to be moving more toward prioritizing economics rather than American leadership in a global system. Fair enough. As we noted, there are real potential gains to be had here. To really understand what that change might mean, though, we have to look at some of the potential costs. We must also consider whether a changed system, whatever the intentions, would actually be better for the U.S. This is exactly what we will do tomorrow.

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