Lexicon Financial Group Weekly Update — October 23, 2024
“As history has repeatedly proven, one trade tariff begets another, then another - until you’ve got a full-blown trade war. No one ever wins, and consumers always get screwed.”
From the desk of Craig Swistun, CIM, MFA-P, Portfolio Manager, Raymond James Investment Counsel, and Wayne Hendry, Client Relationship Manager, Raymond James Investment Counsel
Looking Around
As is always the case, the economy is a big topic of conversation in the run-up to elections. Why would it be any different in the United States? We covered this a few weeks ago, but thought we should spend some time on the often-talked-about-but-unfortunately-never-truly-understood issue… tariffs.
Tariffs are a type of trade barrier that is imposed by countries in order to raise the relative price of imported products compared to domestic ones. Tariffs are inherently protectionist -- aimed at providing preferential treatment.
Foreign countries do not pay the tariff. They are instead paid by importers who often elect to pass those costs on to consumers. Who am I kidding? They almost always pass those costs on to the consumer.
Free-market economists will almost always claim that international trade has benefits. It increases the number of goods that domestic consumers can choose from, reduces the cost of those goods through increased competition, and allows domestic industries to ship their products abroad. Indeed, global expansion for business is not possible if countries impose high tariffs on imports. They hinder free trade policies in a global market.
A business importing a good to which a tariff is applied experiences higher costs. The importer pays the tariff. Sure, this raises revenue for the government but the tariff is paid for by the consumer. We’ve just seen what happens to the price of goods and services when prices rise. It’s called inflation, and it impacts all aspects of the economy.
Our last piece on tariffs may have glossed over this. But why would anybody wat to impose a tariff if it means increased costs to the consumer? Well, there is a policy reason that may make some sense. When foreign products are made relatively more expensive, it may be possible for domestic manufacturers to compete and earn business.
Often, goods from abroad are cheaper because they have cheaper capital or labor costs. If those goods become more expensive, it might create an incentive to purchase a domestically-made product (to which the tariff does not apply).
Tariffs are used for the following reasons:
Protecting Domestic Employment: The possibility of increased competition from imported goods can threaten domestic industries. These domestic companies may lay off workers or shift production abroad to cut costs, which means higher unemployment and a less happy electorate. Studies show that overall, tariffs are harmful than beneficial as they impede economic growth, negatively impacting everyone.
Protecting Consumers: A government may levy a tariff on products that it feels could endanger its population. For example, China may place a tariff on imported beef from Canada if it thinks that the beef could be tainted with a disease.
Infant Industries: Tariffs are often used to protect infant industries. For example, the Import Substitution Industrialization (ISI) strategy employed by many developing nations. The government of a developing economy will levy tariffs on imported goods in industries in which it wants to foster growth. This increases the prices of imported goods and creates a domestic market for domestically produced goods while protecting those industries from competition. This decreases unemployment and allows developing countries to shift from agricultural products to finished goods. This strategy is often criticized because an industry that develops without competition, it could wind up producing lower quality goods, and the subsidies required to keep the state-backed industry afloat could sap economic growth.
National Security: Tariffs are often employed by developed countries to protect certain industries that are deemed strategically important, such as those supporting national security. Defense industries are often viewed as vital to state interests, and often enjoy significant levels of protection.
Retaliation: Countries set tariffs as a retaliation technique if they think that a trading partner has not played by the rules. For example, if France believes that the United States has allowed its wine producers to call its domestically produced sparkling wines "Champagne" (a name specific to the Champagne region of France) for too long, it may levy a tariff on imported meat from the United States.
The benefits of tariffs are uneven. Why? On the one hand, a tariff increases government revenue as imports enter the domestic market. Domestic industries benefit from a reduction in competition. On the other hand, for consumers, higher import prices mean higher prices for goods. If the price of steel is inflated due to tariffs, individual consumers pay more for products using steel, and businesses pay more for steel that they use to make goods. In short, tariffs and trade barriers tend to be pro-producer and anti-consumer. More importantly, these higher prices contribute to the bane of our existence over the last few years, namely, inflation. (1)
But here’s the crazy thing about tariffs. They distort the market.
Imagine two identical products. One is imported and subject to a tariff while the other is manufactured domestically. The tariff makes the import more expensive. People buy the domestic product. In fact, there is increased demand for the domestic product because it has a price advantage. Increased demand leads to increased cost. The domestic manufacturer does some math and decides to raise their price to a level where it is still competitive (and cheaper) than the imported good. The tariff creates an artificially high price, which again is paid for by the consumer.
A recent report from the Canadian Chamber of Commerce issued a stark warning—protectionist policies by the United States (U.S.) could damage economies on both sides of the border. Additionally, whoever takes the White House will be in charge during the review of the Canada-U.S.-Mexico agreement in 2026. Even though Vice-President Kamala Harris is expected to stay close to the Biden administration's path on relations with Canada, she has recently highlighted her opposition to the NAFTA replacement that was negotiated under the Trump administration, saying it allowed major auto companies to outsource American jobs. Meanwhile, Trump has signalled his plans to impose a 10-per-cent, across-the-board tariff on imports if he gets a second term. These are not insignificant policy differences, at least when it pertains to the Canadian economy.
The same report suggested that an across-the-board tariff in the U.S. could reduce the size of the Canadian economy between 0.9 and one per cent, resulting in around $30 billion per year in economic costs. The U.S. would see around $125 billion US a year in economic costs. This situation would be exacerbated if other countries retaliated with tariff walls of their own. In that case, Canadian may fall by 1.5 per cent and productivity by 1.6 per cent.
This is not the first time such a policy has been put forward in the U.S. There was the 1971 "Nixon Shock," when the U.S. levied a temporary 10-per-cent surcharge on imports, including from Canada. Then, as now, Canada sought an exemption, citing its unique and integral role as a dependable trade partner. Nixon's tariff lasted only four months before it was reversed, but research found it resulted in a 2.6-per-cent reduction in total imports into the U.S. from Canada.
Today, Canada and the U.S. share an economic relationship that is substantial, deeply interconnected and mutually beneficial. Consequently, the effect of tariffs would likely be greater today. For instance, Canada is the top export destination for thirty-four states in the U.S. In Michigan, trade with Canada is valued at 14 per cent of the state's economy. It is 10.2 per cent in Illinois and 6.7 per cent in Wisconsin. Most of the oil that Alberta produces goes to the U.S., so with a 10-per-cent tariff, there would be implications for Canada. How large these implications are, depends on how much of hit U.S. refineries take. Ontario and, to a lesser extent, Manitoba could also feel broad implications from tariffs in their respective auto and transport industries where there could be about a 20 per cent decline in terms of exports to the U.S. which is one-fifth of their overall business. (2)
Tariffs are highly politicized which makes them a possibility no matter who is in power. They are like the emergency stop on a train where the complete effects only become fully visible after the lever has been pulled. And once enacted, tariffs are not easy to get rid off. The Biden administration has kept the sweeping tariffs on about $300 billion of Chinese-made products implemented by Trump when he was in office. They even decided to increase some of the rates on about $15 billion of Chinese imports. China is expected to retaliate by increasing tariffs on US-made goods. It is clear that tariffs are one of the hot 2024 election topics and how they will be implemented in the future will depend on who wins. (3)
Read and Watch
Want deeper insight into topics in your Weekly Update? Then, read and/or right click:
How to invest in today’s market
Trump vs. Harris: Who's Better for the US Economy? - DW News
China’s economic stimulus isn’t enough to overcome that sinking feeling
Looking Back
Two years ago, inflation was above 7 per cent in Canada and the U.S., central banks globally were in the midst of a historically aggressive rate-hiking campaign, and the S&P 500 had dropped 25 per cent off its high. My, how things have changed. Inflation has come down significantly, central banks have and are continuing to cut interest rates (except for Japan, Nigeria and Brazil), and the markets have come back strongly.
The question that begs an answer here is “where do markets go from here?” Traditionally, when inflation and interest rates decline there is a boost to the market. Will that be the case? How will the US election factor in? Or, will there be another external shock to the system?
It is worth noting that the technology sector (information technology and communication services), which far outpaced other sectors in 2023 and in 2024’s first half, began underperforming the broader market. An easing interest rate environment has led investors to shift their focus. The biggest post-June beneficiaries are utilities and real estate stocks. Timing the markets and trying to be precise on when to be in and when to be out is challenging to say the least so we monitor what is happening globally and look for opportunities that are in line with our client’s investment objectives. If you have any have any questions in regard to where the markets are going or how your portfolio is doing, please contact us by email or phone. We value any opportunity to communicate with you as it helps us build our relationship with you. (4)
Canada’s main index, the Toronto Stock Exchange’s S&P/TSX (TSX) notched its third straight day of record closing highs on Friday last week despite the looming uncertainty around the Middle East conflict and the upcoming U.S. election, as metal mining shares jumped on higher gold and copper prices. (5)
The Bank of Canada (BoC), as expected, cut its key policy rate today by a half per cent to bring it to 3.75 per cent. Will it so again at its next meeting on December 11, or stick to a more traditional 25 basis point reduction? Time will tell bur money markets are, for now, heavily favouring a more traditional 25 basis point cut, by about 94 per cent odds. the succession of policy cuts since June, rates are still way too high given the state of the economy. This means more interest rate cuts in 2025. The pace of interest rate cuts going forward may not be clear but the direction for rates is firmly downwards. (6)
In the U.S. all the major markets ended last week up slightly. The S&P 500 Index advanced, thanks to the utilities and real estate sectors. Energy stocks pulled back as fears of possible Israeli attacks on Iran’s oil and gas infrastructure subsided. A positive for third-quarter U.S. economic growth, the value of retail sales increased 0.4 per cent in September, up from the 0.1 per cent uptick registered in August. Strength in consumer spending was broad-based as 10 of the 13 retailer categories reported higher sales for the month. On the employment front, initial jobless claims in the U.S. fell unexpectedly to 241,000 during the week ended October 12 - a decline of about 19,000 filings.
In Europe, most major markets ended higher last week. The European Central Bank (ECB) lowered its key deposit rate by a quarter of a percentage point to 3.25 per cent. This the first back-to-back reduction in 13 years. And, although the ECB reiterated that it would not pre-commit to a particular rate path, financial markets appeared to expect the ECB to reduce rates in December to support the economy.
Japan’s stock markets were down last week. Exports declined 1.7 per cent in September from a year ago. Easing domestic inflation in September, although expected, led to some speculation that the Bank of Japan (BoJ) may be less likely to raise interest rates again this year.
Chinese markets rose last week as the central bank unveiled more support measures after data showed that deflationary pressures had grown more entrenched in China’s economy. Although economic growth in the third quarter surprised to the upside, it still remains below target. China’s economy in the third quarter expanded 4.6 per cent from year-ago levels but was slightly lower than the 4.7 per cent expansion recorded in the second quarter and below the government’s stated target of approximately 5 per cent. (7)
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable, but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors, and we recommend that clients seek independent advice from a professional advisor on tax-related matters.
The Basics of Tariffs and Trade Barriers, Brent Radcliffe, June 26, 2024
Canadian Chamber of Commerce sends stark warning about U.S. trade relationship, The Canadian Press, October 8, 2024
Biden finalizes increases to some of Trump’s China tariffs, Katie Lobosco, CNN, September 13, 2024
Is a market correction coming? US Wealth Management, U.S. Bank, October 16, 2024
The close: TSX adds to weekly winning streak as metal prices climb, The Globe and Mail, October 18, 2024
Don’t count on another jumbo-sized rate cut: How markets and economists are reacting to today’s BoC decision, Darcy Keith, The Globe and Mail, October 23, 2024
Global Markets Weekly Update, T. Rowe Price, October 18, 2024
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Looking to Learn?
If you want to know more about some of the topics we wrote about this week, just click on the links below:
Video: A History of Tariffs, From Hamilton to Trump - Forbes
Video: How Trump's tariff plan would affect U.S. consumers
Tariffs as a Major Revenue Source: Implications for Distribution and Growth – The White House
Global Trade Series: The Benefits of Free Trade
U.S. vote has Canadian business leaders worried about protectionist policies: KPMG
Growing Threats to Global Trade – International Monetary Fund