Why Markets Hate Tariffs (and Trade Wars)

Two weeks ago, we talked about the litany of issues that the stock market is fretting about. Recently, those have crystallized into one main thing: worries about a US trade war with China.

A number of you have asked why that would cause such a negative reaction from the markets. Why did the market fall out of bed when the president called himself “Tariff Man”?

Putting aside public policy views, markets hate tariffs. That’s because, as a rule, tariffs can act as a “tax increase” for consumers … which can in turn slow the economy, which is in turn generally negative for the stock market.

Tell me more, you may be saying …

OK, I’m going to way oversimplify … and I’m not going to opine on any of the public policy issues on trade.

Let’s just say you and I are two farmers.

It costs me $1 to grow x amount of corn. And it costs me $10 to grow the same x amount of asparagus.

As for you, you’re my mirror image: It costs you $10 to produce that same x amount of corn. But asparagus is no problem; that costs you just $1 for x amount.

If we don’t trade with each other, my choices are to go with only growing corn and eating all corn for my meals. (Boring.) Or I can grow both corn and asparagus. (More variety, but much more expensive.)

If we decide to trade with each other, there’s a third way.

A way in which we each focus on what we do best. I can produce all corn and sell some to you, and you can produce all asparagus and sell some to me. Maybe you sell me some of your $1 asparagus for, say, $5. And maybe I sell you some of my $1 corn at $5. We both make a profit, we both have more variety, we’re both better off.

I can use the extra money to eat more, to buy something else, or to save. We both win. And as we spend our profits, others win as well. Like the tractor manufacturers.

Who loses?

The farmer down the road who has no corn seeds and produces only $10 asparagus. Her issues are real; the $1 asparagus producers will gain share, and she will go out of business.

Perhaps as a society, we’re not willing to have higher-cost asparagus producers like her go out of business. So the government could decide to put a tariff on those $1 asparagus producers, meaning their asparagus price is increased. That would help our $10 asparagus farmer (and others like her) be competitive.

Countries do this a lot in order to try to protect domestic industries against foreign competition. But the extra cost of that asparagus (the tariff) is ultimately paid by consumers to the government. This, in turn, leaves less money in the pockets of asparagus eaters than they would otherwise have had.

And right now, the amount of tariffs being paid in the US on foreign goods is at record levels.

At a macro level, this means more money to the US government, but less money for consumers to spend, and less money for businesses to invest and grow. And all at a time when economies outside of the US have been slowing … so at a time when there’s already slowing demand for US goods.

How bad can “protectionism” get? Bad: High tariffs are generally agreed to have worsened and extended the Great Depression, and cutting off trade was a reason cited for the American Revolution.

So this is some fraught stuff.

Which is why the stock market breathed a sigh of relief when it looked like a trade war between the US and China would be averted last week … and why it reacted so badly when the president tweeted, “I am a Tariff Man.”

From the markets’ perspective, “Tariff Man” is about the worst superhero alter ego name a grown man can give himself.

CO-FOUNDER & CEO, ELLEVEST