The economic conditions of the United States have been spectacular as stock market indexes have hit all-time highs and unemployment rate hits new lows. However, over the past several weeks, market conditions have been volatile due to inflation and interest rate fears and trade war disputes with China. Let’s analyze further the cause and effect of these market disrupters.
Inflationary environments are typically attributed to economic expansions. Inflation is price changes in goods and services, and interest rates change accordingly with inflation. Typically, when an economy is expanding, consumers have more money to spend on goods—demand increases. As demand grows, supply decreases, and the supplier (seller) can increase prices to improve their profit margin. This increase in price is inflation. Interest rates counteract inflation by making spending more expensive. If interest rates increase, rates on loans (e.g., mortgages, student loans, etc.) increase, making borrowing and spending more costly. When costs increase, businesses and consumers will spend less; therefore, the economy contracts or tightens. Conversely, to stimulate an economy, a central bank will lower interest rates by making borrowing and spending less expensive. The utilization of changing interest rates to stimulate or to shock the economy is monetary policy.
The above mentioned, quick review of inflation and monetary policy is similar to the case for tariffs. Tariffs are taxes on foreign, imported goods. When tariffs are implemented, it cuts into the profit margin of the supplier. To make up for this marginal decrease, it will be apt to increase the price of that good. Because that foreign good is more expensive, consumers will seek alternative substitutes like cheaper, domestic products. In the past and currently, the United States have been in a trade deficit with China. This means the amount of US exports to China is far less than Chinese imports to the US. In March, President Trump imposed 25% tariffs on Chinese steel and 10% on Chinese aluminum. This will yield advantages to US steel and aluminum businesses as US manufacturing and construction businesses will favor domestic steel and aluminum (because the Chinese products are more expensive). This seems great for the US, but such strict international trade policies rarely escape without repercussions.
Following the initial imposition of tariffs on Chinese goods, China has fired back with tariffs. The Trump Administration provided a list of about 1,300 Chinese products—worth roughly $150 billion annually. As a direct response, China retaliated with plans to impose a 25% tariff on $50 billion worth of US products. Both international trade policies have not been formally implemented but has raised concerns in the market and US companies that outsource their supply chain in Asia. Some believe that these are merely empty threats to produce leverage in realigning the trade gap.
The gross domestic product (GDP) is a measure of a country’s growth. It encompasses of the following measures: consumption, investment, government expenditures, and net exports (exports – imports). The relative size of each factor varies with each country as some nations are developed and others are still developing. However, compared to other nations the Chinese GDP relies heavily on its net exports. According to data by The World Bank, in 2016, net exports made up roughly 37% of China’s GDP. Therefore, imposition of tariffs on Chinese goods will have a negative effect on their overall economic growth—Chinese GDP growth rate has already been declining despite their tremendous growth over the past decades.
Nonetheless, the imposition of tariffs will have a negative effect on both the United States and China. Fortunately, some believe that these tariff threats are just negotiation tactics. Although that may seem like the case, if negotiations are unsuccessful, this may result in the implementation of these tariffs. Over the weekend, there were announcements that the tariffs were put on hold as progress was made in negotiations. However, President Trump has since announced that no deal has been made and provided comments that conflicted with his representatives Secretary Steven Mnuchin and National Economic Council Director Larry Kudlow.
Whether the trade war disputes will resolve is dependent on how things pan out over the following weeks. Keep in mind that many US businesses will be affected if tariffs are imposed on US exports due to decrease in profit margins and overall foreign demand for US goods. Furthermore, costs associated with production will increase for US businesses that outsource parts of their supply chain to China. Consequently, since domestic goods will be cheaper than Chinese imports, demand for domestic goods will increase. Application of our supply and demand review will yield that prices will increase for domestic goods as demand for them increase. If prices increase in an already expanding, heating economy, the Federal Reserve may be more inclined to raise interest rates higher or faster than expected. A spiraling effect of economic conditions will leave the United States with no benefit from a trade war. How will interest rates and tariffs affect your business?