“Trade wars are good, and easy to win”

March 2018

In an effort to protect domestic steel and aluminum producers, U.S. President Donald Trump recently announced his intention to impose tariffs on imports of the two materials. Trade wars are a contentious issue, so the pushback to the announcement was swift. In an attempt to defend his stance, Trump responded with the quote in our title.

Actually, we apologize. Calling trade wars a “contentious issue” is misleading. Let's rephrase that: trade wars are dumb. Or as the China Iron and Steel Association more eloquently put it, “stupid”.

We previously discussed the issue of tariffs and protectionism in our fourth quarter 2016 client letter. In this month’s market commentary we’re going to review some of the things we discussed in that letter, while updating those views in the context of the newly-proposed steel and aluminum tariffs.

What are Tariffs?

But before we do that, let’s make sure we’re all on the same page about what tariffs are. Let’s say you live in an apartment building that has a convenience store on the ground floor. This store does have food in stock, but the selection is limited and overpriced. So when it comes time to do your weekly grocery shopping, you don’t go to the convenience store. Instead, you go to the supermarket down the street.

But the manager of your apartment building really likes the owner of this convenience store. In fact, they’re often seen together socially. Frequently he has been overheard remarking, “IF YOU DON’T HAVE POTATO CHIPS, YOU DON’T HAVE AN APARTMENT BUILDING!”

The building manager doesn’t like that you do your grocery shopping down the street. He wants you to do all of your shopping at his friend’s convenience store so that his friend doesn't risk going out of business and losing his job. So he hires a security guard that sits at the building’s entrance and inspects your grocery bags anytime you come back from shopping. If anything in those bags was bought at the supermarket down the street, he collects an extra 25% of what you spent in an effort to discourage you from shopping there. You complain about this additional tax, but the manager simply explains that it is Timely Assistance Rightfully Improving Friends' Fortunes or “tariff” for short.

Two Sides to Every Story

We don’t want to be accused of being flippant about people losing their jobs because of competitive pressures. As we previously wrote in our fourth quarter 2016 letter:

We understand why voters find protectionist messages like these appealing. Unemployment can be devastating for both individual workers and their communities. This is one of the reasons why a great deal of Trump’s support came from the Rust Belt. But these protectionist messages focus only on one side – the negative side – of globalization. That is, it mentions only the loss of jobs for those supplying labour to specific industries. But these messages make no mention of one of the big the benefits of globalization: how the cost and quality of goods and services supplied to consumers has continually improved over time.

Tariffs can successfully protect domestic industries that face intense competition from foreign countries. But should any industry even be protected in the first place? In the client letter we continued with the following example that considered whether the U.S. automobile manufacturing industry should be protected from foreign competitors who sell lower-priced vehicles:

These two opposing forces, the costs to workers versus the benefits to consumers, must be weighed together if an honest analysis of free trade is to be made. For example, in the U.S. there are 934,000 people employed in automobile manufacturing.  But there are also 191 million licensed drivers in the U.S.  If we assume each person employed in the automotive industry supports a family of four who are all licensed drivers, there would be 3.7 million people in the U.S. whose household income depends on the automotive industry. But this also means there would be over 187 million drivers in the U.S. who derive no income from the automotive industry. This 187 million would, however, benefit significantly from a decline in new car prices.

It may sound like a heartless argument to make: pointing out how some people save some money, or get a better quality product, because some of their fellow countrymen lost their jobs. But it is, indeed, important to consider the net economic impact of sweeping policy proposals like this. What if, in the late 1800s, policies were put in place to protect workers in the American-made horse-and-carriage industry, while stifling the development of the automotive industry? Your commute to work would look quite different today. Or what if every laptop now sold in the U.K. had to be manufactured domestically by workers earning wages multiple times higher than the workers currently building them? Low-income Brits would not be able to afford computers for their children. Or what if our government legislated that only Canadians could play for professional baseball teams based in the country? Attendance at Blue Jays games would probably be limited to the grounds crew.

Protectionist trade policies also reek of an “us versus them” attitude. Far too often trade is incorrectly treated as a zero-sum game where foreigners have to lose if we want to win. But history has shown that isn’t the case. Not only can domestic consumers benefit from increased globalization, but it also helps alleviate poverty in developing countries:

…many companies in developed countries outsource their labour to developing countries where the wages are lower. In the vast majority of cases, the workers in these developing countries are being paid more in these jobs than they would in their next-best employment option. As a tangible example, a study has shown that when the U.S. lowered its import barriers with Vietnam in late 2001, the incidence of poverty decreased faster in the regions of Vietnam that had more workers employed by industries that benefited from the increased trade. Moreover, between 2002 and 2004 the average annual drop in Vietnam’s poverty was 31%1.


As we discussed in our January market commentary, consequences have consequences. A country whose exports are suddenly subjected to tariffs is apt to retaliate with their own tariffs on imports. That’s why protectionist trade policies can escalate into full-blown trade wars. With respect to the proposed steel and aluminum tariffs, Canada has already responded by pointing out that we buy 50% of the United States’ steel exports; a tariff on these shipments is apt to negatively impact U.S. steel producers.

Back to our Q4 letter to see how tit-for-tat protectionism can unfold poorly:

For an example of the real-world consequences of protectionist trade policies, we’ll bring your attention to how a tax on poultry helped make the Ford F-Series the best-selling American vehicle of all time. Thanks to advances in farming techniques, the cost to farm chickens in the U.S. plummeted following World War II. With this low-cost advantage, American farmers increased their exports to Europe to the point that they were the dominant chicken supplier in the region by the early 1960s. Subsequently, to protect their domestic farmers, European countries implemented tariffs on the chickens imported from the U.S. This then caused U.S. chicken exports to Europe to decline by 25%.

In retaliation, President Lyndon B. Johnson implemented a 25% tax on U.S. imports of potato starch, dextrin, and brandy: products that were all European exports. Oh, and at the last minute he was convinced by an auto workers’ union (who wanted to protect the jobs of its members) to include light truck imports on the new tariff list too.  This “chicken tax” was implemented in 1963 and is still in place today. The result? Have you ever seen a Volkswagen Amarok on streets in the U.S. or Canada? What about a Mitsubishi Triton? How about a 2016 Ford Ranger? No, you haven’t seen any of these trucks here because they are manufactured internationally and would be prohibitively expensive to sell in North America. As a result, truck buyers here are faced with the same limited, overpriced truck options year after year.

Source: volkswagen-vans.co.uk, mitsubishi-motors.com.au, fordeumedia-d.ford.com
Pictured: What the chickens are keeping away from us.

Going back even further in history, the Hawley–Smoot Tariff Act of 1930 raised tariffs by as much as 50% on tens of thousands of goods imported into the U.S. Inevitably, U.S. trading partners retaliated. How did it all work out? We’ll let Ferris Bueller’s economics teacher explain:

How the Markets View Trade Wars

We aren’t alone in our distaste for trade protectionism. The S&P 500 index – the most prominent equity index in the U.S. – sold off almost 4% in the wake of President Trump’s tariff announcement.2 In other words, this suggests that investors believe these tariffs to be a net negative for the U.S economy.

Specifically, while the tariffs would be good news for domestic steel and aluminum producers in the U.S., it would be bad news for any company that uses those materials as an input. For example, tractor manufacturer Deere & Company (DE-NYSE) was down approximately 7% on the news, machinery manufacturer Caterpillar (CAT-NYSE) was down 9%, and electric car manufacturer Tesla (TSLA-NASDAQ) was down 6%. In turn, this suggests that farmers, construction workers, and environmentally-friendly drivers are all going to be footing the bill for these proposed tariffs.

We don’t own any equities in our portfolios that are as directly exposed to these tariffs. However, some of our holdings that export other goods to the U.S. did sell off. Investors seem to becoming increasingly concerned that more protectionist policies are coming from President Trump. We aren’t yet in that camp; we do believe that cooler heads will eventually prevail. They may not prevail in the next month, quarter, or year, but over a long-term horizon, we find it hard to believe that the world’s biggest economy and bastion of capitalism will wholeheartedly embrace trade wars.


2All index and stock return data from Bloomberg.