The stock market has seen both positive and negative volatility over the past few weeks as headlines have focused on trade tariff announcements between the United States and China. While this has been a recurring theme throughout 2018 and 2019, investors have seen their account balances fluctuate and may be wondering: “What has occurred, and what does it mean for my investments?”
Tariffs are a tax levied by one country on a product imported from another country. The tax is paid to the government where the good is imported, thus making foreign goods more expensive and domestic goods more affordable in relative terms. The U.S. has utilized tariffs since 1789, and they were the primary source of government revenue until federal income taxes were first collected in 1913. More recently, they have been used to influence foreign trade policy, which is the case with the U.S. and China.
The U.S. and China have had a trade imbalance for approximately 40 years, with China exporting more goods to the U.S. than it imports in return. However, that trade imbalance has significantly increased since China joined the World Trade Organization in 2001. Last year, the U.S. imported $539 billion of goods and only exported $120 billion of goods to China. In an effort to improve perceived trade fairness, the U.S. has imposed or threatened four rounds of tariffs against China, each covering different amounts and types of goods. Rounds 1, 2, and 3 have been imposed, while Round 4 has only been threatened.
ROUNDS 1 & 2: $50 billion in Chinese goods
The U.S. first threatened tariffs of $50 billion on Chinese goods in March of 2018. These tariffs were imposed in two parts ($34 billion in July 2018 and $16 billion in August 2018). They cover mostly capital and intermediate goods, affecting only a few consumer products. China retaliated by applying three rounds of tariffs: $34 billion (July 2018), $60 billion (Aug. 3, 2018) and $16 billion (Aug. 23, 2018), thus taxing nearly all U.S. imports into their country.
ROUND 3: $200 billion in Chinese goods
The U.S. then announced further tariffs in August 2018 when President Trump imposed a 10% tariff on $200 billion of goods, which was set to increase to 25% on Jan. 1, 2019. Prior to implementation, the U.S. delayed the scheduled increase twice in order to give both sides more time for negotiations. However, in May 2019, the U.S. accused China of backtracking and raised the tariffs from 10% to 25%. Like the first two rounds, these tariffs still primarily cover capital and intermediate goods, but they also cover $40 billion in consumer goods.
ROUND 4: $267-$300 billion in Chinese goods
The final round of tariffs would essentially cover all remaining goods imported from China. They were first threatened in September 2018, but it wasn’t until trade talks stalled in the summer of 2019 that the U.S. announced that they would impose an additional 10% tariff on remaining goods beginning Sept. 1, 2019. Unlike the previous rounds, a large percentage of these tariffs would cover consumer goods, and they would likely lead to higher prices for consumers in the U.S. if implemented. In mid-August, the U.S. announced partial relief to consumers that smartphones, laptops, toys and video games, which represent about $156 billion of imports, would be excluded from the tariffs.
Trade wars are not beneficial to any country. Thus, it is in both countries’ best interest to reach a compromise. If a trade deal is reached, we would likely see continued GDP growth for both countries and equity markets would continue their upward trajectories. Meanwhile, investors are likely to see short-term volatility as trade discussions continue and markets rise and fall with corresponding news headlines. Over the last century, there have been many events that have created similar short-term volatility. There have been 23 recessions, seven wars in which the U.S. has fought, four presidents who died in office and numerous natural disasters. Through it all, the U.S. equity market has increased exponentially, and it has rewarded investors with a long-term focus.