I’m losing thousands of pounds a year to shops. I’m therefore going to pay more than I need for stuff, to encourage myself to make and grow my own goods. I'm looking forward to my kale-based diet.
You might think I’ve lost what little sense I ever had. But I’m using exactly the same thinking (I use the word loosely) that President Trump used when raising tariffs on Chinese goods. He tweeted recently: “The United States has been losing, for many years, 600 to 800 Billion Dollars a year on Trade. With China we lose 500 Billion Dollars. Sorry, we’re not going to be doing that anymore!”
This, of course, is bonkers. The US’s trade with China is just like mine with Ocado. It is not a loss but an exchange. What Mr Trump misses is the point that Adam Smith recognised in the very first paragraph of the Wealth of Nations, written in 1776 – that the division of labour makes us all better off. Just as it makes no sense for me to grow all my own food, so there are some things the US should buy from overseas.
What Mr Trump is expressing is a pre-Smithian idea – that of mercantilism, the idea that the only form of wealth that matters is the gold accumulating in a nation’s vaults that it acquires by running a trade surplus. On this view, trade is a zero-sum game: China’s gain is the US’s loss, and Ocado’s gain is my loss.
From this perspective, I’m not entirely convinced by the standard explanation of why Mr Trump’s decision hurts world stock markets – that the tariffs will hurt China’s economy. In fact, there are other things going on.
One is that tariffs hurt US citizens too. A recent study by Mary Amiti, Stephen Redding and David Weinstein found that “the full incidence of the tariff falls on domestic consumers, with a reduction in US real income of $1.4bn per month by the end of 2018”. That means Americans have less to spend on other things – including on domestic goods and services.
Secondly, the mere thought of me having to subsist on kale tells us that attempts to make everything ourselves make us all poorer. This explains an important fact – that there has for years been a close correlation between equity returns and growth in world trade. Anything that jeopardises world trade threatens to impoverish us, which is obviously bad for equities.
You might think that there’s a comfort here. It’s that higher tariffs do little to reduce trade imbalances: in fact, the US’s trade gap has actually widened in recent months. Trade deficits are usually the counterpart of domestic investment exceeding domestic savings, and tariffs only reduce deficits if they curb investment or raise savings – and they are weak tools for achieving either.
Personally, I find this of little comfort. If Mr Trump sees the deficit remaining big, he might double down on the trade war rather than realise that tariffs are daft. And this raises another danger for stock markets – of continued high uncertainty. Economists had hoped for a resolution of the trade war. While the US trade deficit remains large, however, there will be a constant danger of Mr Trump reigniting it. And it’s not just specific uncertainty about a few percentage points on tariffs that matter. All this reminds us that the liberal(ish) world order that has been so good for stock markets since the 1980s is itself now in question.
