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Understanding the impact of tariffs

Tariffs on steel would have a ripple effect throughout the U.S. economy. ( Photo: Shutterstock )

The effect on transports, trade, and the economy

As the Trump administration makes public its intent to look at using tariffs to address what it believes are inequities in global trade markets, it set the stock market into a tailspin for good reason. We decided to lay out a basic primer and history lesson on tariffs.

In general, anything that inhibits trade in the long run results in lower prosperity for everyone globally.

We would question why, when world trade was hitting all-time highs and creating more prosperity for more people (including Americans) than ever before, would you do anything to dampen or inhibit world trade?

Ninety-five percent of the world’s consumers live outside the U.S. if we want to sell them goods, we cannot institute protectionist policies. Open markets are in our favor. Free trade improves the standard of living for the average American family of four by $12,000 a year.

Forcing others to open their markets makes sense, and if this is just a negotiating tactic to open other markets, then fine.

The Smoot-Hawley Tariff Act of 1930, which instituted high tariffs on imports, was the single largest reason that the recession of 1929 become the Great Depression. 

In fact, it was America’s willingness to open our markets after World War II that not only helped rebuild all of the countries that had been destroyed by war (Japan and Germany are shining examples of this), but arguably introduced a middle class for the first time to many of the world’s countries and was responsible for pulling billions of souls out of poverty in the decades that followed.

The current proposed tariffs are centered upon goods that are relatively low value / high density in their nature. 

The kinds of products that railroads move. Before steel becomes steel, it is iron ore and metallurgical coal, after it becomes steel it becomes a car or a washing machine or a bridge. 

Tariffs on steel would make us less competitive in the world market for the manufacture of autos, so we will make fewer of them. That is important to understand because there is a big difference between the freight flow of an imported car and a domestically produced or exported car. Moving a car produced with steel that is cheaper overseas results in one freight move, from the port to the dealership. The freight moves for making a car here or making a car here and exporting it are multifold. You move the iron ore and metallurgical coal from the mine to the steel plant, steel from the steel plant to the auto parts or engine plant, auto parts and engines from the plant where they are produced to the car assembly plant, and from the car assembly plant to the dealership or to the port to be exported to another country. 

If tariffs are imposed on steel, aluminum, and other relatively low value/high density items, unless it sets off a trade war (which is always possible) there shouldn’t be much of a change on the other end of the tangible goods spectrum. 

High value/low density goods such as technology or the vast preponderance of goods moved by the FedEx, UPS, and XPO Logistics of the world should emerge relatively unscathed. Without trade war retaliation by other countries (and that’s a big if), e-commerce volumes might continue to grow at an unabated pace.

It has been the opening of markets and the deregulation of transportation in the late 70s and early 80s first in airfreight and then in railroads and trucking that helped create an environment in which the world’s largest and most competitive transportation companies (and national transportation infrastructure) could be built. 

Global trade has been growing at a pace of over 2 times that of our GDP, and that has driven prosperity for the entire world but it has driven prosperity for Americans first. We are the world’s largest importer, and I know that China has surpassed the U.S. as the world’s largest exporter, but that is only if you use the old fashion Keynesian model to calculate trade flows. 

Apple products are a perfect example. China imports parts and pieces from all over the world, including the U.S., to assemble IPads and IPhones. None of those parts or pieces is by themselves that valuable, but assembled into an IPhone it becomes quite valuable and is exported from China with that inflated value attached to it. That inflated value is driven by the intellectual property that was created and is owned by Apple (an American company). So, while it inflates the amount of the stated exports from China, that value creation ends up residing on an American income statement before it becomes part of an American balance sheet. 

Bottom line is this: open markets are good for everyone; negotiating fair trade deals makes sense, raising tariffs does not; low value/high density goods will be more impacted by the current tariffs being proposed; open markets and deregulated transportation have been a powerful force in the creation of a thriving economy and some of the most productive transportation companies in the world. 

Let’s hope that the Trump administration is only negotiating, or that before any tariffs are put in place someone is able to convince them how disastrous the implementation of tariffs could be.

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Donald Broughton, Principal & Managing Partner, Broughton Capital

Prior to starting Broughton Capital Mr. Broughton spent nine years as the Chief Market Strategist and Senior Transportation Analyst for Avondale Partners. Before that, Mr. Broughton spent over twelve years at A.G. Edwards. At A.G. Edwards, in addition to being the Senior Transportation Analyst, he was the Group Leader of the Industrial Analysts and served on the firm’s Investment Strategy Committee. Prior to going to Wall Street, Mr. Broughton spent eight years in various distribution and operations management roles in the beverage industry, including serving as the Corporate Manager of Distribution for Dr. Pepper/Seven-Up companies and Chief Operating Officer for Bevmark Concepts.