Trump Bump Turns to Slump?
Donald Trump was elected President of the United States of America on Wednesday, November 9, 2016.
Much to the surprise of pundits and the chagrin of detractors, the U.S. stock market not only extended its record bull run, but seemed to accelerate. Between the day results were announced and the start of 2018, the Dow Jones Industrial Average rallied nearly 40%.
Analysts, authors, newscasters, everyone was more than a little shocked. But we were all content to go along with it. I mean, who argues with gains?
The rejuvenated bull market even earned the moniker the “Trump Bump.” Pretty catchy, huh?
But as we move further into his presidency, it’s starting to look like that bump might turn into a slump.
All Good Things Must End
The Trump Bump carried the market up to multiple new high levels. But it set the highest mark on January 26th, less than two months ago. That marked a 50% rally since The Donald’s election.
But it may have also marked the end of the run and the start of the “Trump Slump.”
Since that fateful day, the Dow 30 is down about 7%. And Trump’s rally is back down to 40% and falling.
You see, Donald Trump may understand how politics works. And he obviously knows how to win the national popularity contest that presidential elections have become.
But he doesn’t seem to have much of a grip on classical economics. And that became glaringly clear last week when he announced a new round of potential tariffs.
Now, don’t get me wrong. I’m all for encouraging the growth of American industry. But one of my degrees is in economics, and I spent years studying the effects of things like tariffs on economic growth.
Spoiler alert: They’re not good for anyone.
Another Word for Taxes
Before we get into the negative consequences of tariffs, let’s talk a little about what they are. And that’s a tax.
Yep. That’s right. Tariff is just a fancy word for a tax on a product from another country. Tariffs are usually calculated as a percentage of the product’s total value, including shipping charges.
And they’re usually levied on imported goods to make domestic products more competitive and affordable. They’re also used to add to government revenues.
In the case of steel and aluminum, you can think of it like this: The extra taxes on imported steel and aluminum will make it cost more for U.S. companies to buy foreign steel. So they may decide to turn to steel made by manufacturers based in the States. And if they keep buying the foreign steel, that extra tax fills up the government’s coffers.
Now, that may sound like a good thing, but what it really does is raise the price paid by whomever the end user is.
When it’s something like steel or aluminum, then everybody who uses steel or aluminum pays the tax. That means everyone who drives a car, owns a cell phone, drinks soda or beer from cans, or does a myriad of other things will be paying more.
It also supports inefficient industries. If American steel manufacturers can’t produce steel for sale in the U.S. cheaper than foreign companies, then the American companies aren’t efficient at making steel. It’s that simple.
Encouraging inefficiencies is not a way to encourage economic growth. And it’s certainly not going to make America great.
Gone Like Yesterday
You see, when you enforce tariffs to make an inefficient domestic industry competitive on a global level, you create what’s called “deadweight loss.”
Deadweight loss is simply a cost to society caused by market inefficiency. And it’s unrecoverable. That means once it’s gone, it’s never coming back.
In economics, the relationship between tariffs (or any taxes) and deadweight loss is shown on a supply and demand chart.
Here, price is on the vertical (or y-axis) and quantity is on the horizontal (x-axis). The line S1 denotes the supply of a given product. D1 is the demand of that product by consumers.
Without a tax, equilibrium is reached where S1 and D1 intersect. This is the quantity and price where the amount of the product supplied matches the amount of the product consumers are demanding. In the chart, it is represented by the point Q1.
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It is the perfect price for the product as determined by a free market. If price were to go higher, demand would shrink. But if price were to drop, supply would fall as well. At the equilibrium point, both customer and producer are satisfied.
But when you add a tax like the tariffs President Trump is suggesting, that equilibrium gets thrown all out of whack. Now, the point where demand and supply meet is unreachable because the tax adds cost without adding value.
With the added tax, the new equilibrium quantity (QTax) is far lower. Consumers demand less of the product since they must pay more for it. And producers supply less of it because it costs them more to make.
The government gains some revenue from the tax. But some of the benefit of the whole transaction is lost forever.
Pre-tax, we see that consumer surplus is equal to the sum of areas A, B, and C. Consumer surplus is the money you save because you can purchase a product for less than the highest price you’re willing to pay.
And producer surplus is made up of the areas D, E, and F. Producer surplus, like consumer surplus, is the extra money made by selling a product for more than the lowest price you’d be willing to take.
But once we introduce the tax, consumer surplus is carved down to just area A and producer surplus becomes area F. Areas B and D get shifted to government revenue — the extra money from the tax — and areas C and E disappear entirely.
The loss of C and E is the deadweight loss. It’s value that’s gone, never to return. And it’s a drag on the economy of all parties.
And the worst part is that one tariff inevitably leads to more...
We’re Having a Heat Wave Trade War
You see, when a country like the U.S. levies a tax on imports from other nations, those nations aren’t usually too happy about it. And they can (and typically do) respond with tariffs of their own.
And that’s what we call a trade war. It’s literally two nations bickering like children about who did what. It’s a tit-for-tat. You hit me so I’m going to hit you back.
But it doesn’t stop with that second hit. It escalates. You hit me for hitting you, so I’m going to hit you for hitting me for hitting you. And so on and so on and so on...
What ends up happening during a trade war? Prices rise across the globe. Inflation hits the combatants’ citizens. Industries, even those intended to be protected, suffer. And the major cost is passed off on consumers like you and me.
And thanks to Mr. Trump’s announcement last week, even our closest allies are threatening retaliatory tariffs on American exports.
Canadian Foreign Minister Chrystia Freeland said, “Canada will take responsive measures to defend its trade interests and workers.”
Bruno Le Maire, France’s minister of finance, said that the tariffs, if enacted, “would lead to a strong, coordinated and united answer from the European Union.”
And Chinese officials have said they’d do what’s needed to defend their markets, too. They’ve even hinted at retaliating with tariffs on U.S. soybeans exported to China — about $12.4 billion last year.
Canada and Mexico are our biggest trade partners. And if we get into a trade war with them, it’s not going to be good for anyone, most of all the American consumer. Same with China. In a trade war with them — with anyone — there are no winners.
So, before you go jumping on the tariff and protectionist bandwagon, look at the long-term consequences of that kind of policy.
The losses in the long run far outweigh the paltry short-term gain they might bring.
In the end, the only truly efficient global economy is an open one.
America led the way to an open political system. I say it’s time we lead the way to an open marketplace, too.
To your wealth (and your surplus),
To your wealth,
After graduating Cum Laude in finance and economics, Jason designed and analyzed complex projects for the U.S. Army. He made the jump to the private sector as an investment banking analyst at Morgan Stanley, where he eventually led his own team responsible for billions of dollars in daily trading. Jason left Wall Street to found his own investment office and now shares the strategies he used and the network he built with you. Jason is the founder of Main Street Ventures, a pre-IPO investment newsletter; the founder of Future Giants, a nano cap investing service; the editor of Alpha Profit Machine, an algorithmic trading service designed specifically for retail investors; and authors The Wealth Advisory income stock newsletter. He is also the managing editor of Wealth Daily. To learn more about Jason, click here.
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