Trade Agreements Take Years to Negotiate
Trade agreements take years to negotiate, so it is unclear what renegotiations of current trade agreements would entail and how quickly they would occur. Tariffs would have a fairly immediate negative effect on growth. Tariffs increase the price of imported goods for U.S. consumers, thus cannibalizing their purchasing power. In addition, tariffs could provoke trading partners to retaliate with similar measures, hurting U.S. exports.
Implementing a 35% tariff on imports from Mexico and a 45% tariff on imports from China, as Trump has suggested, would increase the cost of imported goods from those two countries by US$310 billion. This would amount to 1.7% of GDP and 2.4% of consumer spending, so the economic impact would be meaningful.
In addition, a trade war has the potential to disrupt established supply chains. Trump’s trade measures are unlikely to result in a relocation of production to the U.S. Even if they did, it would take a long time for the U.S. to see the benefits, and it would mean much higher prices for those domestically produced goods.
The Possibility of Rising Geopolitical Uncertainty
If the U.S. takes a less active role in foreign affairs, global geopolitical uncertainty would increase, which would likely result in higher risk premiums. Ultimately, it seems that the outcome of the election is likely to create:
1) Stronger growth in the near term, leading to a continued upward drift in inflation.
2) Higher interest rates.
3) A wider deficit/higher debt.
4) An increase in risk premiums, including potentially lower P/E ratios, until there is more clarification on trade policy.
Looking farther out, if action on trade policy follows Trump’s rhetoric, the outcome is likely to be an unwelcome combination of slower growth and higher inflation, with a reasonable probability of a recession starting in 2018.
Darrell R. Spence is an economist at Capital Group. He has 23 years of investment industry experience, all with Capital Group. He holds a bachelor’s degree with honors in economics from Occidental College graduating cum laude, and is a member of Phi Beta Kappa and Omicron Delta Epsilon. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics. Darrell is based in Los Angeles.