Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, rose 1% for the week.
  • Why are markets responding so calmly to President-elect Trump’s plans for high tariffs on imports?

Some of the lasting stock market memories of President-elect Trump’s first term were the daily gyrations he was able to stimulate simply by uttering the word “tariff”. Those market swings now register as barely a blip, and the market did just fine whilst Trump was president. The financial media loved to amplify those bumps, though. It made for exciting news.

Trump has been vociferous about his intention to ratchet up tariffs on imports once he is back in office (continuing the tariff-trend under the Biden administration), but markets have shrugged those comments off. The S&P 500 continues to make new all-time highs despite the financial press’s hyperventilating about Trump’s tariff plans. Do markets even care about tariffs?

While no one knows what Trump’s trade policy will ultimately look like, tariffs are nothing new. There is a long history of countries deploying tariffs. The evidence is that in some cases, tariffs appear to “work” by stimulating domestic investment in manufacturing (or in whatever industry tariffs are attempting to stimulate). In other cases, tariffs have not worked at all.

The author and economist Michael Pettis’s main contention is that tariffs “work” to shrink the trade deficit by raising prices on imports, shifting real income from consumers (who save less) to domestic producers (who save more). Any mechanism that successfully raises national savings relative to national investment will reduce the trade deficit.

Policies that attempt to increase national savings such as tariffs (or any policy geared for that end) will not necessarily work. As Mr. Pettis notes, one reason tariffs may have a limited effect is the US dollar’s role as the de facto global currency. There are no capital controls on the dollar, and given the deep, liquid, and foreign investor-friendly capital markets in the US, it is the currency of choice in which the rest of the world prefers to save. Because the dollar is the preeminent currency for savings on the global stage, the US may be somewhat at the mercy of other countries’ domestic policies.  

Also, bilateral tariffs on trade (such as tariffs solely upon China) will tend not to work, claims Mr. Pettis, because they will not alter the domestic balance of savings and investment. For example, a China-specific tariff may reduce Chinese imports, but if they are replaced by Korean imports then nothing has changed. Mr. Pettis writes that “this, by the way, is exactly what happened after the administration of President Donald Trump first imposed bilateral tariffs on China in March of 2018: both China’s trade surplus and the U.S. trade deficit continued rising, just not with each other”.

In recent comments, Mr. Trump has singled out countries (China, Mexico, and Canada) he plans to target with tariffs. Such an approach may not make much of a difference for the overall trade deficit.

This could be why the stock market has been blasé about all the recent tariff talk. Tariffs sound protectionist and good for a “strong” dollar, but unless the tariffs – and trade policy in general – are structured in a way that moves the needle on aggregate domestic savings, they may ultimately have a minor impact on the US trade deficit.

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