How Does Trade Policy Affect Me? - The Free Financial Advisor

With talks of trade and tariffs filling headlines, I thought it fitting to explain what these terms actually mean and how they affect our economy.

Trade

In its most basic form, trade is the exchange of goods and services. What we’re talking about, however, and why this article is so relevant, is global trade.

The current “trade war” between the U.S. and China is about “unfair” trade (so President Trump says). Now I’m not debating as to whether trade between our two countries is fair or if I agree with his use of tariffs, I’m going to explain why this all matters.

China and the U.S. are complete opposites when it comes to trade. China is a net exporter and the U.S. is a net importer. China exports more than it imports and the U.S. is the reverse of that.

China is able to produce goods at a much lower cost because their cost for labor is so low. The U.S., on the other hand, is more costly to employ workers.

Tariffs

President Trump is utilizing tariffs to do two things. One, he’s trying to keep people employed domestically, instead of companies shipping jobs overseas.

A tariff increases the overall price of a good. By doing this, it gives employers an incentive to keep jobs in the U.S. because the money they save by shipping jobs abroad is reduced or taken away.

Two, he wants to reduce our trade deficit. Remember the U.S. is a net importer. By slapping tariffs on Chinese goods, it encourages U.S. consumers to buy products from U.S. manufacturers. Thus, fewer imports from China.

Theory vs. Practice

In theory, this sounds like a great plan, but in practice, however, it’s the consumer that pays the price.

When a tariff is used, the exporting country doesn’t see any taxes or penalties. The end result is an increased cost for each product.

For example, if you bought a pair of headphones for $100 and the electronics that make up those headphones are the recipient of a 15% tariff, those same pair of headphones now cost $115.

Now here’s where things get a little more complicated.

China’s Response

China has retaliated with tariffs of their own, but what they’ve also done is manipulate their currency.

You may have seen that in the news a few weeks ago when President Trump labeled them a currency manipulator.

When Trump put tariffs on Chinese goods, China reduced the value of its currency compared to the USD (U.S. Dollar).

This counteracts the effect those tariffs have.

Why It Matters

One, the markets hate uncertainty, so the more this is dragged out, the less likely we are to see an agreement between the two countries. Uncertainty leads to volatility, volatility leads to selling, and selling leads to declines.

Two, through the use of technology and more efficient supply chains, our planet has become very interconnected.

Global trade is a great thing. Each country has its strengths and weaknesses. When countries can focus on their strengths, we can produce more of something for less cost, and then trade with each other. Everyone wins.

Protectionism

This trade war does the opposite. It’s reducing everyone’s willingness to work together by creating a protectionist environment.

A protectionist mentality favors home country and doing business only in your home country. That restricts global trade and the exchange of goods.

The goal here is creating a fair trade agreement that benefits the global economy and (now) minimizes damage to individual economies.

What You Can Do

The most challenging part about this whole situation is we don’t know what’s going to happen. If a deal gets done, the market will like that, but if a deal doesn’t get done, I see a stock market decline in our future.

How do you prepare then? My best advice is the same as the advice I usually give, allocate according to your risk tolerance and time horizon. Those two things should dictate your investment strategy and whether or not you should be concerned with the outcome of this trade war.