The History and Impact of Tariffs in the U.S.
“Should I Stay, or Should I Go” is not just a popular song by the Clash but a question that is on the mind of every investor as they contemplate what just happened in the stock market this week. Should you stick with your investments or pull out? The market hates uncertainty, and the recent global tariffs enforced by the U.S. have caused a lot of confusion and concern. Investors, no matter what their political views, are all asking similar questions: Could the severity of this market correction been avoided? Did the administration's push to revive U.S. manufacturing “manufacture” a correction? What do I do next?
We will answer the “Should I stay or should I go” dilemma in a minute. First, the answer to the question of whether the severity of this correction could have been avoided is a resounding yes! The last two years were extremely strong as the S&P 500 was up over 20% each year fueled primarily by technology stocks and the prospect of great advances via Artificial Intelligence. Were we do for a pull back in stocks, absolutely. The year-over-year growth and earnings assumptions were becoming harder to achieve. A correction was in order but most likely not in such an abrupt fashion. The U.S. economy is at full employment, interest rates have been trending down, and inflation is in the high 2% level – hardly a recipe for a steep, abrupt correction.
Did the administration’s push to revive U.S. manufacturing manufacture a correction? There is no other answer than yes! The facts speak for themselves, we have had the largest two-day sell off in recent memory precipitated by the tariff announcement. There are no other outside factors to blame.
So, what should we do now? At this point, perspective is in order.
Foundations of Tariff Policy
Tariffs have been extremely important throughout American history. The second bill signed into law by President George Washington was The Tariff Act of 1789. Back then, tariffs were crucial for government revenue without putting a burden on states or citizens. The initial tariff was a modest 5% on almost all imports. Alexander Hamilton, the first Secretary of the Treasury (1789-1795), created a financial framework of tariffs and protectionism that guided the U.S. for the next 125 years. Tariffs ranged from 5% to as high as 40%, providing about 95% of government revenue during this period. This protectionist stance helped the U.S. grow into a global industrial powerhouse.
Tariffs continued to be important during the 19th century. Tariffs were essential for federal funding until personal income taxes were introduced in 1913.
The 20th Century: A Shift in Economic Policy
One notable event regarding tariffs was the Smoot-Hawley Tariff Act of 1930, which some historians blame for making the Great Depression worse and that many see correlations with today. However, it's important to note that the stock market crash happened in 1929, before the Smoot-Hawley Tariff was enacted. This Act raised U.S. tariffs on imported goods to record levels, causing international trade friction, retaliations and a global trade war. Does this sound familiar. In the end, however, it was not tariffs alone that deepened the economic downturn but also the financial credit crisis caused by the failure of so many banks that caused trade liquidity to dry up. In the end, this Tariff Act was deemed a failure as it did not provide the stimulus the government expected.
Interestingly, prior to 1934, Congress – not presidents- had power over tariffs. In 1934, the Democratic party was in control and passed the Reciprocal Trade Agreements Act of 1934, which gave the president control to negotiate tariffs.
After World War II, U.S. tariff policy changed significantly. The General Agreement on Tariffs and Trade (GATT) was established in 1947, marking the start of a global effort to reduce tariffs and promote free trade. This transition was crucial as the global economy became more interconnected. Importantly, it allowed Europe, specifically Britain, to rebuild economically after the war. Unfortunately, it also allowed China, as well as many other countries, to sell freely into the U.S. with limited restrictions while simultaneously putting tariffs and barriers on the U.S. goods sold into those countries. This paved the way for China to become the economic behemoth it is today.
In the latter half of the 20th century, the U.S. embraced free trade agreements, like the North American Free Trade Agreement (NAFTA) in 1994, which aimed to eliminate tariffs between the U.S., Canada, and Mexico. However, tariffs continued for U.S. made goods exported to many countries outside of the NAFTA agreement.
More recently in President Trump’s first term, in retaliation for China’s tariffs and unfair trade practices, he enacted tariffs on $300 Billion of Chinese-made products. President Biden kept those tariffs and increased them on several more Chinese-made products: 100% on electric vehicles, 50% on solar cells and 25% on electric vehicle batteries, critical minerals, steel, aluminum, face masks, etc.
Conclusion: Should You Stay or Should You Go?
Our position is this is not the time to sell. However, the decision to stay or go remains a personal one, influenced by individual risk tolerance and largely your individual experience. It might help to remember how you reacted and the decisions you made the last time the stock market was faced with a similar unknown – COVID 19. Between February and March of 2020, the S&P 500 declined by over 35%. Many investors, including institutional investors, were freaking out. No one had ever experienced a global pandemic (the last one was 1918) and there appeared to be no short-term solution other than social isolation – which was an even worse prospect for corporations and the stock market.
If you were a client of Gwynedd during that time you may recall we stayed the course and sold a portion of our long-term government bonds as the 10-Year Treasury dipped below 1% and purchased some retail and other stocks that had been decimated by the sell-off. Many investors forget how quickly the market adjusted, even though a vaccine would not be available for another year, the market quickly began to rebound. By the end of April, the market had regained two-thirds of its losses. By August it had achieved a new all-time high. The S&P ended the year with a 16% gain. Our portfolios and our clients benefited tremendously from staying the course and re-investing at the right time.
Here is the link to the update I wrote in March of 2020 https://www.gwyneddwealthpartners.com/blog/friday-march-13-2020-stock-market-update
There are many similarities between 2020 and today. We are in unknown territory and are unsure when it will end. What I wrote in 2020 still rings true today: “Our expectation is that performance will resume when this event subsides. This week we made more adjustments to the portfolios and will continue to do so over the coming weeks. These adjustments are not always immediately reflected in performance and sometimes need time to play out. We are long-term investors and not traders. We will continue to pare the weak positions and add to or initiate strong ones.”