Up until very recently the stock markets have been complacent, working under the assumption that the trade war rhetoric would not erupt into a real trade war. As of today, May 13th, however, it seems that traders are not so sure about that “not really” assumption.
Why does the stock market react negatively both to applied tariffs and to a real threat of more tariffs being imposed on Chinese imports? Because, quite simply, tariffs are a tax. In some commentary on tariffs, I’ve seen explanations that suggest it is the Chinese who will pay the tariff/tax. Not so. It is you and I who will ultimately pay the tariff tax.
It works like this:
1. Companies who source component parts or materials from China will find their cost of materials increase by 10% to 25%. They must pay the tariff duty to the US Treasury. What do they do with that cost? They either absorb it and reduce profitability, maybe they will lay off workers to preserve profitability, or they pass it on to the end user – us.
2. Consumers buying finished articles from China, either directly or through a distribution channel, see the cost of that item increased by 10% to 25%. The importer will pay the tariff duty to the US Treasury, but, as the end user, we pay the tariff cost.
The stock market collectively sees the longer impact of the tariffs. While increased consumer costs may take several months to work through the supply chain and on to the consumer, in the end the consumer will pay more. We should expect this higher cost to generate weaker consumer demand. As the consumer is roughly 70% of the US economy, the market is getting ready for lower earnings and slower GDP growth.
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