China Sends a Message With Soybeans: Beware of Tariffs
A mountain stream flows along the path of least resistance. So does international trade.
When governments toss tariffs into the middle of trade flows, like boulders into a stream, the trade will simply take a new path.
The longer governments toss their protectionist boulders into the flow of international trade, the more that flow will fan out in new directions. And once trade flows carve out their new paths, they rarely return to old ones.
In other words, it’s difficult to “untoss” a tossed boulder once it has landed in the stream.
The soybean market provides a real-time example.
For several weeks, Chinese buyers have been shifting away from U.S. soybeans and shifting toward Brazilian beans. That’s a clear reaction to the prospect of a serious trade war between the U.S. and China.
Ever since President Trump began threatening a “winnable” trade war with China, U.S. soybeans have been losing. That’s because China has made it clear from the outset that it would retaliate against any U.S. tariffs by levying its own tariffs on soybean imports from the U.S.
This threat has now become a reality. China has announced it will impose a 25% tariff on U.S. soybeans.
China targeted soybeans not only because they are the largest agricultural import from the U.S., but also because soybeans are readily available from Brazil.
Anticipating this outcome, Chinese soybean buyers have ramped up their purchases of Brazilian soybeans. As a result of this “soybean rush,” the price of Brazilian beans has soared, while the price of U.S. beans has plummeted…
Near term, this extreme pricing disparity will probably subside. But longer term, China’s soybean buying patterns may continue to shift from the U.S. market to the Brazilian one. China’s trade flows had been heading in this direction for several years already.
The chart below shows U.S. and Brazilian soybean imports to China. As you can see, the U.S. and Brazil have traded places…
In 2011, the U.S. supplied nearly half of China’s soybean imports. Today, that number is down to about 36%. Meanwhile, Brazil’s share of China’s soybean imports has climbed from 33% in 2011 to about 50% today.
So it’s not hard to imagine that the new Chinese tariffs on U.S. beans will accelerate both of these trends: fewer U.S. imports, more Brazilian imports.
U.S. soybeans may be one of the most visible victims of the nascent U.S.-Sino trade war, but they are hardly the only ones. Many industries have been suffering casualties from this trade war for several months.
Back in January, for example, the solar sector took fire.
The Guggenheim Solar ETF (NYSE: TAN) had just reached a new two-year high and was showing every sign of continuing its upward climb. But then the president approved tariffs against imported solar panels.
The announcement knocked the Solar ETF share price down 15%… and the stock remains below its January highs.
A few weeks later, on February 28, the president announced his intention to levy tariffs on imported steel and aluminum. That was when the financial markets caught a whiff of the president’s intentions… and when the shares of numerous mining stocks took a tumble.
For example, the stock of Brazilian iron ore producer Vale (NYSE: VALE) had been moving up nicely and had just reached a new 3 1/2-year high. But the tariff announcement knocked the stock down 15% over the following month.
It managed to recoup those losses and make a new 3 1/2-year high in May. But the most recent trade war banter between the U.S. and China has knocked the stock down 15% for a second time.
Numerous metal mining companies have suffered a similar fate recently. The entire resources sector has been straining under the weight of trade war salvos between the U.S. and various trading partners.
More broadly, stocks don’t like tariffs very much… and they certainly don’t like trade wars. That is one of the clearest lessons of history… including the history of the last two weeks.
Since June 11, global stock markets have lost more than $2 trillion of market value.
For perspective, the total bilateral merchandise trade between the U.S. and China amounts to just $636 billion. So even if both governments levied a 15% tariff on every single imported item, the governments would reap less than $100 billion, or less than one-twentieth of what global markets have lost in the last two weeks.
When tariffs go up… stocks go down. That has been the recent pattern in the stock market… and, not surprisingly, that has been the pattern in the stock market for many generations.
As I pointed out previously, in 1930, two U.S. senators, Reed Smoot and Willis Hawley, sponsored a bill to impose heavy tariffs on more than 20,000 imported goods. Their bill became the law of the land on June 17, 1930. The stock market collapsed almost immediately, and within just two years, the market had plummeted more than 80%.
The Smoot-Hawley tariffs do not deserve all of the blame for this epic collapse… nor for the Great Depression that followed on the heels of this legislation. But most economic historians believe the Smoot-Hawley tariffs deserve a great deal of the blame for the Great Depression’s severity and duration.
So colossal was the economic disaster that ensued from the Smoot-Hawley Tariff Act, and so severe was the pain these tariffs imposed on the national economy, that Americans have feared trade wars ever since.
Or at least they did until now.
Perhaps the Smoot-Hawley episode is simply ancient history that bears no relevance to our current circumstances. Or perhaps this episode is directly relevant and the lessons it imparts deserve our attention.
As Spanish writer George Santayana once observed, “Those who cannot remember the past are condemned to repeat it.”
Tariffs are a clumsy and unreliable weapon of financial warfare.
Even though China is the intended target of the president’s newest suite of trade tariffs, many U.S. industries could become the unintended casualties.
Investors are also standing in the line of fire.
So if the trade war salvos continue to fly, remember to keep your eyes open and your head down!