What Would a Trade War Mean for Investors?

The United States is close to being in a trade war for the first time since the Great Depression.

In this segment from Industry Focus: Financials, host Michael Douglass and Fool.com contributor Matthew Frankel explain where things stand as of now, and what a full-blown trade war could mean to both consumers and investors.

A full transcript follows the video.

This video was recorded on June 11, 2018.

Michael Douglass: The trade war that appears to be brewing between the United States and a number of other countries, let's say, certainly has some big potential impacts on the financial industry.

Matt Frankel: Yeah, definitely. And whether we're actually in a trade war yet or not is another argument for another day.

Douglass: [laughs] Right. Let's just say, if we end up in one at some point.

Frankel: Yeah, let's just say. Basically, our president's mentality is that it's unfair if certain countries charge us high tariffs on goods and we're not charging the same tariffs in response. And, to be fair, it's tough to make the argument that, say, if another country is charging us 50% tariffs on imported cars and we're charging that same country 5%, it's really a tough argument to make that that's fair. But it's a lot more complex than that. That's what we're getting into now with this back-and-forth on what trades we're going to impose, what countries they're going to be imposed on, who's going to be exempt, and all these things. It seems like we are going in the direction of a trade war.

With that said, the effects of a trade war are generally going to be, life is going to get more expensive. Trade wars generally lead to inflation because the increased tariffs are passed on to consumers. You may have read that other countries are considering retaliatory tariffs on us, which would make some of our products a little bit more expensive. This, in turn, higher prices are also known as inflation, and the Federal Reserve likes to keep a close watch on inflation as one of its triggers for raising interest rates.

So, higher consumer prices can lead to higher interest rates, which could lead to not only an economic slowdown or recession, but it also translates to higher borrowing costs. So, not only are goods and services going to be more expensive, but it's going to cost you more money to borrow for them. So, this could be a very taxing trade war on American consumers' pockets.

Douglass: Yeah. Just to operationalize that a little bit, some things respond directly to interest rate hikes, some things don't. For example, credit card rates usually march in, not precise lockstep, but very close to. The Fed announces a rate hike, credit card rates go up. Pretty much, it's a one-to-one. With, say, mortgages, for example, it's a little bit more tenuous of a relationship. They tend to react a little bit more slowly. But, long-term, those also tend to go with them. Auto loans tend to be a little bit closer to a one-to-one relationship, similar to credit cards. There are definitely a lot of things that could be getting a fair amount more expensive in, let's say, a relatively short-term.

Now, again, one of the big questions here is, do we end up in an actual trade war? There's a lot of saber-rattling going on. What actually ends up happening ultimately? Then, what parts of the economy are affected? There are a lot of different things at play here, in part because we haven't really been in a true trade war since the Great Depression. Now, to be clear, that was during the Great Depression, not before it, so it wasn't necessarily a cause. But the Smoot-Hawley tariffs are generally viewed as a set of regulations that worsened the Great Depression. The other piece to keep in mind there is that it's been almost 90 years since that happened. The world has changed a little bit since the 1930s. So, there are a lot of question marks as we think about that going forward. But, for banks specifically, higher interest rates, generally a good thing, but in this case, not necessarily.

Frankel: Yeah. First of all, like Michael said, most people alive have never lived through a trade war. That's why you're seeing the market jump all over the place every time, will this tariff be announced, will there be retaliatory tariffs. You'll see the market jump a little bit more than you might expect, just because no one really knows what to make of it, especially in the current situation, when we're talking with our allies, talking about putting tariffs on them.

This is not necessarily good news for banks, especially if we see an economic slowdown and things like lending demand drop. That's definitely not a positive thing for the bank. Or, if unemployment starts to pick up because of it, and consumers can't pay their bills, that's a negative for banks. So, there are a lot of reasons why this is not as good news for banks as when, say, interest rates rise because the economy's doing well, as has been a case for the past couple of years.

Douglass: And that's one of the interesting things -- again, taking us back to that earlier conversation about cycles. The economic cycle itself really underlies a lot of these other ones, so when the economy starts, let's say, turning south -- which, inevitably, it will one day, because things can't just expand for forever, much as we all wish they could -- when that happens, the credit cycle starts to turn, basically, banking gets tougher. And that's when banks that have done a really good job of properly managing their credit risk really shine compared to everybody else. That's because everyone's facing a headwind. And that can be a difficult thing across the board.

It's definitely something we're going to want to watch going forward. For obvious reasons, it's very difficult to pick out winners and losers, or even what people should do right now, because it's been so long since we were in a position like this that it's just not clear.

Frankel: Yeah, definitely. It's been a little while since we've had to deal with this. Like you said, we'll see what actually happens with it. Maybe it'll turn out to be a whole lot of talk over not a big problem. And, some tariffs may actually do their job and be a positive catalyst. But we'll see where this goes.