The Quick and Dirty on Tariffs

In light of the recent tariffs -- 25% on imported steel and 10% on imported aluminum -- proposed by President Trump, this week's Industry Focus: Energy is all about tariffs. Host Sarah Priestley and Motley Fool contributor Dan Kline explain how tariffs work (and don't work) in general and what this one is probably going to do to the U.S. economy, citizens, and businesses.

Price increases will make imported steel more expensive, but that doesn't necessarily mean manufacturers will switch to American-made as a result. Though most companies will probably be hurt by this, some are going to see big wins and others will have a mixed bag of results. While the vast majority of reactions to this news have been negative, tariffs aren't always bad, and some have helped companies find their footing and thrive for the long run. Tune in to find out more.

A full transcript follows the video.

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This video was recorded on March 22, 2018.

Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking energy and industrials. It's Thursday, the 22nd of March, and we're going to be talking about tariffs. I'm your host, Sarah Priestley, and joining me in the studio is Motley Fool contributor, Dan Kline. Dan, thank you for coming!

Dan Kline: Thank you for having me!

Priestley: All the way from Florida.

Kline: You have to do something about the weather next time, it's very cold here.

Priestley: [laughs] I'll see what I can do. Yeah, I'm sure that was a big shock. I think we could all use some Florida weather.

Kline: I was going to say, there's cameras and recording stuff in Florida, we could absolutely do it down there.

Priestley: Fool Florida, I'll make the pitch. Yeah, we're going to be talking about tariffs today. Obviously, it's been a big part of the news for the last month. President Trump announced that there will be a tariff of 25% on imported steel, 10% on imported aluminum. It's caused a bit of a frenzy. There's a lot of politicians unhappy about it, a lot of industry experts unhappy about it. His own economic advisor quit rather than give the decision his support. The fuel industry is kind of the only fairly happy party about all of this.

Kline: It's a typical Donald Trump negotiating tactic. Basically, diplomacy is, we both talk, we discuss what we could do to each other, but you work on a compromise and it all happens behind the scenes. The Trump tactic is more to say, "Here's the penalty. Come to me and negotiate a deal to get rid of the penalty."

Priestley: Yep.

Kline: It's effective in real estate, I'm not so sure it's going to be effective on the global stage.

Priestley: We shall see. Yeah, imported steel makes up about a third of the 100 million tons of steel used in the U.S. each year and 90% of the aluminum used. It was all started -- in case anybody is interested in the background -- the Department of Commerce conducted an investigation, they sent several recommendations to President Trump which included, and its most extreme, the suggestion of a 7.7% tariff on aluminum, 24% tariff on steel, and levies the accusation of dumping on China specifically, which we've heard before. This has all come about from the 2014 and 2015 surge that we saw in steel from China. The presentation of this from the Department of Commerce was that this is an issue of national security, and that is how they've been able to pass this. There's a loophole. They could enact this using a provision from 1962 trade law. Which opens us up to questions on precedent.

Kline: This isn't atypical. In the past 9-10 years, between the previous administration and this one, finding back doors to past policy has been an easier path than trying to get things through oppositional Congress. It's weird to think that a Republican Congress would be oppositional to a Republican president, but obviously, if you're in Pennsylvania, a steel tariff is very different compared to if you're in California, which is where a lot of it is being dropped off, a lot of it is being used. So, this was really the only way this could get done, is to find what is essentially a loophole.

Priestley: Yes. The consensus on this has been very negative. A lot of people are not happy. But, it's important to note, tariffs can work, and they have provided protection in the past for a few vulnerable companies or a vulnerable industry. They do come with a lot of costs and risks, and we're going to be talking about those. Dan, outline for us simply, what do you think that President Trump is trying to achieve with this?

Kline: Not to be too disparaging of the president, but he likes to make bold proclamations and he likes to be the guy in charge. He's not the kind of person who's going to go into a back room with a bunch of Chinese diplomats and work out a quiet, "I'll give you this if you give us that." He wants to be the winner here. This is a very pro wrestling tactic of making your threats and then seeing if you can back them up. And arguably, he's trying to protect American jobs. But realistically, he's just trying to win.

Priestley: When he signed the tariff, he said, "Steel is steel. You don't have steel and you don't have a country." And he's right, to a certain extent. Steel is very, very important for so much stuff.

Kline: It is, and you don't want to drive the U.S. steel business out of business. On the other hand, when you raise the price of something, we all saw the Commerce Secretary holding a Budweiser can and saying, it's only two-tenths of a cent, so it won't change the price of a can of beer. It might change the price of a steel anything. There's not a lot little steel things. Steel tends to be very big. So, you take a 25% tariff over anything -- a steel building, a steel plane, whatever it is. Well, of course, a plane would not be mostly steel, that would be very heavy plane. But, that's going to translate into protection for these companies at the expense of American taxpayers.

Priestley: And the Commerce Secretary was accused of this, he was accused of a tax on the average American, and he said the impact would be trivial. He said there's about a ton of steel in a car. The price of a ton of steel is about $700 or so. That's unprocessed, I think. [laughs] So, 25% on that would be a 0.5% increase on a typical $35,000 car. But, that's still 0.5%.

Kline: Yeah. And it's 0.5% across all of the steel things you buy. Even things like a building, when they build a new 30-story housing development, that's a significant amount of money that adds to that cost. So, this isn't trivial. And, the people who support this tend to be the same ones who are against agricultural subsidies to keep American farms afloat, but this is really just doing the same thing in reverse.

Priestley: There's a couple of reasons, mostly, that people are against this. One is jobs. Obviously, the reason this has been put forth is that it's going to save a lot of steel jobs. However, some have predicted that it would lead to a net job loss, essentially, because other industries are going to see price increases. You also have construction, where they may put off development projects.

Kline: And there's going to be retaliation. One in four Boeing planes go to China. China could easily decide to slow down those orders, to buy them someplace else. Other countries aren't just going to say, "Oh, hey, there's a tariff, now I just won't sell stuff to America." There's absolutely going to be jobs lost in the shipping business and in all the trades that make things with steel.

Priestley: Absolutely. So, we're waiting to see the reaction. We've seen some claim about the soybean exports that we give to China, too. But, a lot of this evokes a memory of protectionist measures that have been taken before that haven't been successful. There was a steel protection between 1968-1984. It didn't modernize the industry, and it continued to decline. The key thing about a lot of these trade tariffs and trade protection measures is not so much the end goal to save jobs, but also to allow the industry some breathing room to modernize and become more efficient. Therefore, at the end of the tariffs, they're in a better position to compete. George W. Bush also briefly imposed a 30% tariff on steel in 2002. That got overturned by the World Trade Organization. And this could happen in this instance, too. Overall, there's a lot of negativity.

Kline: I'm not sure he has any intent of this being a long-term tariff. I think we really have to think about, yes, he may implement it out of spite because people say he shouldn't. But, the reality is, it's a negotiating tactic, and we're starting to see a little bit of thawing with saying, maybe Canada, maybe Mexico, there could be long-term exceptions to this. And, I imagine with China, something will happen.

Priestley: I think Canada and Mexico, he's basically said they're exempt. I think we get 25% of imports from our neighbors, and it would not be wise to irritate both of those. Dan, you're more likely to be heard on our Tech and CG shows.

Kline: That's true. We've never done one of these before.

Priestley: No, we haven't. But you have a personal experience, or unique insight, into the industry, because of a former life. Tell us about that.

Kline: Sure. My family owns a ladder and scaffolding company, and for four years I ran a factory and was involved in our other factories. And we made steel scaffolding in New Hampshire. And when we made a steel scaffolding frame in New Hampshire -- I'm going to round off all the numbers just to make it easy -- a typical six-foot frame might cost $100 on a wholesale basis. Maybe it cost us $65 to make it. So, we could import from China the same frame for maybe $30 and sell it for $60.

So, we would make U.S. product, but we couldn't sell any of it in the U.S. You can't walk into someplace and say, "I have something that's twice as expensive and 10% better." That's not good. We would use that in our own rental inventory. You say, "Steel is steel." Steel is not steel. The steel made in America, bought here, would hold up longer. Now, you look at it and say, with this tariff, the Chinese scaffolding frame is going to be more expensive, but not so much more expensive that it makes sense to buy the U.S. one. So, in terms of a company like my family business, my former company, they're still going to import steel, they're just going to have to charge more for it or make less money on it. So, it becomes a tax on the construction industry.

The same thing with aluminum. They still make aluminum stages, all different sizes. You'd have to place your order for them to sit on this aluminum, not knowing what size you'd want to cut it too, so it made sense to buy that in the U.S. because changing demand, you had a little bit of pricing flexibility based on how quickly you could get it out. But if somebody said, I need 1007 foot scaffold planks three months from now, you might be able to order the same thing in China and just make more money on it. So, you're going to see that the prices go up, and it's not the ladder company that's going to make more money, it's the aluminum companies and the steel companies.

Priestley: And you're already starting to see steel futures up about 7% this year. I think it's important to note, this tariff particularly, I think it deals with unfinished products. But, you're right, construction, like construction rebar, things that people don't think about that go into making these huge complexes that we're starting to see go up in urban areas, reurbanization is huge, there's so much building going on. For a normal family house, you're probably talking 1% or 0.5% of steel content. For these big sky rises, it's a huge percentage increase.

Kline: It's like we talked about earlier with cars. It's going to hit you so many places where you're not aware of it. I don't think you walk through the city and think, "That's made of steel. That's made of aluminum." That's not how people process. But, these are going to be direct increases. And with what you talked about with investment before, if the steel industry was coming out and saying, "We going to spend the next year modernizing our factories, doing everything we can to take cost out of producing steel," then this might make sense. But, as we've seen with the tax cuts, most of the extra money they make will get returned to shareholders. It's not going to workers and it's not going to modernization. I know I'm speaking very broadly, but I have not seen any pledges for that type of thing to be happening.

Priestley: Not within this industry. We've definitely seen some of the techs giving thousand-dollar bonuses to --

Kline: Yeah, but those are smoke screens. I read the earnings reports for all of the various retailers, and they're reporting pretty significant -- Sears, which would have lost $600 million, made money last quarter because of the tax change. OK, they just needed to keep the lights on. But Walmart giving workers a $1 raise is really just so they don't look too evil in keeping all the money from this.

Priestley: So, we want to kind of have a balanced discussion on this because there's so much negativity out there, so we're going to want to talk about a couple of tariffs that have worked, one most notably being Harley-Davidson in the early 80s. They were facing really tough competition from cheap Japanese imports. Reagan enacted a really swift and very focused tariff, 49% falling to 4% over five years. And this essentially gave Harley-Davidson time to reorganize and improve efficiency. If you translated this to the steel industry, the big-ticket item to watch is their capacity utilization. They could improve capacity utilization. I think it's already up over the last year by about 4%. We could start to see those efficiency gains.

Kline: That's certainly what you hope happens, and that this is just a stall tactic, because the last thing we want to see in the United States is us lose the capacity to create things that we need. That obviously becomes an issue in times of political strife and war. So, propping these industries up does make sense, as long as that's what they do. And the examples of tariffs working are all tied to companies that needed breathing room, as you said earlier. Here, I'm not sure any of that was thought out. Hopefully the industry will take it as what it is and realize that this is not a forever tax.

Priestley: Yes, it's an opportunity, essentially. And the thing is, as soon as you mention protectionist measures, people get very angry. But, the thing is, they are enacted across the world, and we probably don't even realize it. American farmers exporting to the E.U. face a 14% tariff. That's 3X what it is in reverse.

Kline: We were actually, on the writing side of things, looking at doing, "These are the tariffs that are in effect now."

Priestley: That you don't even know about, yeah.

Kline: It's so big that you can't even penetrate the list. Down to very specific things, like, we've talked about before, you cannot import chocolate from England.

Priestley: Which is such a shame.

Kline: Finished Cadbury, you have to make it here. It is such a shame. It's a protectionism measure to keep the factories here going. And it's a different recipe, and yes, it's much better in England. But, there's tariffs in all sorts of areas. But, this is very public, and what you have to worry about is reprisal.

Priestley: Yeah, absolutely. And as you rightly pointed out, the President said a strong steel and aluminum industry are vital to our national security. If the goal is national security, if it's that we can build planes and ships in the event of a national emergency, that's a well-defined objective. If, however, it's to improve U.S. manufacturing jobs, a lot of other stuff has to happen before that can be realized. The dollar has to fall further, U.S. consumers have to stop buying so much imported stuff.

Kline: And the reality is, if the steel industry does invest, they will probably need less people. Factories, the more they're automated, the better they produce. And there's a huge investment and upfront cost in doing that. So, if the steel industry was really doing everything right, they would be looking at how they could take people out of the process. So, this is not a job protection measure. It really is an industry protection measure.

Priestley: And we import so much stuff, there's a lot of other countries, if you take Japan or China or Germany, they save so much more and buy so much less. I think you really have to have a big cultural shift before people change their way of thinking. So, obviously, we've touched on some companies and industries that are going to be affected by this. Steel, very happy. It's been hailed by a lot of steel executives and union leaders. They've promised new investments and restarting multiple mills. [laughs] It's like we said.

Kline: [laughs] Yeah.

Priestley: It's how well-targeted that is. U.S. Steel, ticker X, they're up 10% year to date. They're reopening one of two idled Granite City blast furnaces in Illinois. Nucor, ticker NUE, they're up 5%. They've said tariffs will pave the way for their own expansion plans, and they've followed this up, announcing that they're building a new mill in your state, Florida, which would employ about 250 people. Now, Nucor uses electrical mini-mills which are easy to switch on and switch off, so they're bound to be a lot more competitive, whereas you have AK Steel, who fell almost 50% last year, they're actually sitting out this rally. The issue is they use conventional blast furnaces. Much harder to remain competitive. So, maybe, it's as you said about looking at your processes and learning and working out, how can we invest to become more efficient?

Kline: A lot of the industries -- I'll go back to my family business. Ladders used to be made in the United States. For a long time, they were made in Mexico, because they didn't automate, they just used cheaper labor. Now, ladders are made largely in China in completely automated factories. So, you really have to invest, you have to figure out how to do it with the least people possible. And hopefully the benefit of the company being stronger creates jobs in other areas. We're not going to have a new nation of steel workers. That seems very unlikely.

Priestley: Yeah, despite what some people are claiming. So, aside from steel, there's been angry reactions from steel-consuming industries, which we've touched on. There are so many. We've already talked about construction. Auto manufacturers. Matt Blunt, who's the president of the American Automotive Policy Council, said, "We're concerned with the unintended consequences the proposal would have, particularly that it will lead to higher prices for steel and aluminum here in the United States." He goes on to say that the U.S. automotive industry supports almost seven million American jobs, and it would put us at a competitive disadvantage. That's a very fair point to make. We've seen other calls from the beer industry. Anheuser-Busch InBev CFO said, about two million jobs depend on the American beer industry, and she urges the Department of Commerce and the U.S. President Trump to reconsider the impact. So, you can see there's very far-reaching. General consensus from businesses across the board is that this is bad. However, anybody looking at a price increase of any amount is going to be --

Kline: And I think it's the companies you haven't heard from. Boeing has been very quiet on this, because the biggest market for planes is not the United States, it's China. So, they're going to have a cost increase and a country that's buying from them that may not want to take the product. So, politically, you can't be for it, you also can't be overly against it. So, I think there's an undercurrent of absolutely, this will benefit certain businesses. But it's going to hurt others. And some will gain in one area and hurt in another. We don't really know exactly how it's going to pay out. Budweiser says that, but you can buy beer in other fashions.

Priestley: [laughs] There's glass bottles. Maybe plastic.

Kline: Maybe glass bottles will go up. Maybe it's time they figure out how to do a box of beer.

Priestley: Oh, wow, that's dangerous. I mean, it's essentially, a lot of industries that it's effecting are cyclical, too. And that's where another problem layers in. You have, auto sales are reaching a peak or plateauing, and in the heavy machinery industry, it's just starting to see a pickup. Caterpillar Director of Investor Relations Amy Campbell said the tariffs would impose a challenge and, again, put Caterpillar at a competitive disadvantage. So, all of these industries that feel themselves at a very vulnerable position are having this added on top of that.

Kline: And I think you're going to see secondary protectionism measures come of this, that where there's unintended consequences, maybe they'll increase tariffs on importing cars. Maybe there will be a tax break to buy a U.S. made car. But, even figuring out what a U.S. made car is has become very tricky because parts are made here, and they're assembled there, and it's very much like omni-channel in retail. It's not pure digital, it's not in-store. But, there's absolutely going to be laws that come about because of this, if the tariffs, in fact, go into long-term effect.

Priestley: Absolutely. We will be waiting to see how this all shakes out.

Kline: We'll be waiting right here.

Priestley: You're not allowed to leave until we find out. But, yeah, very interesting to see how it all plays out. It'll be fascinating to see the global reaction to that, too, because a lot of the people that will be affected by this are actually allies. You've got South Korea, we import from a lot of Europe, a lot of European steel, too.

So, that's it from us today. If you would like to get in touch, please feel free to email us at industryfocus@fool.com, or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thank you, as always, to the marvelous Austin Morgan for mixing the show. For Dan, I'm Sarah Priestley. Thanks for listening and Fool on!

Daniel B. Kline has no position in any of the stocks mentioned. Sarah Priestley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Anheuser-Busch InBev NV. The Motley Fool recommends Nucor. The Motley Fool has a disclosure policy.