The Difference Between Good Inflation and Bad Inflation

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By Charles Sizemore

It seems that some bad ideas never die.
President Trump rattled the markets last week by unexpectedly announcing his intent to impose a large 25% tariff on imported steel and a 10% tariff on imported aluminum. The market was already trending lower, but the tariff news was enough to make the bottom fall out.
The Dow closed Friday down more than 1,200 points from its highs on the week.
Now, by themselves, I don’t see these two tariffs as being particularly dangerous. Yes, cars and beer cans might get marginally more expensive. But it’s likely that most consumers would never know the difference.
While president, George W. Bush slapped some short-lived tariffs on steel, and Barack Obama did the same with imported Chinese tires.
Most economists agree that both sets of tariffs were mildly negative overall for American employment (jobs gained or saved in the protected industries were lost in other industries due to higher prices) and didn’t really accomplish what they ostensibly set out to accomplish.
The fact that Trump is considering slapping tariffs on steel is a pretty good sign that Bush’s steel tariffs a decade and a half ago did little to revive the domestic industry.
So, it’s not the steel and aluminum tariffs, per se, that caused the market to tank. It’s the fear that something worse is coming: an all-out trade war.
Trump has been known to shoot from the hip, throwing out an extreme idea before eventually reconsidering, backing off, or using it as a negotiating tactic. And based on the market’s action on Monday, it looks like investors are betting that this will be one of those cases. The tariffs may or may not pass, but fears of an all-out trade war seem to be receding.
That’s good. Because contrary to President Trump’s comments, you can never “win” a trade war. There are no winners. Only losers. Trade wars lead to rising prices and lower growth. Or, if you lived through the 1970s, stagflation.
The Fed has been desperate for years to generate a little inflation. The problem is that there are two kinds of inflation… and this is the wrong kind.
Inflation can be “demand-pull” or “cost-push.” Demand-pull is “good” inflation, the kind of inflation the Fed is trying (and mostly failing) to generate. This is inflation that is caused by rising demand. Consider ballooning professional athlete salaries. Stephen Curry makes a staggering $35 million per year playing for the Golden State Warriors because there is high and growing demand to watch him shoot a basketball.
The problem is that tariffs and trade wars don’t create new demand. They simply reduce supply and raise the cost of inputs. This is cost-push inflation, the kind of we had in the 1970s when OPEC restricted energy exports to the West.
A little demand-pull inflation wouldn’t necessarily be bad for the stock market. In fact, it’s the sign of a healthy economy and confident consumers.
But cost-push inflation from trade restriction is a very different animal.
The Dow and S&P 500 lost half their value in the 1973-74 bear market. And the 1930 Smoot-Hawley Tariff – arguably the dumbest financial move in the entire history of the United States of America – turned what might have been a garden variety recession into the Great Depression. The Dow lost 90% of its value before finally bottoming out.
Let’s hope cooler heads prevail and that it doesn’t come to this. I have to believe our leaders aren’t quite stupid enough to go down this particular rabbit hole again. But we should expect higher market volatility to be the norm until there is better visibility here.
In the meantime, you might want to stock up on beer. You know, just in case cans get more expensive.

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