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A Funny Thing Happened On The Way To The Trade War

Tariffs designed to protect American steel and aluminum have led to depressed stock and commodity prices.

It has been a year since President Trump placed tariffs on imported steel and aluminum to protect American producers. Since then, the import taxes have not worked as expected. Rather than driving up the price of the metals and boosting the stock prices of the companies that produce them, prices of both aluminum and steel have declined in the past year. The same is true of the stock prices for steel and aluminum companies.

The intent behind Trump’s protective tariffs was to drive up prices. Increased costs are a feature, not a bug, of protectionism. In theory, the taxes on imports will make foreign products more expensive and allow domestic producers to raise prices and reap more profits in turn. That is not what happened.

In reality, steel prices spiked in the months after the tariffs were implemented and then crashed in late 2018 before rebounding slightly over the past couple of months. Overall, the trend has been slightly downward since the beginning of 2018.

The story is similar for aluminum prices.  There was a spike in April 2018 followed by a long decline to a current price level that is lower than pre-tariff prices.

The slump also applies to stock prices. Steel producers US Steel and Nucor both have stock prices that are far lower than their highs from last spring. The same is true of aluminum producer Alcoa.

So, what happened? The answer seems to be found in decreasing demand. As you may remember from Econ 101’s price curves, as prices go up, demand falls. Fewer goods are sold as prices rise higher.

CNN points out that expectations of rising prices and possible supply problems led to a glut of orders in 2018. This surge in demand led to the price spike last summer and helped steel companies post nice profits.

When faced with rising prices and demand, the steel producers did the logical thing. They boosted production in order to maximize their profits. Some mills reopened and others added capacity, which led to about 9,000 new steel jobs, which reportedly cost American consumers about $900,000 each. Production in the first quarter of 2019 increased by approximately 1 million tons over the same time last year.

That’s when another economic law kicked in: the law of supply and demand. The increased steel output led to another glut, this time in supply. As steel inventories piled up, prices fell drastically.

“We observe that supply exceeded demand … over the last six months,” UBS analyst Andreas Bokkenheuser said. “This explains the corresponding 25% price correction.”

There were other reasons for softening demand as well. Steel purchasers had built up their own inventories, expecting possible interruptions in supply. When those interruptions never materialized, purchasers slowed new orders while they worked through their inventories.

The Fabricators and Manufacturers Association also notes that “steel’s major end-use markets, construction and automotive, show signs of slowing compared to last year.” This softening demand may be due to the trade war’s effects on other manufacturers who use steel and aluminum as a component in their products. Other buyers are watching prices and keeping inventories lean as they prepare to place orders when the price finds a bottom.

Despite the falling prices, US steelmakers are still adding capacity. Per CNN, both US Steel and Nucor are spending billions on projects that will add a combined 2.6 million tons of production capacity in coming years. If other factors remain the same, the new capacity could drive prices even lower. Investors who would have preferred dividends and stock buy-backs voted on the investments in new capacity by selling off stocks.

With the new investments, the American companies will be more dependent on continued tariffs to protect them from foreign competition.

“We’re among the lowest-cost producers. We’re extremely competitive if we’re operating on a level playing field. But there is massive overcapacity of steel from China, multiples of US capacity, and it’s heavily subsidized by the government. That’s led to a very distorted global market for steel,” said Kevin Dempsey, senior vice president of public policy for the American Iron and Steel Institute. “If we lifted the all the tariffs, I think we’d see another flood of imports.”

That is already happening. President Trump announced this week that he would lift tariffs from Canadian and Mexican imports. The US imports far more steel and aluminum from these two North American neighbors than it does from China and the rest of the world.

The bottom line is that the tariffs have failed to protect the steel and aluminum industries and, ironically, have left them more vulnerable than they were before. Steel producers invested their windfall in more capacity which will be of little use in a market with declining prices. As competition from foreign imports returns, the future of American steel and aluminum companies appears to be difficult.

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