Swapping the Goods: How International Trade Affects the U.S. Economy and Markets

Free trade nerds point to economist David Ricardo and his 19th-century theory of comparative advantage, which proved that international trade can benefit all nations involved, even if one of them holds an advantage in the production of all goods. But if international trade is so universally great for everyone, why isn’t the entire world on board? It’s complicated, and it can be messy, involving individual winners and losers among the players—even though the nations may be better off as a whole. Here’s what U.S. investors should know. 

At its heart, international trade refers to the import and export of goods and services across national borders, as dictated by politics, tariffs, and ultimately, demand from end users, according to Patrick O’Hare, chief market analyst at Briefing.com.

Gradually, globalization has opened up the world economy to interconnectedness like never before. Developments in transportation logistics and technology have added to that web, creating a global playing field that can favor some nations over others—such as manufacturing exporters versus those that don’t have that capacity.

So Where Does That Leave the United States?

Last year, the United States ran a trade deficit of more than $616 billion. Even though the nation exported more services than it imported, that surplus was more than offset by massive imports of goods.

“Because we are such a huge consumer economy, we always import more than we export,” O’Hare noted.

With consumer spending contributing 70% to annual gross domestic product (according to data by the Bureau of Economic Analysis), and the country running a big trade deficit because of all the goods Americans import, it’s safe to say that the U.S. consumer is a driving force of the global economy.

It’s also true that Americans in general wish to pay as little as possible for the things they buy, and in recent decades, have become accustomed to cheap goods. Cheaper goods have been made possible by globalization as companies moved manufacturing out of the United States and into locales with cheaper labor, such as China.

Wages in China have been rising, and some manufacturing—such as for apparel—has been leaving for other countries like Vietnam, Indonesia, and Bangladesh. However, China remains the world’s largest manufacturer, followed by the United States and then Japan, Germany, and South Korea, according to 2018 data from the United Nations.

So How Does All This Relate to the Stock Market?

Although many investors and policy makers look to the stock market as the barometer for the nation’s economic health, the market isn’t the economy. But the two are linked. Economic benefit from consumer activity typically translates into corporate earnings for companies selling goods domestically—including those that were made overseas. Multinational companies also benefit from selling goods abroad in markets where the United States has free trade agreements. Because earnings drive the market, that profit can help the Dow Jones Industrial Average ($DJI), S&P 500 Index (SPX), and other indices move higher over time.

When things are going well, free trade can lead to an expansion of the price-to-earnings multiple, and thus a bullish bias in the stock market, O’Hare pointed out.

Why Isn’t Everybody Happy with International Trade?

Globalization remains controversial. Social protests often point to sweatshops where low-wage workers are exploited in less-developed countries to sell products back to developed nations. While that may be great for our standard of living, critics question how great it is for the workers, who might not even be able to afford the T-shirt they’re making.

Critics also argue that the United States has been losing jobs that it might otherwise have retained if it weren’t so reliant on foreign manufacturing. International trade forces U.S. businesses to become more efficient to compete against foreign goods. That can mean painful cost cutting—including, for example, replacing humans with robots.

Even among proponents of free trade, there’s controversy surrounding whether countries treat each other fairly. Keeping free trade fair is one of the reasons that the World Trade Organization was formed, although the international body itself is not without its critics.

One trade dispute that weighed heavily on investors was the battle between China and the United States that involved billions of dollars in tariffs as the United States pressed the Asian nation on intellectual property issues, forced technology transfers, and the U.S. trade deficit.

The two sides reached an interim deal in January 2020. But the coronavirus has reignited worries, partly because of a blame game between the two nations about the origin of the outbreak and partly because of worries that China won’t be able to live up to its end of the trade bargain.

How Could the Coronavirus Affect International Trade?

Even before the coronavirus outbreak, changes were afoot in international trade, O’Hare noted.

There’s been a growing awareness that some U.S. companies have been too reliant on a manufacturing base in China, where there can often be more red tape and arbitrary decisions on allowing companies to operate, he said.

The pandemic’s shutdown of factories in China put a major crimp in global supply chains and brought this reliance into full view.

That could mean an acceleration of U.S. companies looking to diversify their manufacturing base, which could be a detriment to the Chinese economy and a benefit to other Asian nations. Companies may even look to reshore manufacturing to the United States, as some firms have already been doing. But the severe hit to government budgets due to the coronavirus could stymie that effort by reducing the incentives officials can offer companies that want to build domestic plants.

“More companies are going to open their minds to the potential to look beyond China,” O’Hare said. But he also noted that wouldn’t be an overnight process, as it takes time to get approvals in place, build facilities, and train workers.

In the shorter term, consumer spending in the United States has taken a huge hit from stay-at-home orders, putting a drastic dent in global trade flows. It remains to be seen how quickly that segment of the globalized economy will recover.

When the dust settles and economies do recover, the international trade status quo might look a little different than it did before the virus hit. Sometimes the push and pull of politics outweighs the aggregate benefits from trade among nations.