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How trade wars can lead to recessions

Canada's new tariffs on U.S. goods suggest things are heating up

Photo (c) claffra - Getty Images
The Canadian government has slapped new tariffs on a range of U.S. exports, retaliating for the Trump administration's tariffs on steel and aluminum.

The U.S. tariffs, which took effect last month, hit Canada particularly hard because the U.S. currently gets most of its steel north of the border.

To retaliate, Canada has slapped a 10 percent import tax on more than 80 U.S. exports, mostly food products. The country has also imposed a 25 percent tariff on more than 40 U.S. steel products.

It may not be coincidental that some economists have begun expressing concerns about a possible recession, precisely at the time the U.S. has imposed tariffs on its major trading partners, including Mexico, China, and the European Union.

Warning sign?

The economy is still strong and so are corporate earnings. Unemployment is near a record low. Yet the gap between the yields on the two-year and 10-year Treasury bonds has been narrowing -- often viewed as a sign of an impending recession.

A recession is defined as two consecutive quarters of negative growth, and we haven't had that since the Great Recession, which ended in mid-2009. Some economists think we're overdue, since these business slowdowns occur about every 10 years or so.

A trade war can be a contributing factor, because slapping tariffs on a wide range of products raises prices for consumers all over the world. Companies importing Canadian steel will have to pay more for it. These companies will either have to absorb that extra cost, perhaps laying off employees, or raise its prices.

The same is true for Canadian distributors importing Kentucky bourbon. They'll have to raise the price to cover the tariff, so they'll probably sell less, and therefore import less from the U.S.

Cascading effect

All of this has a cascading effect, as governments around the world essentially raise taxes on businesses and consumers. Commerce tends to slow down, leading to a recession.

It's happened before. In 1929, as the economy was roaring, Congress debated the Smoot-Hawley Tariff Act, which started out as a tariff on agricultural products but was expanded to other imports. After the stock market crashed, Congress passed it by a narrow margin and other countries retaliated.

While economists say it didn't cause the Great Depression, they say it certainly didn't help. It wasn't until 1934 that Congress began to relax some of its protectionist measures, but the economy didn't recover until after World War II.

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