2018 Q2 Legacy Group Commentary

Freeish Trade

In the last commentary we made the following comment: 

Will there be a trade war?  In our opinion, it seems unlikely.  Thus far, the Trump administration’s actions regarding almost any policy have been more measured relative to the President’s rhetoric. This trend appears to be continuing with foreign trade.

Well, the trend broke.  A lot has happened since we wrote those words, and a trade war (we’re not quite sure when a trade dispute becomes a trade war, but we’ll roll with it) is looking more likely.  The temporary exemption of the steel and aluminum tariffs granted to Canada, Mexico and the European Union (EU) expired, and the tariffs went into effect.  In response, Canada threatened to impose tariffs on several products, including ketchup, maple syrup and lawn mowers. Mexico imposed tariffs on $3 billion worth of goods, and the EU responded with tariffs against the US on $3.2 billion in goods.  China’s tariffs against the US went into effect on April 2nd, and soon after that, they listed another set of goods—worth $50 billion of imports—that it says it may place tariffs upon.   

Things don’t look to be slowing down either.  $34 billion of the original $50 billion in goods the US outlined as tariffs went into effect on July 6th, with the rest scheduled to go into effect on July 31st.  The US has now floated the idea of a 10% tariff on another $100 billion to $400 billion of Chinese imports.  If enacted those tariffs will become active sometime in September.  The US is also in the process of researching potential tariffs that would impact Europe’s auto industry. 

Trade disputes have continued and probably won’t be stopping anytime.  Yes, the World Trade Organization (WTO) is still out there trying to regulate free trade but let’s face it…the WTO is basically the home owner’s association for world trade…it works as long as everyone is on board, and right now, that’s not the case.  What will bring this all to a close?  President Trump is still looking for a deal, and until some of these countries come to the table with satisfactory offers, this will probably keep going.  

There is room for some countries to make concessions.  President Trump’s main target, China, is a serial offender when it comes to free trade.  China has used tariffs to protect developing markets.  This tactic has been used by almost every developed nation at some time in history, including the US.  Alexander Hamilton argued for the same structure of protectionism in his book, Report in Manufactures.  His argument was that American industry was up against the much more developed industrial countries of England and other European powers, and in order to build the young American economy, tariffs would need to be placed on key industries.  This concept was shelved for a time, later be resurrected by Henry Clay, and then implemented after the Civil War.  By the time the income tax was passed in the early 20th century, tariffs accounted for 90% of the US government finance.  Many European nations adopted similar policies through 19th and 20th centuries. 

But the problem the US – and much of the rest of the world – has with China is not protective tariffs.  In fact, China only imports about $150 billion of US goods.  They “tax” foreign companies through subsidizing certain industries (such as steel and solar, flooding the market with underpriced product) and requiring businesses to partner with Chinese companies if they wish to sell product in China.  Take General Motors, for instance.  They entered the Chinese markets decades ago but were required to be in joint venture with a Chinese company, where General Motors owned 50% or less. Why does China do this? One alleged reason is to steal technology.  They make the GMs of the world partner with their companies so they can learn how to make better cars.  Those processes are then (allegedly of course, wink-wink-nudge-nudge) passed on to other Chinese companies.  And they do this with virtually every industry, not just high-tech ones.  In order for a company to transport powdered milk (baby formula) into China, the company must provide regulators with the ingredients, a detailed explanation of their process, and even curricula vitae and contact info for employees in their R&D department.  While these practices were less harmful when the Chinese economy was still in its infancy, China is now the 2nd largest economy in the world and has a global presence.  These practices make it difficult for companies to compete, not only in China but also globally.  Because of its presence, China has plenty of room to make concessions regarding these practices without giving up too much. 

In the meantime, the estimated impact these tariffs have on GDP growth, both domestically and internationally, are still benign.  Domestic markets have responded by continuing to post gains for the year. More pressure has been placed on foreign markets, which are in negative territory for the year, but that isn’t just due to tariffs. The dollar has been strengthening, and several emerging market economies—Turkey, Argentina, and Brazil—are struggling right now, which tends to drag down the rest of the emerging market sector.   Regardless of the practical impact, tariffs make for good television.  As long as the rhetoric between nations remains the way it is, the “trade war” will continue to dominate the financial news cycle. While the increasing trade tension may eventually cause us to rethink some of our portfolio allocations, we believe long term trends remain the same. We will diligently continue to look for opportunities to invest capital with an acceptable level of risk.

Blake

Past performance is not a guarantee of future earnings.  Asset allocation does not assure a profit or protect against loss in a declining market.  Blake A. Stanley, CFP® is an Investment Advisor Representative of Legacy Advisory Group, LLC a Registered Investment Advisory Firm.

Join Our Newsletter

Let us know you're human! {captcha}

Latest Blog Posts