Trump vs The World
It’s been a while since I’ve graced these virtual pages. At least, it feels that way. So settle in and buckle up!
Markets are still coming to grips with the reality of the trade war after many months of complacency.
The first trade war since the 1930s has escalated and may continue for years to come.
Trump may not be done with tariffs. In the days and weeks ahead, we can expect further mentions of tariffs on all Chinese goods entering the US.
If Trump does go ahead with further tariffs, you can expect China to retaliate again, as it did in response to the latest US tariffs.
Initially, the stock market decided the trade war fears were overblown. Inside the Beltway, conventional wisdom said that Trump would reach a deal with China; that all of his tough talk was just a negotiating ploy.
It wasn’t. Agree or disagree with Trump, he means what he says about tariffs and trade.
Trump has never wavered in his belief that China and other countries are taking advantage of the US’s low tariffs to export to the US, hurt US industry, and steal US jobs and intellectual property.
The only reason he didn’t act sooner was because he wanted China to help him reel in North Korea’s nuclear program. But those efforts largely failed, and Trump took off the gloves.
This month, the conventional wisdom proved wrong — again — and the stock market has now been forced to shift its view. Just look at the market reaction since Trump began tweeting that a deal was unlikely earlier this month.
Monday’s losses were particularly heavy after China announced retaliatory tariffs shortly before the market opened (do you think the timing was a coincidence?).
Yesterday, the market recovered some of Monday’s heavy losses. But I don’t place much stock in yesterday’s market rally. There are fundamental differences in the US and Chinese positions that cannot easily be negotiated away.
There’s a big difference between confronting China today versus confronting, say, Japan in the 1980s. Remember when everything was made in Japan and the Japanese were buying up American icons like the Empire State Building and Rockefeller Center?
But today, China has much more leverage than Japan ever had. China is also in a much more adversarial posture towards the US than Japan was. The US basically defends Japan and maintains several military bases on Japanese territory. Despite some local frictions, Japan welcomes the US presence as a counter to Chinese ambitions in the region.
These realities mean that China will not acquiesce but will retaliate for any actions taken by the US. It has already proven that. Next time, the Chinese may choose to retaliate not only with further tariffs of their own, but with other forms of financial warfare. China could also become more aggressive in confronting the US in and around the South China Sea.
With regional tensions already high, the risks of an incident between US and Chinese forces could increase even further.
One of my major theses is that in times of too much debt and too little growth, countries resort first to currency wars and then to trade wars, and then finally to shooting wars to steal growth from trading partners and geopolitical rivals.
The problem with currency wars is that all advantage is temporary and is quickly erased by retaliation. Not only is the world not better off, but it is worse off because of the costs and uncertainty resulting from the currency manipulations. Eventually, the world wakes up to this reality and moves to the trade war stage. Then to the shooting war stage.
This new trade war will get ugly fast and the world economy, which is already slowing, will be collateral damage. Given the trillions in US dollar-denominated debt in emerging markets, a full-scale foreign sovereign debt crisis could be in the making if emerging market countries cannot earn dollars from exports to pay their debts.
Markets still are not fully prepared for this, but you can be. Now is a good time to increase your cash allocation to reduce volatility, and increase your exposure to gold.
Let’s pray the shooting wars are not hot on the heels of this coming trade war.
In the meantime, let’s continue on with today’s Reckoning…
Why tariffs are ‘as American as apple pie’
(and the flaws in free trade ideology)
Listening to hysterical commentary from the mainstream media about President Trump’s tariffs, one would think his policies were in violation of the US Constitution. Nothing could be further from the truth.
America grew rich and powerful from 1787-1962 — a period of 175 years — using tariffs, subsidies and other barriers to trade in order to nurture domestic industry and protect high-paying manufacturing jobs.
In fact, tariffs are as American as apple pie.
Trump is using the same basic playbook that predominated in US policy from George Washington onward. Washington’s Secretary of the Treasury, Alexander Hamilton, drafted a report to Congress called the ‘Report on Manufactures’, presented in 1791. Hamilton proposed that in order to have a strong country, America needed a strong manufacturing base with jobs that taught skills and offered income security.
To achieve this, Hamilton proposed subsidies to US businesses so they could compete successfully against more established UK and European businesses.
These subsidies might include grants of government land or rights of way, purchase orders from the government itself or outright payments. This was a mercantilist system that encouraged a trade surplus and the accumulation of gold reserves.
Hamilton’s plan was later proposed on a broader scale by Kentucky Senator Henry Clay. This new plan began with the Tariff of 1816. Clay’s plan was called the American System. Abraham Lincoln adopted the American System as his platform in the election of 1860, and it became a bedrock principle of the new Republican Party.
The 19th and early 20th centuries were a heyday of the American System. This period was characterised by enormous economic growth and population expansion by the US. The American System was also accompanied mostly by low inflation or even deflation (which increases the purchasing power of everyday citizens), despite occasional financial panics and some inflation during the Civil War.
Trump is simply returning to that tradition.
Against this mercantilist system was a theory of free trade based on comparative advantage, as advocated by British economist David Ricardo in the early 19th century. Ricardo’s theory said that trading nations are endowed with attributes that gave them a relative advantage in producing certain goods versus others.
These attributes could consist of natural resources, climate, population, river systems, education, ports, financial capacity or any other factor of production. Nations should produce those goods as to which they have a natural advantage and trade with other nations for goods where the advantage was not so great.
Countries should specialise in what they do best, and let others also specialise in what they do best. Then countries could simply trade the goods they make for the goods made by others. All sides would be better off because prices would be lower as a result of specialisation in those goods where you have a natural advantage.
It’s a nice theory, often summed up in the idea that American football star Tom Brady should not mow his own lawn because it makes more sense to pay a landscaper while he practices football.
For example, if the UK had an advantage in textile production and Portugal had an advantage in wine production, then the UK and Portugal should trade wool for wine.
But if the theory of comparative advantage were true, Japan would still be exporting tuna fish instead of cars, computers, TVs, steel and much more.
The same can be said of the globalists’ view that capital should flow freely across borders. That might be advantageous in theory, but market manipulation by central banks and rogue actors like Goldman Sachs and big hedge funds make it a treacherous proposition.
The problem with this theory of comparative advantage is that the factors of production are not permanent and they are not immobile.
If labour moves from the countryside to the city in China, then suddenly China has a comparative advantage in cheap labour. If finance capital moves from New York banks to direct foreign investment in Chinese factories, then China has the comparative advantage in capital also.
Before long, China has the advantage in labour and capital, and is running huge trade surpluses with the US, putting Americans out of work and shutting down US factories in the process.
Worse yet, countries such as China can pull comparative advantage out of thin air with government subsidies, exactly as Hamilton proposed 227 years ago. The most famous example of this is Taiwan Semiconductor.
In the 1970s, Taiwan had no comparative advantage in semiconductor production. But with government subsidies to a national champion, today Taiwan Semiconductor is the largest supplier of semiconductors in the world.
When did the US abandon the system that worked so well for so long?
Beginning in 1962, the US turned its back on a successful legacy of protecting its jobs and industry, and embraced the free trade theory. This was done first through the General Agreement on Tariffs and Trade, or GATT, one of the original Bretton Woods institutions in addition to the World Bank and IMF.
Beginning in 1995, the World Trade Organization (WTO) displaced GATT and has been the main venue for US free trade policy ever since. China became a member of WTO on 11 December 2001, but has notoriously broken many WTO rules since joining.
The globalist approach might work if everyone were a free trader and no one resorted to tariffs, subsidies, non-tariff barriers to trade, and theft of intellectual property. Unfortunately, that’s not the world we live in.
We live in a world where the US is a free trade sucker and everyone else breaks the rules. In a world where a few parties are free traders but most are mercantilists, the mercantilists win every time. They are like parasites sucking the free traders dry.
If open trade and open capital flows are flawed ideas, why do elites support them?
The switch in US policy from quasi-mercantilism to free trade was driven partly by academics who embrace the simple version of free trade without understanding the flaws (exemplified by China and Taiwan).
Others understand the flaws in free trade well enough, but value the world at large over the US. Their agenda is to diminish the power of the United States, and the US dollar, in world affairs and to enhance the power of rising nations, especially China.
If several hundred million Chinese can be pulled from poverty by leaving the US market open while China subsidises its companies, imposes its own tariffs, steals intellectual property and limits US foreign direct investment, then that’s fine. If US workers lose their jobs in the process, that’s fine too.
The globalists consider that a form of progress towards their ‘one world’ utopia. They don’t care about the US; they only care about their ‘one world’ vision.
Globalists are often supported by major international firms in the pharmaceutical and other industries that profit from global supply chains even as Americans lose their jobs.
But Trump is a thorn in the globalists’ side. Trump focuses on restoring lost US jobs, even if the cost to China is high. That’s China’s problem, not America’s. Trump’s policy is ‘America First’ and he means it.
Now the battle is heating up again. Whoever wins the war of the globalists versus the nationalists could decide the world system for decades to come.
All the best,