Trade wars

RYAN  By Guest Blogger Ryan Lewenza

“Trade wars are good, and easy to win. Example, when we are down $100 billion with a certain country and they get cute, don’t trade anymore-we win big. It’s easy!” – Donald Trump

President Trump’s twitter feed can be breathtaking in its volume and level of craziness, but the tweet above really stood out for me as it goes against almost everything I’ve learned about economics and history. In this week’s blog I discuss the prospect of a Trump-led global trade war and its implications for economic growth and the markets.

Let me start out by saying that I actually agree with Trump’s overarching views on China regarding the massive trade deficit with the US and them stealing intellectual property.

Since China’s entry into the World Trade Organization (WTO) in 2001, the trade deficit with the US has risen nearly fourfold from US$83 billion in 2001 to US$376 billion today. The trade deficit stems from the fact that the US imported US$506 billion worth of goods from China in 2017 while it exported only US$130 billion. In the chart below you can see how this trend has worsened consistently for decades and it really picked after China became a member of the WTO.

There are a number of reasons for this massive trade imbalance but the key ones are: 1) China has a much lower standard of living, which allows companies to pay lower wages; 2) China has pegged its currency to the US for years (only recently loosening this up), which allows them to manipulate their currency making their exports more attractive; and 3) the US has a terrible savings problem and therefore requires foreign nations to fund their deficits and savings shortfall, with the trade deficit being one tool to facilitate this.

US Has a Huge Merchandise Trade Deficit with China

Source: Bloomberg, Turner Investments

Trump’s other key beef with China is their stealing of US intellectual property. China has the upper hand with US companies by requiring them to partner up with a Chinese company if it wants to gain access to the large Chinese market. In doing this they cap US ownership of the joint venture at 50% and essentially force US companies to transfer technology and other intellectual property rights to the Chinese joint venture, which in turn, is accessible to the Chinese government. According to the Office of The United States Trade Representative, this costs the US economy between US$225 billion and US$660 billion annually.

Finally, trade with China is not always “free” or “fair” as they impose sizable tariffs on many foreign products. For example, China imposes a 25% tariff on US autos coming into China while the US imposes a much smaller tariff of 2.5%. My uncle, Ken Lewenza, ex-CAW (now Unifor) President brought this to my attention years ago as he felt strongly that North American car manufacturers were at a terrible disadvantage with these high tariffs. He and I don’t agree on much but on this issue we found common ground.

So these are the key issues that Trump is rightly trying to address. My issue with Trump is not his positions, rather how he goes about it and the potential for his impulsive and emotional behavior to have unintended consequences, thus dragging down the US and the global economy and negating many of his pro-growth policies. Here’s a quick list of these potential consequences:

  • The US consumer will feel the brunt of a trade war as they will end up paying higher prices for the goods they consume, much of which come from China.
  • As prices rise this will push inflation higher, which in turn could cause the Federal Reserve to hike interest rates more aggressively. This will lead to higher borrowing costs, provide a headwind to economic growth, and in the worst case scenario could lead to a recession.
  • Globally a trade war would likely lead to weaker economic growth as trade is a major contributor to global growth.
  • And finally a full-out trade war would be greatly destabilizing to the global economy and create significant uncertainty, which is never good for the economy or equity markets. This uncertainty could lead to a compression of equity multiples (i.e., P/Es) and lower stock prices

A Trade War Could Lead to Higher Inflation and Interest Rates

Source: Bloomberg, Turner Investments

Trump and his supporters like to tout his deal-making abilities and negotiating skills. Well he’s going to need them bigtime if he wants to address these issues and get a better deal for the US. So far his tactics are yielding mixed results as China has declared they are going to fight this tooth and nail while also signaling some openness to these grievances.

Chinese President Xi Jinping made an important speech this week laying out his plans for their economy and the changes they intend to make to help address these issues. Specifically he said China will look to significantly lower tariffs on automobiles, ease restrictions on foreign financial firms operating in China and step up enforcement of intellectual property rights protection. The markets liked this, rallying sharply on the news. Hopefully Trump will accept the olive branch that China has extended and can get to work on addressing these issues while not going off the rails and continuing down this path of an all-out trade war, where few people actually win despite his tweet proclamation that “trade wars are good, and easy to win”.

Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.