trade agreements

Surviving A Trade War

© Can Stock Photo / gina_sanders

 The interlocking international trade agreements crafted over the past several decades have all been threatened by recent abrupt changes in U.S. trade policy. Many countries seem to be in the business of threatening retaliatory tariffs, in the name of ‘fair trade.’ When countries engage in rounds of tariff-raising, it is called a trade war.

The human tendency is to expect current conditions to continue. We believe we must strive to think objectively about how things may change, assess possibilities, and be proactive in our decisions and actions.

We can seek to understand the impact of a tariff by examining the case of pickup trucks. The U.S. assesses a 25% tariff on imports of these vehicles1. In practice, this tax collects no money—it simply stops the import of pickup trucks.

Have you noticed how expensive trucks are, relative to cars? This benefits U.S. manufacturers at the expense of consumers, farmers, and businesses small and large which use trucks.

So generally the tariff has the effect of increasing consumer costs and reducing consumer choice, while making profits for a very few companies higher and reducing profits at all truck-using companies by a little bit.

Imagine if other countries retaliated by increasing tariffs on things made by Deere and Caterpillar and Boeing. This would be great for Airbus and Kubota and Claas, which would have less competition in the rest of the world. Foreign consumers, both individuals and companies, would pay more and have less choice. And workers employed in the U.S. by Deere, Caterpillar and Boeing would lose their jobs.

Forget for a moment which countries are charging how much in tariffs on which goods. Any increase, either by other countries or the U.S., increases costs on balance for consumers everywhere and reduces employment overall, in every country.

Typically, in a trade war the economy is depressed because consumers face higher prices so buy fewer goods. Production decreases to match reduced demand. Incomes are lower, jobs are fewer, and profits are slashed. This is why the stock market reacts to potential trade disruptions.

We believe the best approach to investing is to seek the best bargains and avoid stampedes in the market, with a very long time horizon. Chaos produces bargains and opportunities and stampedes; taking the long view may be the best hope for coming out on the far side in better shape.

Diversification may help, but will not eliminate volatility. It is not good fun to see portfolio values go down in the short run—but it is inevitable from time to time. Clients, if you would like to discuss this or anything else, please email us or call.

1Wikipedia, https://en.wikipedia.org/wiki/Chicken_tax. Accessed March 2018.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

A Dangerous Fairy Tale

© Can Stock Photo / andreykuzmin

We have written about the power of narrative—stories—before. Stories help us understand and organize the world, and our lives. But not every narrative is helpful, or positive, or improves things.

Much of our political discourse today revolves around a central narrative that does not stand up to examination. We strive to be nonpolitical at 228 Main. Our clients come from every walk of life, and you run from one end of the political spectrum to the other. But the false narrative going around today has the potential for great mischief in our economy and markets. We therefore must address it.

The general theme is that other countries, both allies and enemies, have sorely abused the United States by crafting trade agreements that our leaders were stupid to sign. This has supposedly gone on for decades, because nobody until now has cared about the working person.

We are “losing” hundreds of billions of dollars every year, the story goes. Our factories and jobs have been stolen. And meanwhile we donate to and defend these countries that have mistreated us so. NAFTA, the World Trade Organization, and other international agreements are allegedly at the heart of our misery.

The mischief rests in the remedies proposed to right these wrongs. Trade deficits will be cut by simply eliminating trade. Retalitory tariffs will straighten out the bad behavior. Students of history or economics know how this ends up: it is the story of the Great Depression.

Here is a competing narrative. The whole world and the U.S. have enjoyed decades of progress and prosperity unparalleled in history. A billion people have been lifted from extreme poverty, more people than ever before are working in America for more money than ever before, unemployment is at a forty year low.2

Trade has helped to make us all richer and our lives better, on the whole. We have been fairly free to purchase the goods and services we want, without regard to origin. Our choices, yours and mine, are what determines the volume of trade between countries.

We have a global system of relatively free trade because enlightened leaders HAVE cared about American workers and American prosperity. Let’s examine some facts:

1. NAFTA hurts us terribly? The United States Gross Domestic Product (GDP) per person is 24% higher than Canada’s, and 205% higher than Mexico. 2 We have added 40 million jobs since NAFTA was signed.1 If they are killing us, why aren’t they richer than us?

2. Our companies can hardly do business in Europe? We sold $501 billion in goods and services there in 2017. Our GDP per person is 19% higher than Germany, 36% higher than France, and 57% higher than Italy. They supposedly have been taking advantage of us for decades, yet we do a lot more business than they do?

3. China is a special case, and the U.S. has legitimate grievances. Although its per person GDP is lower even than Mexico, piracy and lack of protection for patents and trademarks are serious issues. These need to be addressed. But a trade war, or mounting a new regime of tariffs, is the wrong approach. There are other means and mechanisms.

Millions of people in the US and virtually all of our farmers are dependent on exports. Our Fortune 500 companies do about half their business overseas. Retaliatory tariffs, trade embargoes or restrictions will hurt them—and all of us.

Clients, if you would like to discuss this or anything else at greater length, please email us or call. We aren’t looking for political arguments. We do believe we will all be better off if we stop believing harmful fairy tales.

1Federal Reserve Bank of St. Louis.

2All GDP numbers derived from the World Factbook at cia.gov.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The opinions expressed in this material do not necessarily reflect the views of LPL Financial.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.