“When the final result is expected to be a compromise, it is often prudent to start from an extreme position”
- John Maynard Keynes
President Trump campaigned on a platform of redoing our nation’s trade negotiations, with a focus on NAFTA and our trade deficit with China, so it is not surprising that he is addressing these items in his second year in office. What has caught markets off guard is the speed with which his administration has turned up the heat on trade. After starting with tariffs on steel and aluminum imports from a select few countries in February, the administration announced this week that it was prepared to impose tariffs on another $200 billion worth of Chinese goods.
With a 24/7 news cycle that feeds each announcement of tariff proposals to our smart phones in real time, it’s hard to ignore the stock market whiplash that comes along with each threat of greater tariffs.
Yet in the midst of increasing hostility towards current trade agreements, it is important to keep context on both the prior actions of the current administration and the scope of negotiations. We thought the following commentary from the Chief Investment Officer at Oppenheimer Fund’s, Krishna Memani, offered a good perspective on the administration’s approach to negotiations:
“While the Trump administration’s rhetoric on trade is becoming problematic, do you remember President Trump’s famous “fire and fury” language that warned Kim Jong Un of the consequences of acting on his threats? Fast forward to the Singapore summit, complete with pictures of a denuclearization of the Korean peninsula in hand and the two principals virtually hugging each other. The rhetoric of fire and fury raining down on North Korea was a negotiating tactic, nothing more.”
When President Trump tweeted out that ‘fire and fury’ would come down upon North Korea, the immediate reactions assumed we were on the precipice of nuclear war, not a working lunch in Singapore. The long-run dynamics with North Korea are far from settled, but the current state of affairs is much calmer than the extreme position from which President Trump started.
Second, with respect to the scope of the trade negotiations, the U.S. is coming to the table from a position of leverage. In essence, we buy $500 billion worth of goods from China each year, whereas China only buys $130 billion of goods from us. Simply put, they cannot match the U.S. with respect to barriers on goods purchased simply due to the sheer size of the imbalance ($370 billion). Given that dynamic, it is clear that President Trump is initiating his position with ‘fire and fury’, which will likely lead to a more moderate compromise over time.
To be certain, if the U.S. were to move forward with implementing tariffs on every item that we import from China, that would result in inflation, a slowdown in economic growth, and greater volatility in the stock market. Some have cited the Smoot-Hawley tariffs in 1930 as a reference point for the negative effects that a trade war has on the economic cycle. The difference between present day and when Smooth-Hawley was enacted in 1930 is that economic growth is heating up as opposed to deteriorating. Corporate earnings have increased rapidly with the tailwinds of favorable tax reform. A sharp change in global trade terms is a headwind that could hurt earnings growth and is a risk that warrants continued monitoring.
Ultimately, we believe there will continue to be back channel discussions that are conducted on the specific terms of trade. In the end, some concessions may be made that would raise tariffs on Chinese goods, allow greater access to Chinese markets for U.S. products like automobiles, and President Trump will likely claim victory and a great relationship with China. This is the base case that we would expect, though we remain prepared to change our opinion if the facts on the ground change.