Is Trump Making a Big Mistake on Trade?

Commentary by Steve Lewit, MA Economics

Every action has a reaction. The reaction to Trumps trade policy has caused a reaction in the markets here, and overseas as China begins to retaliate. Volatility in the market was on the rise before Trump’s tariff decision. Now, it’s off the charts; China has done nothing but sit on the sidelines throughout all of Trump’s commentary about their trade policies. Today they’ve moved from the sidelines onto the playing field. Where will this take us? Is this policy a mistake?

Before we go any further, I want every reader to understand that this is NOT a politically motivated commentary.  Frankly, I wish success for every President, for the benefit of each one of us and for our nation.  I’m hoping this commentary will give you some insight and understanding as to what is now happening economically and in the stock markets, so you can settle your emotions and make better financial decisions in the future.

Let’s start with a fundamental understanding of what trade means.  When people or countries trade with each other, there is always a perceived win for both parties once the trade is completed. Trade does not happen if it’s a win-lose transaction. Why? Because trade is a voluntary action. You voluntarily give something away, to get something back. It’s no different for countries.

For example, Americans bought $506 billion worth of goods and services from China in 2017 and China bought $130 billion worth of goods and services from the United States.  Americans got what they wanted and the Chinese got what they wanted.  Both parties win. The ideas that we lose because we buy more from China than what China buys from us is not entirely correct. The proposition Trump tweeted, (see below) demonstrates a basic misunderstanding of how and why trade works. The question is, will that misunderstanding create more problems that it solves?

“When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, 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!”   5:50 AM – Mar 2, 2018 – President Donald Trump: Tweet.

The ideas that we are losing billions of dollars and that trade wars are good, misses the point. Trade always has benefits (even when at a deficit). But, the current and potential turmoil in the markets, along with likely reciprocal repercussions economically, can all lead to a trade war which, as Senator Ben Sasse (R-NEB) said, “No trade war has ever worked.” And, indeed, if you check history, he is correct.

The idea that trade must be a zero-sum game is a reversion to old economic thinking where your Kingdom must buy as much from my Kingdom as my Kingdom buys from you. In other words, you win, and I lose, when I buy more from you and visa-versa.  On the other hand, modern economics thinks otherwise. It understands that some countries can produce product more efficiently than others and that free-trade between those countries is an economic benefit to both.

Trump is correct that there are problems in how fairly (or not) trade is taking place between our countries and, specifically, China. For example; we now know that China subsidizes home-grown industries and that those industries ‘dump’ products on the global market. We also know that the pricing of those products, in many cases, doesn’t even cover their cost of production. China also seeks out U.S. trade secrets and does so in underhanded ways. Historically, there are methods of handling these issues on a product by product basis, and the U.S. has done that for years. Would you say it’s safe to say we have not done a great job of that? In my professional opinion – yes. But the solution lies far from a broad, politically dangerous, trade tariff that will, likely, ignite retaliation as time goes on.

There are other considerations that we need to consider. We must recognize and admit that trade deficits do hurt some workers. There is no doubt about that. When one countries production has an advantage over another, industries have been lost or decimated. The other side of the coin, however, is that what we spend on foreign goods, for the most part, gets circulated throughout the global economy and often ends up back in the U.S. For example, China buys US government debt. If they didn’t, and demand was lower, interest rates would rise further. Another example is that Chinese consumers buy real estate in the United States by purchasing shares of US companies or they invest directly in the U.S. resulting in more jobs here.

The global economy is complex. The idea that a tariff will protect jobs and industries is historically false, not research based and bypasses the total impact of tariffs on all citizens. Sure, taxes on imported cars will benefit auto producers here in the U.S., but those same manufacturers will suffer from the impact of taxes on imported steel. Agricultural communities may gain on one type of crop but lose on another. Plus, there are short-term and long-term considerations. Tariffs always bring short-term unrest and loss. Long-term, it is hoped that trade stabilizes and the nation, as a whole, is in better shape. But, that’s a big “if” so to say. Unfortunately, the impact of all this is going to be higher prices along with some increase in the Federal Reserve interest rates. And, finally, we haven’t even considered the social costs of protecting uncompetitive jobs; a cost which is not to be underestimated.

How will all this impact the stock market? Recent turmoil suggests that if things don’t come ‘round’ right, there is the possibility of far more punishing circumstances as billions of dollars of investments, retirement funds and 401(k)’s are lost in a market on the slide. Remember, the trade wars of the early 1930’s helped trigger, deepen and prolong the Great Depression. Trade wars bring into question the entire political and economic framework that we have developed over the past 100 years. Once there are retaliations on Tariffs, the next will be a questioning of NAFTA and other trade agreements and more specifically, how trade takes place with our allies and our enemies. As industries shift and realign themselves to a new pricing structure, a technically driven unemployment rate will develop as it takes time to restructure and reeducate the job pool. Restructuring industry also requires capital. Will that capital be available and or cost-effective if interest rates continue to rise? These are the dominos that have been set in motion, and, while no-one knows how they will fall, history, research and data indicate they won’t fall well for a vast majority of citizens.

Finally, the question always lingers about just what to do in the face of such unknowns.  I remember asking that question in a very different environment, under very different circumstances when I was a professional tennis player.  I was in a match and my opponent was running me ragged and wiping me off the court. Nothing that I did worked. He had, literally taken the best I had to offer away, and was now in control. I was out of control. Fortunately, we got into a rain delay and I was able to quickly whisper into my coach’s ear.  I said, “Jeff, I’m getting killed out there. What should I do?” He whispered back, “Basics, man, basics!” Now, I didn’t win, but I made it a pretty close match. So, my recommendation to you, about what to do in face of a market and economic world that may be in turmoil is, “Basics, man, basics.”

“The Basics” in investing is to remember these three research-based guidelines:

1. The market always recovers – so don’t panic and sell.
2. Portfolio growth is mostly the result of asset allocation and using all 27 asset classes, (in fact it’s 90% of the reason). Most believe portfolio growth is a result of market timing or buying the right mutual funds or stocks, but this is not the correct method.
3. That Modern Portfolios should include Stocks, Bonds, Alternatives (REITs, Commodities, Managed Futures) and Annuities (Fixed Index) – this is based on the Morningstar’s research. All of which serve to produce Gamma, which is protection and growth over and above what happens within your portfolio.

So, what will happen next? Well, truthfully, no one really knows! But, most of us would agree that war, of any type, unless a very last resort, is rarely a good idea. Any type of war is not ‘easy to win’, but if you have a strong foundation, you can keep almost any house protected against all storms.