Trump’s world: to Trade or Not to Trade
Dear Clients and Friends,
As we alluded to last week, today we write about President Trump’s economic agenda. Most notably his interest in narrowing our scope of free trade, as well as his plans to implement a border tax to pay for a wall between the US and our Mexican neighbors. I know there are a lot of concerned people out there, and I personally am one of them. This article is not about politics in any way, shape, or form. We will stick solely to facts, advantages, and disadvantages of his proposed policy. Most of our readers are very conscious of our social agenda and commitment to the community, but that must be left out of this particular discussion. Please excuse a lack of criticism of Trump’s social agenda herein. This article is about the economy and our investment philosophy only.
Ironically, as many voters have pointed out, the recent succession of power was not Democratic, but rather indicative of a Republic. In a truly democratic election, the people cast votes. In a republic, the people vote for representatives who cast votes. In both the Bush and Trump presidential elections, the popular vote was lost, yet irrelevant. While this may be of little concern at this juncture, what is notable is Trump’s accusation of three million accounts of voter fraud, every single instance having been cast for Clinton. Trump claims that had this not occurred, Trump would have been victorious in the popular vote as well. The issue herein is that no authority has born witness to more than four possible accounts of voter fraud. Four… versus three million. Another similar concern among economists was raised when Trump proclaimed that the unemployment rate might be as high as 48%. At the time, the two most usable indicators of unemployment, were between near 5% and 11%. Unemployment at the height of the Great Depression was an unprecedented 25% in 1933. Yet Trump claimed unemployment was nearly twice that last year! Again, the concern herein has little to do with unemployment. Among economists’ greatest worries is that Trump and his administration seem to have little interest in facts, or that they are strategically attempting to mislead, either of which spell trouble for the investment markets since such markets are more sensitive to perception than reality in the short run.
Over the last several months, we at MORWM have remained steadfast in our opinion that the economy has been strong. In the face of the August 2015 market correction, and the correction in early 2016, we put faith in our long term opinion of the markets and actually profited, as you all know, by investing more while others were bailing out. Many inquired about profit taking just prior to the election. Although we did reduce risk over the summer, we remained otherwise fully invested due to the metrics we use to evaluate the health of the domestic and global markets in almost all instances. While we have serious concerns regarding the long term sustainability of the recovery, which is now in its 8th year, much of Trump’s policy - including but not limited to tax cuts for the ultra-wealthy, and reduced regulation in the banking and environmental sectors- will likely support further economic expansion, though only in the short term. (Belaboring intended- we are only talking about the short term.)
The big “But” comes with Trump’s trade and tariff policy…
Free trade has been the economic machine that we Americans have relied on for decades. We have also enjoyed and exploited our positon as the global trade leader, albeit while having to endure some of the negative effects that go with it. As we all know, with all good, there will be some bad; for every action, there is a reaction, etc., etc. But for the most part, we have been willing to accept the symptoms and minor ailments of free trade in favor of the grossly disproportionate advantages. Let’s explore the basics of free trade before we continue:
Free Trade means that international trade is left to its natural course without tariffs or other restrictions. Let’s assume that it costs a Floridian farmer $1 to grow one orange, while in Canada (colder climate) it costs $4 to grow one orange. Let’s further pretend that it costs a Canadian farmer $1 to “grow” a block of ice whereas it cost the farmer in Florida $4 to grow a block of ice (We’re in the land of pretend folks, just go with it). In the world of free trade, Canada would grow four blocks of ice for a dollar each, and sell half to Canadians and half to Americans for $2 each, making $4 of profit. Simultaneously, the Floridian farmer would grow four oranges for $1, sell half to us and half to Canada for $2, and they would also make $4 of profit. The problem with this arrangement is that ice growers in Florida will be out of luck. Herein lies the disadvantage of free trade. Even if we tax the Floridian farmer $1 to pay for programs to help the ice farmer to re-establish themselves, we still have $3 of profit. Trump’s policy is based upon the premise that if we tariff Canadian “ice,” this will protect the Floridian ice farmer. This doesn’t actually work in reality due to one of two reasons: A) Even if we put a 100% tariff on Canadian ice, the cost of ice + tariff ($2) is still less than what it cost the Floridian farmer to grow the same block of ice ($4). The result is that the CONSUMER pays more for Canadian ice, or B) The tariff does make Canadian ice more expensive than Floridian ice, so we save the Floridian ice farmer, but every consumer in America is now paying significantly more at the grocery store for ice! Simultaneously, Canada would have reacted with a tariff on oranges, so in reverse, now Canadian consumers are not buying as many Florida oranges, so now the orange farmer feels pain, as well as every American consumer.
Protectionism and taxing foreign goods to help domestic business sounds good on the surface, and is certainly something a presidential nominee can campaign on. I also believe that after decades and decades of a certain aspect of our lives being taken for granted, it’s easier to see the costs than it is to see the benefits. But when we open the hood, there is a lot more at play than “talking” about helping US business. A border tax on imports would likely be paid by consumers, not the foreign manufacturers. “Consider Walmart, which imports about $50 billion in goods each year from China. A 20-percent border tax would cost $10 billion per year, money that would either come from Walmart’s profits or (more likely) its customers’ pockets, in the form of higher prices. With Walmart’s sales at around $130 billion, that $10 billion would represent price increases of more than 7 percent. This would hit the poorest Americans the hardest—in many cases, wiping out the past three years of wage growth in one shot. What would this do to confidence and consumer spending growth—and by extension, the economy as a whole? The U.S. auto industry depends on Mexican factories and parts. If costs go up, so do car prices. If the border becomes less efficient, so do the auto companies. This hurts U.S. workers, who will be paying more for cars, and who may be working less due to parts shortages. It hurts companies, who will be making fewer cars and less money. Of course, it will also hurt Mexico, making it a far less accommodating neighbor. Extending this strategy to China would only exacerbate the damage.”
While we import a lot from Mexico, we also export a lot as well. We import $291 billion of goods from Mexico while we export $236 billion, but our population is nearly 2.5x the size. While dollar for dollar we are at a deficit, if you calibrate that according to population, we are at an enormous gain. So toying with NAFTA is like playing with fire.
There are also subjective effects of this closed door trade policy as well. We at MORWM wrote a lengthy article several months ago about the Transpacific Trade Partnership. This article highlighted the social concerns we have, which were possibly short term though substantial, as well as the economic effects of the TPP which would be long term and possibly very beneficial to the citizens of third world countries involved. While these were heavy and conflicting considerations, what we do know now is that our withdrawal from the TPP has eliminated the ability for the US to be the center point and most powerful participant in the Asian economic system. For better or for worse, our volume at the negotiating table with China has just been muted.
So, what do we do? Well, I started this conversation by indicating that this article is about investing, not politics nor social good. MOR Wealth Management spends endless hours ensuring that we are providing social good in the community (Final result for 2016: 13% of profits went to charity!! That’s not a typo folks- thirteen percent). So as we contemplate our investment position, with all the economic evaluation we’ve done, we have come to a few very simple conclusions. Many of you may be bored by this article already, and may find our conclusion even more boring. Others may criticize or even condemn us for lack of commitment at this juncture. But this is what we know, not what we guess:
According to metrics, the economy is as healthy today as it’s been at any time since the financial meltdown of 2008, and this includes metrics ranging from unemployment (no matter which metric you use) to the producer price index, to consumer confidence, etc. It also includes metrics from Europe. Yes, there are problematic places, as there will always be. But by and large, the economy, in the absence of Trump related considerations (yes, I said that), is solid.Trump cannot simply implement a border tariff just because he says so. It requires congressional support in a governmental system built on three (not one) departments of governance.The market is up considerably since Trump won the election, so even with 2000 point decline on the Dow, that brings us back only to the day before the election! When framed in that light, it certainly changes peoples’ perceptions.Statistically we know that far more money has been lost trying to anticipate market corrections than has been lost during corrections themselves. This is why all of our clients are inherently diversified, and our retired clients have portfolios which are far less aggressive and risky than our younger clients- so that we don’t have to worry as much.You have us watching, staring, and obsessing over all of this so that you don’t have to!Our country has never gone more than eleven years without a recession, so folks, Trump or no Trump, more recessions will be experienced in our lifetime. Let’s think about the bargains we will buy when that time comes to pass.
I wish I didn’t have to write about this topic now because as you can see, all I am saying is the following: that I too am scared, we are obsessing over this, we’ve already reduced risk, and will again if we feel compelled to do so. The Dow was at 17,888 the day prior to the election, and its previous all-time high prior to this election was 18,559. It hit 20,000 the other day. Folks, I cannot stress this enough. If the Dow falls 1,000 points, don’t worry. Everyone else will worry and maybe we can cherry pick some profitable moves. Discipline is everything and we commit to you, our readers, and clients, and our family, that we will not break our discipline without due process. We still believe a recession is looming, not because of Trump, but because we believe in obvious things like the natural forces of economics, gravity, and global warming; we’ll save that next topic for another day.
I hope this article was helpful, or at least provides the peace of mind that we are, in fact, obsessing over this topic every single day, and will reduce risk even further when and if the time is right. Let me say again that this article has nothing to do with our social agenda. We are horrified by the possible ill-effects of Trump’s irresponsible intent to reduce environmental and financial regulation, his complete lack of compassion for the LGBT community, and countless other social affairs. Please understand that our opinion about the economy, albeit intertwined, is a wholly separate topic for the purposes of our weekend readings.
We wish everyone a loving and peaceful weekend, and we remind those of you who are like-minded that social responsibility has likely never been more important.
Matt
Matthew Ramer, AIF® Principal, Financial Advisor MOR Wealth Management, LLC
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