Trumponomics and tariffs

Note:  I’ve been writing this in fits and starts over the past couple of weeks.  It doesn’t reflect whatever agreement the US and China made over the past weekend.  (More on that as/when details become available.)  But I’m realizing that it’s better to write something that’s less than perfect instead of nothing at all..  I think the administration’s economic plan, if that’s the right word for a string of ad hoc actions revealed by tweet, will have crucial impacts–mostly negative–for the US and for multinational corporations located here.  I’ll post about that in a day or two.

 

On the plus side, Mr. Trump has been able to get the corporate income tax rate in the US reduced from 35% to 21%, stemming the outflow of US industry to lower tax-rate jurisdictions (meaning just about anyplace else in the world).  Even that has a minus attached, though, since he failed to make good on his campaign pledge to eliminate the carried interest tax dodge that private equity uses.  The tax bill also contained new tax reductions for the ultra-wealthy and left pork-barrel tax relief for politically powerful businesses untouched.

 

At its core, international Trumponomics revolves around the imposition of import duties on other countries in the name of “national security,” on the dubious rationale that anything that increases GDP is a national security matter and that tariffs are an effective mechanism to force other countries to do what we want.  (Oddly, if this is correct, one of Mr. Trump’s first moves was to withdraw the US from the Trans-Pacific Partnership, thereby triggering an escalating series of new tariffs on farm exports to Japan by  our “Patriot Farmers,” many of whom voted for Mr. Trump.  I assume he didn’t know.)

If the Trump tariff policy has a coherent purpose, it seems to me to be:

–to encourage primary industry (like smelting) and manual labor-intensive manufacturing now being done in developing countries to relocate to the US (fat chance, except for strip mining and factories run by robots)

–to encourage advanced manufacturing businesses abroad that serve US customers to build new operations in the US, and

–to retard the development of Chinese tech manufacturing by denying those companies access to US-made components.

 

The results so far:

–the portion of tariffs on imported goods (paid by US importers to the US customs authorities) passed on to consumers has offset (for all but the ultra-wealthy) the extra income from the 2017 tax cuts

–the arbitrary timing and nature of the tariffs Trump is imposing seems to be doing the expected —discouraging industry, foreign and domestic, from building new plants in the US.  BMW, for example, had been planning on building all its luxury cars for export to China here, because US labor costs less than EU labor.  The threat of retaliatory tariffs by China for those imposed by the US made this a non-starter.

–Huawei.  This story is just beginning.  It has a chance of turning really ugly.  For the moment, inferior US snd EU products become more attractive.  Typically, such protection also slows new product development rather than accelerating it.  (Look at the US auto industry of the mid-1970s, a tragic example of this phenomenon.)   US-based tech component suppliers are doing what companies always do in this situation:  they’re  finding ways around the ban:  selling to foreign middlemen who resell to Huawei, or supplying from their non-US factories.  Even if such loopholes remain open, Mr. Trump is establishing that the US can’t be relied on as a tech supplier. Two consequences:  much greater urgency for China to create local substitutes for US products; greater motivation for US-based multinationals to locate intellectual property and manufacturing outside the US.

 

 

 

 

 

 

the Fed’s dilemma

history

From almost my first day in the stock market, domestic macroeconomic policy has been implemented by and large by the Federal Reserve.  Two reasons:  a theoretical argument that fiscal policy is subject to long lead times–that by the time Congress acts to stimulate the economy through increased spending, circumstances will have changed enough to warrant the opposite; and ( my view), until very recently neither Democrats nor Republicans have had coherent or relevant macroeconomic platforms.

If pressed, Wall Streeters would likely say that Washington has historically represented a net drag on the country’s economic performance of, say, 1% yearly, but that it was ok with financial markets if politicians didn’t do anything crazily negative–the Smoot-Hawley tariffs of 1930, for example.

During the Volcker years (1979-87), money policy was severely restrictive because the country was struggling to control runaway inflation spawned by misguided policy decisions of the 1970s (Mr. Nixon pressuring the Fed to keep policy too loose).  Since then, the stock market has operated under the belief that the Fed’s mandate also includes mitigating stock market losses by loosening policy, the so-called Greenspan, Bernanke and Yellen “puts.”

recent past

We’ve learned that monetary policy is not the miracle cure-all that we once thought.  We could have figured this out from Japan’s experience in the 1980s.  But the message came home in spectacular fashion domestically during the financial crisis last decade.  As rates go lower and policy loosens, lots of “extra” money starts sloshing around.   Fixed income managers gravitate toward increasingly arcane and illiquid markets.  In their eagerness to not be left out of the latest fad product, they begin to take on risks they really don’t understand as  well as to forego standard protective covenants.

We could almost hear the sigh of relief from the Fed as the tax bill of 2017, which reduced payments for the ultra-rich and brought the corporate tax rate down to about the world average, passed.  Because the bill was so stimulative, it gave the Fed the chance to raise rates as an offset, meaning it could tamp down the speculative fires.

today

Enter the Trump tariffs.

Two preliminaries:

–tariffs are taxes.  Strictly speaking, importers, not foreign suppliers (as the president maintains (could it be he actually believes this?)) pay them to customs officials.  But the importer tries to ease his pain by asking for price reductions from suppliers and for selling price increases from customers.  How this all settles out depends on who has market power.  In this case,it looks like virtually all the cost will be borne by domestic parties.  Domestic economic growth will slow.  The relevant stock market question is how much of the pain consumers will bear and how much will be concentrated in a reduction of import business profits.

–I think Mr. Trump is correct that the US subsidy of NATO is excessive.  It represents the situation at the end of WWII, when the US left standing–or at best the time when the USSR began to disintegrate into today’s Russia (whose GDP = Pennsylvania + Ohio, or California/2).  I also think that China, with a population five times ours and an economy 1.25x as big as the US (using PPP), is a more serious economic rival than we have seen in decades.  It doesn’t have the post-WWII sense of obligation to us that we have seen elsewhere.  So we have to rethink our relationship.

Having written that, I don’t see that Mr. Trump has even the vaguest clue about how the country should proceed, given these insights.

To my mind, tariffs + retaliation mean both domestic and foreign companies will be reluctant to locate new operations in the US.  Tariffs on Chinese handicrafts may bring industries of the past back to the US, at the same time they force China to increase emphasis on industries of the future.  I don’t get how either of these moves should be a US strategic goal….

the dilemma

The question for the Fed:  should it enable the president’s spate of shoot-yourself-in-the-foot tariff policies by lowering rates?  …or should it let the economy slide into recession, hoping this will jar Congress into action?

 

Trump on trade: unintended consequences?

A straightforward analysis of what Mr. Trump is doing would be:

–tariffs slow overall growth and rearrange it to favor protected industries.  There’s no reason I can see to believe something different might happen in the US

–apart from the third world, protected industries tend to have domestic political clout but to be in economic trouble.  In my experience, these woes come more from bad management than from foreigners’ actions

–the go-it-alone approach is a weak one, since it provides ample scope for a target country to shop tariffed goods through an intermediary

–the apparently arbitrary way the administration is acting will cause both domestic and foreign corporations to reconsider future capital investment in the US.

 

There are, however, two other issues that I think have long-term implications but which aren’t discussed much.

–tariffs may cause industries that have moved abroad to retain labor-intensive work practices (and continue to use dated industrial machinery) in a lower labor-cost environment to return to the home country.  If such firms come back to the US, it won’t be with the old machinery.  New operations will be very highly mechanized. In other words, one likely response to the Trump tariffs will be to accelerate the replacement of humans with robots in the US.

–as I see it, China is at the key stage of economic development where, to grow, it must leave behind labor-intensive work and develop higher value-added industries.  This is very hard to do.  The owners of low value-added enterprises have become very wealthy and powerful.  They employ lots of people.  They have considerable political influence.   And they strongly favor the status quo.  The result is typically that the economy in question plateaus as labor-intensive industries block progress.  In the case of China, however, the threat that the US will effectively deny such firms access to a major market will kickstart progress and deflect blame from Beijing.

 

If I’m correct, the effect of trying to restore WWII-era industry in the US will, ironically, achieve the opposite.  It will accelerate domestic change in the nature of work away from manual labor.  And it will run interference against the status quo in China, allowing Beijing’s efforts to become a cutting-edge industrial power to gather speed.

 

 

slowdown in China

In the late 1970s Deng Xiaoping was forced to tackle the gigantic mess that central planning had made of the Chinese economy during Mao’s rule.  The problem:  highly inefficient, loss-making, corruption-infested, Soviet-style (feel free to add more negative, hyphenated adjectives) state-owned enterprises dominated the industrial base.  The products were poor;  the books more fiction than not.  Deng’s solution was to adopt Western-style capitalism under the banner of “Socialism with Chinese Characteristics.”  This meant pulling the plug on bank credit and political favor for state-owned enterprises and redirecting support toward the private sector.

The result has been 30+ years of economic growth so strong that it has vaulted China from nowhere into first place among world economies.  In fact, the PRC is now 10%+ larger than #2, the US, using Purchasing Power Parity as the yardstick.

According to an astute observer of China, Nicholas Lardy, writing in the Financial Times, however, current Chinese leader Xi Jinping has not simply been cracking down on the cumulative excesses of the private sector over the past couple of years.  He has also reversed Deng’s policy in favor of building up the state-owned sector again.  Lardy thinks this decision is reducing China’s annual GDP growth rate by a whopping two percentage points.

I’m not sure why this is happening.  But for China, the highest economic principle has never been about achieving maximum sustainable GDP growth.  Rather, it’s whatever is necessary to maintain the Communist Party in power.  Reduction in GDP growth is a secondary concern.

 

I don’t know how this affects China’s stance in tariff negotiations with the US, especially since White House economists seem to be suggesting that the US economy is already beginning to contract under the weigh of current tariffs plus the government shutdown   (increased tariffs slated for March will only deepen any decline).  From a longer-term point of view, though–and assuming Chinese policy doesn’t change–for a company to simply have exposure to China will no longer be any guarantee of success.

 

internet companies vs. state-owned enterprises in China

Recently Beijing announced it wants to take equity positions in the major internet companies in China and place Communist Party officials on their boards of directors.

What’s going on?

I see two general possibilities.

Some background first.

Deng’s economic reform

In the late 1970s, Deng Xiaoping realized that the Chinese economy was too big to be controlled through central planning.   To grow it had to adopt Western economic (but not political) methods.  So he began to allow the market, not doctrinally-correct political cadres, to dictate the direction of expansion.

A major issue he faced in doing so was that, say, three-quarters of Chinese industry was owned by the state.  These companies were rudderless, and hopelessly inefficient–but they employed tons of people.  If large numbers lost their jobs all at once, the ensuing social instability might threaten the rule of the Party.  Therefore, economic progress had to be tempered by the need to avoid this outcome.  And this in a nation without sophisticated macroeconomic tools to control the pace of growth.

The result over three+ decades has been a Chinese economy that lurches between boom and bust, depending on the temperature in the state-owned enterprises.  The strategy has generally been successful, I think, with the state-owned sector now representing less than a third of China’s overall output.

possibilities

–China’s internet companies have become large enough that their actions, intentional or not, can accelerate the speed at which state-owned companies shrink.  So they need to be monitored much more carefully than in the past.  This is the benign interpretation, and the one which share prices suggest the market has adopted

–China’s internet companies have become large enough to generate “creative destruction” in large enough amounts to threaten the economic control over China exercised by the Communist Party itself.  If this is the case, then the oversight over domestic internet conglomerates will be much more draconian than the consensus expects.  That would presumably result in considerable PE contraction for the firms being controlled.

My guess is that the first possibility is much more likely to be the case.  But I think we should watch the situation closely for new hints about Beijing’s intentions.

the amazing shrinking dollar

So far this year, the US$ has fallen by about 14% against the €, and around 8% against the ¥ and £.

A substantial portion of this movement is giveback of the sharp dollar appreciation which happened last year after the surprise election of Donald Trump as president.  That was sparked by belief that a non-establishment chief executive would be able to get things done in Washington.  Reform of the income tax system and repair of aging infrastructure were supposed to be high on the agenda, with the resulting fiscal stimulus allowing the Fed to raise interest rates much more aggressively than the consensus had imagined.  Hence, continuing dollar strength on a booming economy and increasing interest rate differentials.

To date, none of that has happened.   So it makes sense that currency traders would begin to reverse their bets on.  However, last year’s move up in the dollar has been more than completely erased and the clear consensus is now on continuing dollar weakness.

 

Dollar weakness has caused stock market investors to shift their portfolios away from domestic-oriented firms toward multinationals and exporters.  This is the standard tactic.  It also makes sense:  a firm with costs in dollars and revenues in euros is in an ideal position at present.

It’s interesting to note, though, that over the weekend China lifted some restrictions imposed last year that limited the ability of its citizens to sell renminbi to buy dollars.

To my mind, this is the first sign that dollar weakness may have gone too far.

It’s too soon, in my view, to react to this possibility.  In particular, the appointment of a new head of the Federal Reserve could play a key role in the currency’s future path, given persistent Republican calls to curtail its independence.  Gary Cohn, the establishment choice, is rumored to have fallen out of favor with Mr. Trump after protesting the latter’s support of neo-Nazis in Charlottesville.

Still, it’s not too early to plot out a potential strategy to benefit from a dollar reversal.

 

 

Jeep as a Chinese brand

A mainland Chinese company, Great Wall Motor of China, has recently expressed interest in acquiring either the Jeep brand + manufacturing operations or all of Fiat/Chrysler.

The press has since been filled with commentary whose thrust is that Washington will oppose either sale proposition.

Several things strike me as odd about this:

–brands like Volvo and Jaguar have looked a lot more interesting recently since coming into Asian hands, so that shouldn’t be an issue (although this is likely the crux of the matter)

Jeep is now part of an Italian company   …which bought it from a German firm that was slowly sinking under the weight of a senescent Chrysler   …which had been foundering despite a government bailout in the 1970s and a huge injection of badly needed engineering talent under Daimler.  So a firmer economic footing for the whole Chrysler enterprise is unlikely to come without outside-the-box thinking.  Also, it’s hard to make a logical argument that foreign ownership for any part of Chrysler is a problem

–if the Great Wall Motor interest is real, it suggests the company has access to foreign exchange at a time when Beijing is cracking down on reckless foreign m&a by domestic corporations.  That likely means that Great Wall has enough influence in China to be able to expand the Jeep brand’s reach quickly

–I haven’t heard a lot of posturing from Washington.  Either I’m really out of touch on this one, or the anti-Great Wall sentiment is mostly in the minds of reporters.