Trump and TSMC (ii)

Over the weekend The Economist published an article about the administration’s attack on Huawei, denying Taiwan Semiconductor Manufacturing Company (TSMC) the use of US intellectual property in making chips for the Chinese telecom firm. The article basically paralleled my post from the 18th.  And it concluded that the ban could easily end up hurting the US far more than China.  In other words, it’s vintage Trump.

Although I didn’t mention it a week ago, I think it’s interesting to observe the behavior of the US companies affected by the initial order, which prevented them from supplying US-made chips to Huawei.

A basic fact about chip manufacturing is that although the output comes from gigantic, multi-billion dollar factories, the chips themselves are tiny and weigh next to nothing.  Output can easily and cheaply be shipped anywhere.  So plants don’t need to be located near customers.  They are highly automated, so no need for a large nearby workforce, either.  The key variables in locating a fab: areas where there are no earthquakes and where government tax breaks and subsidies are the highest.

Anyway, US firms continued to supply Huawei as usual after the initial directive, just from non-US facilities.

 

My point isn’t about administration ineptitude in taking months to realize this elementary workaround.  It’s that the chipmakers acted as businessmen.  They did what they thought was best for the long-term survival and prosperity of their firms.  Logically, it’s what they should have done as stewards of other peoples money.  More important, it’s what they did do.  That is, we have a reason to think that they will continue in this manner–to at least plan to put their operations out of the reach of Washington.  In addition, they will presumably pressure their suppliers of capital equipment–the semiconductor production equipment makers, some of which are heavily concentrated in the US–to do likewise.

 

 

 

 

 

 

 

delisting Chinese companies in the US

The Senate passed a bill that, as news reports have it, would require that any company traded on a domestic stock exchange establish that it is not controlled by a foreign government.  The bill is being framed as setting accounting standards to protect shareholders and guard against fraud.

My thoughts:

–most US investment disasters are home-grown.  Think Bernie Madoff, Enron, Michael Milken, Henry Blodget.  There are also cases like Moviepass or Blue Apron or Trump Hotels and Casino Resorts, where the major sin is ineptitude.

–the real intention is to deny China access to US capital markets, as well as to cast China as a villain, diverting attention from Trump’s tragic failure to deal with the coronavirus

–there’s a good chance the move will backfire.  The major effect of removing the US from the China equity equation will likely be to restore Hong Kong to front of mind for foreigners’ research and investment into the world’s larges economy.  Also, the more onerous US rules become, the more likely it will be that even investors of average means will begin to move funds abroad.

restricting portfolio investment in China

According to press reports, the Trump administration has ordered a government pension fund not to hold a non-US equity index fund, about 4% of whose value is Chinese stocks, on the grounds that the Chinese shares represent a national security threat.  Because the board of the fund has ignored this order in the past, Trump is asking Congress to remove a majority of its members and replace them with his loyalists.

If there is a conceptual argument for this action it is that buying shares in Chinese publicly-traded companies, albeit indirectly, potentially lowers the firms’ cost of capital, making it easier for them to expand–and that ultimately this expansion might be somehow bad for the US.  This is a real stretch.  As a practical matter, whether this fund owns the index the board figures is best for pensioners or one like it that excludes Chinese shares won’t make much difference, either to China or to the fund.  Why inject politics into the decision, then?

I see three possibilities:

Assuming Congress allows the change of board members, Trump can force the change he wants and has a talking point about taking action against China at a time when others are ignoring him.  Or, the idea may be to establish the principle that Trump can control the fund’s investment decisions.  Maybe then the fund would like to take over a hotel lease in Washington, or a golf club in Scotland, or pump money into an underground coal mine in West Virginia.  Or it could be this is a tiny first step in a plan toward barring all American investors from buying Chinese shares.  If this last, it would likely only result in Americans’ moving investment accounts to, say, Canada, losing Washington tax revenue.

 

 

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?