*We’ve been focusing on politics much more than normal because these are highly abnormal times. The U.S. presidency usually has very little impact on the U.S. stock market. But Trump is not a run-of-the-mill president. In fact, he has probably impacted stocks more than any president since Teddy Roosevelt.
We are concerned about a trade war because of its impact on the financial markets. However, this will be a very unconventional trade war (not what most people think).
How Trump can fight a trade war
Before we predict whether Trump will fight a trade war, let’s look at HOW he can do so if he chooses. Trump has a few primary targets:
*Japan has already let Trump walk all over it.
Everyone knows that Trump cannot put up standard tariffs or “a big border tax”. Doing so would require Congress, and neither Democrats nor many Republicans will support the tariffs. So this is out of the question, no matter how loudly Trump threatens e.g. Mexico with a border tax.
However, there are ways for Trump to enact tariffs or tariff-like taxes without Congress.
- The least likely method was first brought to our attention by CNN. Using the International Emergency Economic Powers Act of 1977, the president can levy tariffs on another country during a “national emergency”, regardless of free trade agreements (e.g. NAFTA). The definition of an “emergency” is vague, and can include “losing manufacturing jobs to other nations”. Although courts have never rejected a president’s reasoning, we think they will this time. The federal court system is very liberal and will most likely block this (look at the courts’ reasoning for blocking Trump’s immigration orders).
- According to CNN, Trump’s 2nd method is to use the Trade Act of 1974, Section 122. It allows the president to impose tariffs for “national security” reasons e.g. lost jobs. This tariff can only go up to 15% and needs to be approved by Congress after 150 days.
- Trump has already considered using the most likely method. Via the Department of Commerce, Trump can declare that industries in other countries are “dumping” their goods on American markets, thereby trading “unfairly”. These anti-dumping tariffs can be enacted without Congressional approval because free trade is only free if it’s “fair” (dumping isn’t allowed).
In fact, Trump is already employing the 3rd method.
Trump had a terrible meeting with Germany chancellor Merkel 2 weeks ago. Trump issued an executive order this week so that the U.S. can conduct a study to see which countries were hurting the U.S.’ balance of trade. Since the U.S. has a trade deficit with most major economic powers, all manufacturing industries around the world are “hurting American interests”. As a result, the U.S. Department of Commerce on Thursday ruled that European (Germany, Austria, Belgium, France, Italy) and Chinese steel producers were dumping their steel onto the U.S. market at unfairly low prices. This means the U.S. (aka Trump) can impose massive steel tariffs without Congress. Germany’s finance minister Sigmar Gabriel urged the EU to file a complaint with the WTO over this matter.
There’s a reason why these anti-dumping tariffs are so potent. Trump’s big target is China. Anti-dumping laws primarily impact heavy industry products such as steel. China’s export economy is heavily reliant on heavy industry products. Thus, these anti-dumping tariffs will hurt China more than anyone.
The odds of Trump starting an unconventional trade war
Secretary of the Treasury Mnuchin has repeatedly stated that “even Trump himself isn’t sure whether he wants to levy tariffs”. We believe he is telling the truth. Ideally, all foreign nations would agree to Trump’s demands so that trade wars are avoided. But if talks break down, Trump will have no choice but to start unconventional trade wars with tactics such as the anti-dumping tariffs. It depends on how his talks with foreign leaders progress.
Let’s analyze the situation. Whether or not Trump fights a trade war depends on 1 factor: will Trump focus solely on domestic policy, or will he act on foreign policy as well?
- If Trump focuses solely on domestic policy, a trade war will not start.
- If Trump acts on foreign policy, a trade war will start. It is inevitable, regardless of Trump’s original intentions. Here’s why.
No other country – Germany, Mexico, China – is wiling to cave into Trump’s demands. Trump always starts with the worst deal possible for the other party.That is his deal-making strategy. But more importantly, other countries have NOTHING TO GAIN by agreeing to Trump’s demands.
Trump’s strategy is simple. “If you (foreign country) don’t concede X, I’ll punish you with Y (e.g. anti-dumping tariff).” But the other country knows that Y (e.g. anti-dumping tariff) is not as bad as a full blown border tax, which they know will not be approved by Congress. Thus, conceding X is worse than punishment Y because Y is not a strong enough. So no foreign country will concede to Trump’s demands, and Trump will have no choice but to start an unconventional trade war.
In short, neither Germany, China, nor Mexico will bow to Trump’s demands. They have nothing to lose by fighting Trump.
The only way to avoid this inevitable trade war is if Trump reduces the scope of his demands. In other words, X (his demands) must be smaller than Y (his punishments). This does not seem to be happening right now. Trump is as stubborn as ever on his foreign policy.
- With Germany, Trump has stuck to his point that “Germany must pay its 2% of GDP to NATO contributions”. Germany has clearly stated that it will not pay its fair share. Why would it want to pay more money than it has to?
- Mexico knows that Trump’s threats are all empty threats. Th U.S. must withdraw from NAFTA before it can put tariffs on Mexico. Congress has control over NAFTA, not Trump. There is no support in Congress for a withdrawal from NAFTA right now.
- China plays perfectly into the anti-dumping scenario described above. China has nothing to gain by conceding to Trump’s demands. In addition, Trump has already said in tweet that “our talk next Friday with Chinese president Xi Jinping will be very tough”.
No one is rolling over that easily. Not even Japan. In the run-up to the Trump-Abe meeting on February 11, Japan had promised it would present Trump with a jobs package for 700k new jobs, thereby creating a $450 billion new market. Nothing came of that deal.
Unlike Japan, China has no choice but to fight the U.S.. Chinese heavy industries are already burdened with an excess supply of e.g. steel, aluminium, and coal (see Reuters). Trump’s demands that China raise its export prices and decrease its exports will only worsen China’s problem. This pain will be worse than Trump’s anti-dumping tariffs. Hence, China will reject Trump’s demands, Trump will levy tariffs, and China will make a complaint to the WTO (just like Germany). That’s a trade war right there.
Some argue that China and the U.S. could strike a deal in which Trump agrees to not target Chinese exports in exchange for Chinese investment in the U.S.. This is unlikely to happen. Japan wants to invest in U.S. infrastructure so that it can export its infrastructure-related technology (e.g. bull trains). There is no way the U.S. will agree to a similar deal with China. China’s infrastructure technology is either stolen or copied. In addition, the U.S. already has strong security concerns regarding Chinese tech. For example, some national security analysts believe that phones made by Chinese companies have a backdoor that allows the Chinese government to hack into.
How this trade war will impact the markets
This will probably cause a small correction in U.S. stocks (e.g. 8% decline?). But since we do not invest based on political decisions, we are still 100% long equities. Political outcomes are hard to predict. Perhaps the ever-changing Trump will reduce his demands on other nations.
In addition, we only avoid the big 15-20%+ declines. It’s unlikely that a trade war will cause the U.S. stock market to crash.
However, this trade war will cause the U.S. dollar to go up and gold/silver to go down. Gold/silver are trying to rise on an inflation theme right now. But when a trade war starts, everyone will forget about inflation.