Tag: Donald Trump

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How tariffs could break America

“To me, the most beautiful word in the dictionary is tariff….it’s my favorite word.” ~ Donald Trump, October 2024

Americans’ experience with tariffs is mixed. The Smoot-Hawley tariffs of the 1930s prompted retaliatory tariffs and trade barriers from trading partners, causing a collapse in international trade that badly hurt US manufacturers. The tariffs were misguided because, at the time, the US ran large trade surpluses, which made it vulnerable to retaliation.

Now the US runs large trade deficits, of between $60 and $100 billion per month, which makes it far more difficult for trading partners to retaliate effectively.

US Monthly Trade Deficit (billions)

Stephen Miran, Trump’s nominee for chairman of the Council of Economic Advisers, wrote a 40-page “job application” in October. In it, he praises Trump’s past performance with tariffs in 2018 and proposes restructuring the global trade system. However, misguided use of tariffs could damage the US.

Miran proposes implementing import tariffs, mainly targeting those trade partners that run large trade surpluses with the US, notably China. China’s global trade surplus has expanded to more than $100 billion per month, and a large percentage of this trade is with the US.

China: Monthly Trade Surplus

Import Tariffs

A tariff on imports will likely provoke two main responses: retaliatory trade barriers and a stronger Dollar.

Retaliation

We can expect trading partners to erect trade barriers to target politically sensitive industries in the US. In the 1930s, Europe responded with import restrictions on US automobiles, hurting the Ford Motor Company. Nowadays, China will likely restrict exports of critical materials in markets it dominates—like germanium, gallium, and rare earth elements—targeting semiconductors, electric batteries, and defense technologies. Another Chinese favorite is tariffs on agricultural imports like soybeans, targeting mid-west farmers. Electric vehicle imports are another obvious target, particularly Tesla because of Elon Musk’s proximity to the president.

Tesla (TSLA) has fallen 39% from its high in December.

Tesla (TSLA)

The Dollar

The Dollar will likely strengthen if trading partners do not retaliate against increased tariffs. A stronger Dollar will tend to offset the cost of the tariff to consumers, as in 2018-2019, when the Yuan weakened markedly against the Dollar.

Yuan per US Dollar

The result was that the US current account showed little benefit from the 2018-2019 tariffs.

US Current Account Deficit

To the extent that the exchange rate adjusts to absorb the effect of the tariff–so that the Dollar price of the imported goods does not change–the tariff is effectively a tax on the foreign exporter. However, the cost incidence is not that straightforward.

Cost Incidence

A central argument for tariffs is that the exporter, not the US consumer, bears the cost. However, it’s not that simple.

Miran cites a 2019 NBER paper by Cavallo, Gopinath, Neiman and Tang which found that the dollar import price increased by the amount of 2018-2019 tariffs, and that appreciation of the Dollar did little to offset this. “The move in the currency didn’t pass through into import prices.”

Pass Through of Tariffs to Import Prices

While Miran is correct that there may be longer-term adjustments, the study makes an important distinction. US producers responding to retaliatory tariffs on their exports were forced to bear a large percentage of the cost. Export prices for affected goods (red below) fell sharply relative to exports without tariffs (blue).

Affect of Retaliatory Tariffs on Export Prices

The difference is that US agricultural exports were a non-differentiated product with ready substitutes. China imposed a tariff on US soybean imports, comfortable in the knowledge that importers would increase orders from alternative suppliers like Brazil. So US farmers were forced to cut prices to compete.

The tariff cost for differentiated products, with no ready substitutes, such as high-level semiconductors and equipment, is far more likely to be borne by the customer.

Weakening the Dollar

Miran recognizes that the strong Dollar will harm exports and speculates that strategies could be employed to weaken the Dollar. However, that would increase the cost incidence on the consumer.

Efforts to weaken the Dollar would likely undermine its role as the global reserve currency and accelerate the migration of foreign central bank reserves to gold bullion as a reserve asset.

There are three likely negative consequences. First, a falling dollar would reduce foreign support for US Treasury markets, driving up long-term interest rates that would hurt financial markets and the economy.

Second, discouraging direct foreign investment in US financial markets—by tearing up tax treaties, for example —would cause an outflow from mega-cap technology stocks, Treasuries, and other key foreign investment targets. The result could crash financial markets and the economy.

Third, printing Dollars to buy assets in a sovereign wealth fund or other strategies that involve increased fiscal spending are likely to fuel an increase in inflation.

Weakening the Dollar may also involve lowering US interest rates vis-a-vis trading partners. However, this assumes that foreign central banks will not respond in kind and that the Fed will cooperate, ignoring the inflation risk.

Re-industrialization

The aim of tariffs is to create a favorable environment for establishing new industry. However, there are many barriers other than the price of competitive imports.

First, you need a skilled workforce with the education and training required to run new factories. Companies establishing semiconductor foundries in the US, for example, under President Joe Biden’s CHIPS and Science Act, have encountered skills shortages. (The Economist)

Then you need infrastructure. ALCOA, the largest aluminum producer in the US, relocated smelters to Canada because of advantageous electricity costs. CEO Bill Oplinger says the increased tariffs would not entice it to return. (Reuters)

You also need to secure the key materials required to support new industries, whether bauxite to supply aluminum smelters, copper for EVs and turbines, or critical materials–like gallium, germanium, and rare earth elements– for high-tech industry. China has spent the last two decades tying up supply contracts, and the US is a late arrival to the party.

Conclusion

Tariffs on imports will likely provoke retaliatory tariffs from trading partners, which could harm international trade and exact a cost on both economies. The US is in a strong position because of its large trade deficit; so it can inflict greater damage on its competitor. However, we should not ignore other forms of retaliation like restricting access to critical materials, where there are no ready substitutes, and erecting other trade barriers that impose a cost on US exporters.

Under no circumstances should tariffs be placed on imports of goods where there is no readily-available substitute. The US consumer will bear the cost.

The Dollar will also likely strengthen in response to US tariffs on imports, which could partially offset the cost of the tariff to consumers. However, a strong Dollar will reduce the competitiveness of US manufacturers in export markets. Miran speculates that the US may be able to offset this by policies to weaken the Dollar. But you can’t have your cake and eat it too.

Efforts to weaken the Dollar could also undermine its role as the global reserve currency, crash financial markets and the economy, or cause a resurgence of inflation. If not all three.

A strategy to re-industrialize the US economy requires a holistic approach. First, ensure that you build up the necessary skills and resources through a comprehensive education and infrastructure program and secure supplies of key materials. Then, progress to the next stage of establishing the groundwork for a new global trade and currency accord. Ignoring the first stage is like putting the cart before the horse.

An impatient president has surrounded himself with a team unlikely to oppose him. Developing a program to re-industrialize the economy will require skill, patience, and meticulous planning. It could take the better part of a decade, but that seems unlikely to happen.

Acknowledgments

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Regime change in America

This article by Anne Applebaum in The Atlantic is confronting:

There’s a Term for What Trump and Musk Are Doing – How regime change happens in America

She describes the destruction of the 100-year-old US civil service and its replacement with a patronage system in which appointees must demonstrate fealty to a patron—either President Trump or Elon Musk—rather than the Constitution.

Anne has written extensively on autocracies. Her early books include Red Famine: Stalin’s War on Ukraine, Iron Curtain: The Crushing of Eastern Europe 1944–1956, and Gulag: A History, which won the 2004 Pulitzer Prize for nonfiction. She is also the author of the recent New York Times best-sellers Twilight of Democracy and Autocracy, Inc: The Dictators Who Want to Run the World.

Conclusion

We are witnessing the end of an era. The damage done in the next two years is unlikely ever to be restored.

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Big Picture reading: Ukraine

Here is some interesting analysis on Donald Trump and his “peace plan” for Ukraine:

Phillips O’Brien, professor of strategic studies at University of St Andrews, Scotland: What Europe Can do in a Worst-Case Scenario

Nataliya Gumenyuk, Ukrainian journalist and co-founder of The Reckoning Project: Putin’s Ukraine – The End of War and the Price of Russian Occupation

Timothy Snyder, American historian and expert on European history: Crossing a line

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Eleven reasons for optimism in the next decade

This might seem more like a wish list than a forecast — there are always risks that can derail predictions — but we believe these are high probability events over the long-term.

Our timeline is flexible, some events may take longer than a decade while others could occur a lot sooner.

Also, some of the reasons for optimism present both a problem and an opportunity. It depends on which side of the trade you are on.

#1 US Politics

The political divide in the United States is expected to heal after neither President Biden nor his predecessor, and current GOP front-runner Donald Trump, make the ballot in 2024. The first due to concerns over his age and the latter due to legal woes and inability to garner support from the center. A younger, more moderate candidate from the right (Nikki Haley) or left (Gavin Newsom?) is likely to be elected in 2024 and lead the reconciliation process, allowing Congress to focus on long-term challenges rather than political grandstanding.

Nikki Haley
Gavin Newsom

Nikki Haley & Gavin Newsom – Wikipedia

#2 The Rise of Europe

Kaja Kallas

Prime Minister of Estonia, Kaja Kallas – Wikipedia

Europe is expected to rediscover its backbone, led by the example of Eastern European leaders who have long understood the existential threat posed by Russian encroachment. Increased funding and supply of arms to Ukraine will sustain their beleaguered ally. NATO will re-arm, securing its Eastern border but is unlikely to be drawn into a war with Russia.

#3 Decline of the Autocrats

We are past peak-autocrat — when Vladimir Putin announced Russia’s full-scale invasion of Ukraine on February 23, 2022.

Vladimir Putin

Vladimir Putin announces invasion of Ukraine – CNN

Russia

The Russian economy is likely to be drained by the on-going war in Ukraine, with drone attacks on energy infrastructure bleeding Russia’s economy. Demands on the civilian population are expected to rise as oil and gas revenues dwindle.

Fire at an oil storage depot in Klintsy, southern Russia

Fire at an oil storage depot in Klintsy, southern Russia after it was hit by a Ukrainian drone – BBC

China

The CCP’s tenuous hold on power faces three critical challenges. First, an ageing population fueled by the CPP’s disastrous one-child policy (1979-2015) and declining birth rates after the 2020 COVID pandemic — a reaction to totalitarian shutdowns for political ends.

China's birth rate

Second, is the middle-income trap. Failure to overcome the political challenges of redistributing income away from local governments, state-owned enterprises and existing elites will prevent the rise of a consumer economy driven by strong levels of consumption and lower savings by the broad population.

Third, the inevitable demise of autocratic regimes because of their rigidity and inability to adapt to a changing world. Autocratic leaders grow increasingly isolated in an information silo, where subordinates are afraid to convey bad news and instead tell leaders what they want to hear. Poor feedback and doubling down on past failures destroy morale and trust in leadership, leading to a dysfunctional economy.

Iran

Ayatollah Ali Khamenei

Iranian Ayatollah Ali Khamenei – Wikipedia

Demographics are likely to triumph in Iran, with the ageing religious conservatives losing power as their numbers dwindle. The rise of a more moderate, Westernized younger generation is expected to lead to the decline of Iranian-backed extremism and greater stability in the Middle East.

#4 High Inflation

The US federal government is likely to avoid default on its $34 trillion debt, using high inflation to shrink the debt in real terms and boost GDP at the same time.

US Debt to GDP

#5 Negative real interest rates

High inflation and rising nominal Treasury yields would threaten the ability of Treasury to service interest costs on outstanding debt without deficits spiraling out of control. The Fed will be forced to suppress interest rates to save the Treasury market, further fueling high inflation. Negative real interest rates will drive up prices of real assets.

#6 US Dollar

The US Dollar will decline as the US on-shores critical industries and the current account deficit shrinks. Manufacturing jobs are expected to rise as a result — through import substitution and increased exports.

US Current Account

#7 US Treasury Market

USTs are expected to decline as the global reserve asset, motivated by long-term negative real interest rates and shrinking current account deficits.

Foreign Holdings of US Treasuries

Central bank holdings of Gold and commodities are likely to increase as distrust of fiat currencies grows, with no obvious successor to US hegemony.

#7 Nuclear Power

Investment in nuclear power is expected to skyrocket as it is recognized as the only viable long-term alternative to base-load power generated by fossil fuels. Reactors will be primarily fueled by coated uranium fuels (TRISO) that remove the risk of a critical meltdown.

TRISO fuel particles

TRISO particles consist of a uranium, carbon and oxygen fuel kernel encapsulated by three layers of carbon- and ceramic-based materials that prevent the release of radioactive fission products – Energy.gov

Thorium salts are an alternative but the technology lags a long way behind uranium reactors. Nuclear fusion is a wild card, with accelerated development likely as AI is used to solve some of the remaining technological challenges.

#8 Artificial Intelligence (AI)

Scientific advances achieved with the use of AI are expected to be at the forefront in engineering and medicine, while broad productivity gains are likely as implementation of AI applications grows.

#9 Semiconductors

Demand for semiconductors and micro-processor is likely to grow as intelligent devices become the norm across everything from electric vehicles to houses, appliances and devices.

McKinsey projections of Semiconductor Demand

#10 Industrial Commodities

Demand for industrial commodities — lithium, copper, cobalt, graphite, battery-grade nickel, and rare earth elements like neodymium (used in high-power magnets) — are expected to skyrocket as the critical materials content of EVs and other sophisticated devices grows.

Expected supply shortfall by 2030:

Critical Materials - Expected Supply Shortage to achieve Net Zero by 2030

Prices will boom as demand grows, increases in supply necessitate higher marginal costs, and inflation soars.

#11 Stock Market Boom

Stocks are expected to boom, fueled by negative real interest rates, high inflation and productivity gains from AI and nuclear.



Conclusion

There is no cause for complacency — many challenges and pitfalls face developed economies. But we so often focus on the threats that it is easy to lose sight of the fact that the glass is more than half full.

Our long-term strategy is overweight on real assets — stocks, Gold, commodities and industrial real estate — and underweight long duration financial assets like USTs.

Acknowledgements

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S&P 500: Donald Trump and the next recession

Treasury yields continue to fall, with the 10-Year testing long-term lows at 1.50%. A sign that investors are growing increasingly risk averse.

10-Year Treasury Yields

Crude oil prices remain weak; a bearish signal for the global economy. Breach of support at $50/$51 per barrel would warn of a decline to $40.

Nymex Light Crude

Volatility (21-Day) above 1.0% on the S&P 500 is flashing an amber warning. Breakout above 2940 is likely and would signal another test of 3000. But expect stubborn resistance at our 3000 target level.

S&P 500 Volatility

Bearish divergence (13-Trend Index) on the Nasdaq 100 warns of secondary selling pressure. Breach of 7400 would warn of a test of primary support at 7000.

Nasdaq 100

Robert Shiller maintains that Donald Trump is unlikely to survive a recession:

“So far, with his flashy lifestyle, the US president has been a resounding inspiration to many consumers and investors. But his personal narrative is unlikely to survive an economic downturn….the end of confidence in Trump’s narrative is likely to be associated with a recession.

During a recession, people pull back and reassess their views. Consumers spend less, avoiding purchases that can be postponed: a new car, home renovations, and expensive vacations. Businesses spend less on new factories and equipment, and put off hiring. They don’t have to explain their ultimate reasons for doing this. Their gut feelings and emotions can be enough.”

I would go further and argue that Trump’s management style is likely to cause a recession.

Some of the aims the President is attempting, like addressing China’s unfair trade practices, are vitally important to long-term US interests and he should be given credit for tackling them. But his constant hyperbole, erratic behavior, with a constant mix of bouquets and brickbats, and on-again-off-again tactics, has elevated global uncertainty. Consumers are likely to increase savings and cut back on expenditure, while corporations may cut back on hiring and new investment, which could tip the economy into recession.

GDP growth contracted to 2.3% in the second quarter, while growth in hours worked contracted to 0.92% for the year ended July 2019, pointing to further falls in GDP growth for the third quarter.

Real GDP and Hours Worked

August employment figures are due for release next week and will either confirm or allay our fears.

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.

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Hope is not a strategy

Bob Doll’s outlook this week at Nuveen Investments is less bearish than my own:

Trade-related risks seem to be growing. President Trump looks to be holding out hope that the U.S. economy will stay resilient in the face of escalating tariffs and rising tensions. So far, the U.S. economy has not faltered, thanks largely to continued strength in the consumer sector and labor market. But if business confidence crumbles (as it has in parts of Europe), it could lead to serious economic damage…..

The president’s recent actions to delay the implementation of some new tariffs show that he is sensitive to the market impact of his trade policies. But the erratic nature of his on-again, off-again approach adds too policy uncertainty. At this point, we can’t predict the ultimate economic impact from these issues. Our best guess is that the U.S. remains more than a year away from the next recession, but risks are rising. In addition to the solid consumer sector, we don’t see financial stress in the system. Liquidity is still broadly available, and fixed income credit spreads are generally stable outside of the energy sector.

With additional Federal Reserve rate cuts already priced into the markets and bond yields falling sharply, the only catalyst for better equity market performance could be improving global economic data. We hold out hope that the global economy will improve, and still think there is a better-than-even chance of manufacturing activity and export levels to grow. But those improvements will take some time, suggesting equities will remain volatile and vulnerable for now.

Where we seem to differ is on the inevitability of the US-China trade war escalating into full-blown disengagement. This week’s events have not helped.

China’s national English language newspaper, Global Times, under the People’s Daily, announced new tariffs.

Global Times

Followed by an admission that the timing of the announcement was intended to cause maximum disruption to US stock markets.

Global Times

The inevitable Twitter tantrum ensued.

Donald Trump

The President also tweeted “Now the Fed can show their stuff!”

He is deluded if he thinks that the Fed can help him here. The best response would be announcement of a major infrastructure program (not a wall on the Mexican border). Otherwise business confidence will decline due to the increased uncertainty. Business investment will contract as a result and slow employment growth.

Retail sales have shown signs of recovery in recent months but will decline if consumer confidence erodes.

Retail Sales

Especially consumer durables such as light motor vehicles and housing.

Consumer Durables Production

The global economy is already contracting, as indicated by falling crude oil

Nymex Light Crude

…and commodity prices.

DJ-UBS Commodity Index

Volatility (21-Day) is rising as the S&P 500 tests support at 2840. Breach is likely and would test primary support at 2750.

S&P 500 Volatility

Bearish divergence (13-Week Money Flow) on both the S&P 500 and Nasdaq 100 (below) warn of selling pressure. The Nasdaq 100 is likely to test primary support at 7000.

Nasdaq 100

The Russell 2000 Small Caps ETF (IWM) is testing primary support at 146. Follow through below 145 is likely and would signal a primary down-trend.

Russell 2000 Small Caps ETF

Fedex breach of support at 150 would also warn of a primary down-trend and slowing activity in the US economy.

Fedex (FDX)

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value because of elevated risk in the global economy.

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No US-China trade deal

“On Monday, US President Trump told reporters that he would impose tariffs on an additional USD 300 billion of Chinese goods if Xi Jinping doesn’t meet with him in Japan.” ~ Trivium China, June 12, 2019

Trump is doing his best to kill any chance of a trade deal. He is making it impossible for Xi to turn up for a G20 meeting. To do so would be admitting defeat. Kow-towing to Trump would totally undermine Xi’s standing in China.

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President Trump should look in the mirror

President Trump has repeatedly attacked the Fed and his recent appointee Jerome Powell for raising interest rates. In an interview with the Wall Street Journal, the President made clear his displeasure, stating that he sees the FOMC as the biggest risk to the US economy “because I think interest rates are being raised too quickly”.

What the President fails to grasp is that his actions, increasing the budget deficit when the economy is thriving, are the real threat. Alan Kohler recently displayed a chart that sums up the Fed’s predicament.

Unemployment and the Budget Deficit

The budget deficit is normally raised when unemployment is high (the scale of the deficit  is inverted on the above chart to make it easier to compare) in order to stimulate the economy. When unemployment falls then the deficit is lowered to prevent the economy from over-heating and to curb inflation.

At present unemployment is at record lows but Trump’s tax cuts have increased the deficit. The Fed is left with no choice but to steadily increase interest rates in order to prevent inflation from getting out of hand.

Real GDP growth came in at a robust 3.0% for the third quarter, while weekly hours worked are rising.

Real GDP and estimated Weekly Hours Worked

It’s the Fed’s job to remove the punch-bowl before the party gets out of hand.

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The circus in Washington | Bob Doll

We don’t want to make light of the mounting troubles the president faces, but we are more focused on metrics such as consumer and business confidence levels as signs of how much the political turmoil will negatively affect financial markets.

Bob Doll, Nuveen Investments – Weekly Commentary

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