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Update: Trade Wars

By beled | April 26, 2018

Extract from the March 2018 quarterly report:

While Donald Trump’s tariff hikes have triggered trade war fears, it is difficult at this stage to know how far a retaliatory cycle of tariff increases would go. This is because he appears to be using tariff increases or threats thereof as a negotiating tactic to reverse unfair trade practices in the USA’s trading partners. We suspect it is just a negotiating tactic because it is almost certain that Trump and his team of economic advisors are aware of the Smoot-Hawley Tariff Act of 1930 which raised tariffs on over 20 000 US imported goods. The consensus of economists is that the Act exacerbated the great depression of 1929-1933 although the legendary monetarist Milton Friedman believes that tight monetary policy played a greater role. Either way, it appears as if Trump’s negotiating tactics may be working.

Quoting from Investec Wealth and Investment’s note of 11 April: “Say what you like about Trump, but he can be effective! Yesterday China’s leader Xi Jinping pledged a “new phase of opening up” in a keynote address to the Boao Forum for Asia. Effectively he has promised to open his nation’s banking and manufacturing sectors to increased imports and lower foreign ownership levels on manufacturing companies, effectively signalling an effort to defuse a burgeoning trade war. Trump yesterday praised Jinping’s “kind words” on the subject. One wonders how long it would have taken to get China to agree to such shifts in policy if the USA and its western trading partners had adopted a policy of gentle/quiet diplomacy with China on this issue.”

Noting the above, if Trump’s sabre-rattling on tariffs continues to succeed it is quite likely that he will ultimately persuade other countries to lower their trade barriers in line with the US rather than raising them in retaliation. This would be a win-win for global trade but only time will tell whether good sense prevails. If not, and should the cycle of retaliatory tariff increases continue, they would have to rise a long way and broaden greatly in application to abort the current US economic recovery. This is because the average US tariff is still very low (see chart) and exports are only about 12% of US GDP. It is also worth noting that China holds $1.2 trillion in US Treasury Bills which must give the US some leverage too.

We conclude that on the balance of probabilities investors are overreacting to the trade war threat and this, along with fears of rising interest rates, has depressed prices and improved the valuations of certain shares significantly during the quarter.

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