In March 2018, President Trump issued tariffs on imported steel and aluminum from all nations, but it seemed specifically aimed at China, since special exceptions were given to allies. China responded two weeks later when the tariffs went into effect by placing tariffs on $3 billion of U.S. imports. News outlets and market pundits ran with this, and by now you’ve heard of our escalating “trade war” with China.
Nearly every economist will say that tariffs are never good, and that free trade allows the consumer to access cheaper goods. Regardless of your feelings toward him, most will agree that Trump is fundamentally a different type of president. Figuratively, he threw the first punch in the fight, but keep in mind, we’re also seeing the exercise of negotiations.
In economics, there is the theory of the second best. The theory implies that if it is impossible to remove a particular market distortion, introducing a second (or more) market distortion may partially counteract the first, and lead to a more efficient outcome. Applying this theory, the distortion would be the needed reform at the World Trade Organization, and the second distortion would be the tariffs. However, add in countries that subsidize some industries affected by tariffs and entry restrictions for nationals from certain countries, and this situation, becomes more complicated to analyze.
We’ve long maintained that we believe the tariffs and actions taken by the Trump Administration are part of a negotiation tactic. We believe he wants to reset how international trade deals are structured. The United States has levied complaints with the World Trade Organization regarding China’s “unfair trade practices” when it comes to respecting intellectual property and treating American businesses fairly in joint ventures. Japan, the European Union and Australia have levied similar charges with the World Trade Organization, especially with respect to technology.
The likely outcome will be reform at the World Trade Organization, in how they treat China. China wants to be considered an economically developed nation but also wants favorable treatment from the World Trade Organization as if they’re a developing country—the equivalent of wanting to sit at the adult table but still acting like a child. In reality, China is looking more like a developed nation, but they’re still an economy where a disproportionate amount of their economic activity is driven by investment spending domestically and exports. We believe this will ultimately drive them to act more like a developed nation, lowering their protective tariffs or removing them.
Most recently, we saw Trump offer $12 billion in federal funding as a stop-gap measure to aid farmers affected by the tariffs on pork and soybean products. We believe this is a bandage while the administration works on a broader solution. We feel you cannot have grand scale reform in world trade without some short-term pain. The long-term objective is to get us to a better place for free trade.
Furthermore, we need to keep in mind that our country hasn’t run a trade surplus since the 1970s. It is the trade deficit with China that allows us to go into Best Buy and buy 50” high definition TVs so cheap, and that trade deficit is offset by China buying U.S. Treasury securities.
Hopefully, we’ll see progress in coming months. We believe investors should stay the course with their investments. There is no need to be day trading based on the direction tariffs seem to be going. If you follow the Henssler Ten Year Rule, your liquidity needs should be met for the next 10 years or more, so the short-term pain we may experience with market volatility should not impact your overall strategy.
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