The World Of Trade Protectionism And The Resurgence Of Inflation

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Includes: DIA, SPY
by: Lee Hoffman

Summary

The US has exported its inflation.

Consumers benefit and workers suffer.

A fix for the Fed's inability to initiate inflation.

Gaining ground in the recent political comments and debates on both sides of the political fence have offered the concept of US worker suffrage at the hands of "world trade" and the reintroduction of trade tariffs to level the playing field of global trade. It's important here to note the macro dynamics of what has been achieved by exporting manufacturing offshore to benefit from less expensive production.

  • Cheap labor has been the hallmark of the US expansion, starting with importation of skilled, cheap, European immigration.
  • Trade unionization in the northeast drove manufacturing from the pro union states of the Mid-Atlantic and New England to the Southeastern states.
  • Southern states enjoyed great growth at the expense of the northeastern US due to the Right to Work laws largely inhibiting trade unionization.
  • Finally, US manufacturers discover the cheap labor of Mexico and Asia as the pro trade concepts provide for exportation of manufacturing to yet even cheaper labor forces.
  • This inexpensive labor source, coupled with virtual non-existence of other inhibitions of building development (OSHA, ADA, Zoning laws, Engineering and Drainage, Environmental, etc.), provide for even greater reduction of the costs to produce.

The bullet points above provide a timeline and short explanation of the migration of American manufacturing and with it American jobs.

But what was the macro impact on the US. Clearly, the reduction of the costs of basic consumption items in great demand here. Or perhaps more accurately, the "exportation of inflation". Without pressure on wages in key components of the supply chain, the pressure on inflation is weakened. Clearly, in the beginning of this diaspora, the pressure on raw materials were great due to the need for construction in China, and other areas of Asia to construct the factories that were abandoned here in the US as well as in Europe.

Now, however, with demand declined or leveling off, the raw material surge has ended, leaving those developing nations who built their economies on exporting raw materials reeling, and their own nascent consumption of consumer goods dropping along with it, exacerbating the syndrome.

The aforementioned deflationary pressure on the US economy and its predecessor, "exportation of inflation" has allowed the US to increase its tax pressure on its populace without the crippling impact on the citizenry. Funds saved in the market can more easily be absorbed by taxation on all levels of government.

But... what if it all ends. What if suddenly clothing, textiles, automobile parts, shoes, etc., all become subjected to ever increasing amounts of tariffs, prohibitions, restrictions or outright bans? Yes, the ensuing trade war with those countries would ignite, but how much do we actually export to China or Asia, or Mexico, compared to what we consume? How would the gap be filled for the demand?

Clearly, the intent of such actions would be to reignite the domestic manufacturing and jobs that go with them. However, the flip side to this is the incredible inflation that would go with it.

Central bankers here in the US have lamented the tremendous stimulus funds injected into the system which has languished on the balance sheets of companies and lenders as opposed to finding its way into the economy. This, along with the stubborn low inflation (think low growth as well), has mandated the continuation of low interest rates. Corporations faced with little prospects for growth, seek additions to the bottom line by reduction of costs, thereby increasing the motivation to produce offshore.

Perhaps this is nowhere more evident than a recent announcement by three large Indian pharmaceutical producers who have recently announced the opening of production plants here in the US, in New Jersey no less! Why? Because FDA inspections in their Indian based plants resulted in so many fines, closures, and restrictions of their product that it became less expensive to open up here. The regulators (think tariffs) drove them here.

The utilization of tariffs and product banning is NOT free markets left to their own design. It is a clear path to reintroduction of domestic production that has been exported overseas.

The challenge for investors who have been accustomed to this period of low inflation, low growth, is what the impact on the economy would indeed be if the recent warbling of Presidential candidates of the need to punish those countries who have absorbed our former domestic production becomes a clarion call for the initiation of those bans.

The great resurgence of production would be startling. The ensuing inflation that comes with it could, indeed, become even more startling.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.