Remember that 5% plunge in S&P 500 futures on election night when it became clear that Trump was going to pull off a surprise victory? That now seems like a distant memory, but it might just be about time to revisit the logic of that selloff.
The selloff was based on fear of the unknown, basically markets didn't really know what kind of President Trump would make. While there were clearly things in his program the markets like (as the subsequent rally testifies), he also raised some concerns, on trade, security, possible conflict of interest and his 'temperament.'
These fears disappeared from sight after a well measured victory speech, and the markets never looked back. But some of the fears might very well reappear shortly, if they not already are. The main fear is Trump's attitude to trade.
Somehow he managed to persuade people of two things:
- Trade is to blame for working class woes.
- He will 'fix' things by slapping tariffs on imports from countries like China and Mexico, and designate the former as a currency 'manipulator.'
We've already taken issue with the first. We think it is odd to single out trade as the great leveler of the US working class, it has played some role, but by no means the main one (as we argued here).
On the second, which we'll shorthand as Trump the protectionist, we guess that people were thinking he wouldn't actually embark on this route.
After all, China is indeed a currency manipulator, but in support of the yuan. In less than two years, the Chinese actually spent a quarter of their forex reserves in defense of the yuan, not trying to manipulate it downwards.
And while there is a case to be made for China engaging in unfair trading practices in a few industries like steel or solar, protectionist measures already have been made in these industries and it's much harder to argue it's generally practicing 'unfair' trade.
More embarrassingly, the protectionist argument of Trump's advisors on trade, most notably Peter Navarro and Wilbur Ross, depends on a rather fundamental error which would flunk students in any economics 101 exam.
They argue that the trade deficits deduct from GDP. It does, but in an accounting sense (this is an accounting identity, as it happens, one that always holds as it derives from how the constituent concepts are defined).
But it most definitely isn't a causal relation, that is reducing the trade deficit doesn't necessarily increase GDP. In fact, depending how it is tried, it could very well reduce, not increase GDP.
As a Business Insider article shows, trying to eliminate the $180B trade deficit in oil does not rise the GDP by the same amount, let alone increase wages by $80B, as the Navarro/Ross logic has it. In fact, slapping prohibitive tariffs on the import will result in lower, not higher GDP and wages.
One would be hard pressed finding any reputable economist agreeing with this as it's simply nonsense. But these people will be in charge of US trade policy in short order. While this could simply be a signaling ploy, but this remains to be seen.
On the one hand, Trump's election victory is in no small measure cemented on the trade issue, but on the other hand, a large swathe of the Republican and business establishment is distinctly pro free-trade.
The markets took notice of Navarro's appointment and we think some anxieties are creeping in as other trial balloons are flying, from CNN:
President-elect Donald Trump's transition team is discussing a proposal to impose tariffs as high as 10% on imports, according to multiple sources. A senior Trump transition official said Thursday the team is mulling up to a 10% tariff aimed at spurring US manufacturing, which could be implemented via executive action or as part of a sweeping tax reform package they would push through Congress. Incoming White House Chief of Staff Reince Priebus floated a 5% tariff on imports in meetings with key Washington players last week, according to two sources who represent business interests in Washington. But the senior transition official who spoke to CNN Thursday on the condition of anonymity said the higher figure is now in play.
This isn't a good idea. It will boost domestic prices, disrupt supply chains and invoke retaliatory actions that will leave everybody worse off.
Then there is the dollar. Trump's reflationary policy platform is not only likely to lead to further rises in the dollar, it could also boost economic growth. Both of which would further increase the US trade deficit and bring additional pressure on the Trump administration to act.
Markets might also be getting nervous as these events could spell the beginning of something much bigger, the end of the liberal world order with its main backer, the US, in full retreat.
There was more of Trump's unpredictability on display when he argued for a substantial increase of US nuclear capability, something which could void existing treaties and/or make some other countries nervous. We're not judging this issue on merit (we're economists), but it is these kinds of bolts from the blue that will provide some antidote to the present market euphoria.
The whole focus on trade is largely a red herring
Yes, it brings disruption, but this is capitalism, which basically is creative destruction. Trade is only one means of destruction and not necessarily the most malign one. The economy is always in flux, there is no creation without destruction.
Automation is responsible for far more job destruction in industry compared to trade, for starters. Only something on the order of 13% of manufacturing job losses are due to trade, the rest is caused by automation, according to a study by Michael J. Hicks and Srikant Devaraj from Ball State University.
Yet nobody in his/her right mind suggests we should abolish, regulate, or slow down automation (and rightly so, needless to say).
And what about innovation? This comes in many forms, new technology, business models, practices, etc. Digital camera's made life very hard for Kodak. Uber is making life hard for regular taxi drivers and driverless cars might eliminate both of them, just to give a few examples.
These developments also create losers, but why these are less deserving than the losers from trade is a mystery to us. Or is it. Why single out the destruction brought by trade?
Well, perhaps because pointing out other types of destruction could delegitimize capitalism itself, or foster calls for a better safety net. Or perhaps with trade one can blame other countries. We don't know exactly, but it's largely a red herring.
Trade, on the whole, is a positive force. Most importantly, it isn't a zero-sum game, that is, our win doesn't necessarily come at the expense of somebody else's loss.
If China sells more to us, they get richer and also start to buy more from us, so both countries can become richer.
The problem of course, is that the cost and benefits aren't evenly spread within economies, there are winners and losers. But, as we've just argued, there are winners and losers from most economic change. Trade is in fact benign as:
- It isn't a zero sum game, in principle, the winners can compensate the losers and still be better off.
- The gains from trade are mostly invisible, they arrive in the form of lower prices for all consumers, while the losses are more visible because they're more concentrated and hence more significant for those involved.
- Protectionism isn't likely to create a better, faster growing economy, nor will it bring the lost manufacturing jobs back. Countries which have embarked on the road of protectionism haven't fared very well, generally.
The markets were in a state of euphoria, but while Trump's platform can be good for stocks (as we suggested before he got elected), his unpredictability and some daft economic ideas like slapping tariffs on imports or designating China as a currency manipulator might keep that euphoria in check.
And based on this, here is an idea how to profit from these two sides of Trump. Volatility is extremely low at the moment, but if we're right, the markets will start swinging a bit more depending on whatever side of Trump temporarily gains the upper hand, only to swing back again.
One could actually buy some options on VIX futures, or long dated futures themselves (which don't suffer as much from time decay as the short end of the spectrum).
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.