Macro Monday - Will Protectionism Be Different This Time?
- Another set of tariffs has allies up in arms this time.
- Are we looking at a trade war and recession, or much ado about nothing?
- Markets are shaky as uncertainty takes center stage.
- An interesting take on oil, inflation and the dollar.
- Subscribers to Margin of Safety Investing received "Macro Monday" earlier in the day.
President Trump announced last week that his administration would be putting a global tariff on steel and aluminum. This comes just days after I published (Editor's Pick) "Welcome To President Trump's Economy And Markets,"which included "protectionism" as one of four key factors in determining where the economy and markets were headed.
The knee-jerk reaction to the tariffs by pundits, academics and European Union mouthpieces were to use the buzzwords "trade war," "retaliation," "recession" and "crash" a lot. Despite President Trump's petulant way of saying things, I'm not so sure that a tariff on steel and aluminum is that big of a deal, or at least maybe it shouldn't be.
Steel and aluminum are clearly strategic industries, there has no doubt been dumping by a handful of global competitors and it shouldn't take much to exempt Canada and Mexico from the tariffs as that's both right and good, so, doing the tariffs in the first place does carry some merit. The fear, of course, is that the Trump administration is clueless and things spiral out of control.
Ultimately, the tariffs might have the most impact on oil prices. This is important because cheap oil is the key "transitory" factor keeping inflation subdued. If oil prices rise to $80, as I have projected, then inflation will rise most likely past the 2% target. That might be just what the Trump administration wants.
The Impact of Protectionism
In general, we know that protectionism is a detriment to global trade and usually results in broad based economic pain. However, the threat of protectionism and in measured amounts can in theory induce even more open markets. That is at least what one of the Trump Administration's stated goals is with the recent tariffs on the strategic industries of solar panels, steel and aluminum (there were also tariffs on washing machines, I am not sure the strategic importance there, clean underwear presumably).
Divining the goals of the Trump Administration is of course difficult as the President comes off as an angry teenager on regular occasion. But, I take at face value a lot of what is being said - what choice do I really have?
I do think the steel and aluminum industries carry strategic defense interests. So, if the President really believes that, to be consistent, he will work out an exemption for our allies Canada and Mexico posthaste as they support our defense infrastructure.
Not only do we benefit from proximity with those two key trade partners, but there is overwhelming economic sense to keeping NAFTA with some minor modifications. A NAFTA deal including exemptions from tariffs makes sense, even if the negotiation tactics are jerky. If a deal is not reached within weeks, or even days, though, then we will have our tip off that something is far more amiss.
If we can not reach exemption deals with Mexico and Canada, then the start of a trade war could in fact be on the horizon. How do we negotiate with anybody else if we can't negotiate with those closest and most important to us? We have had a hint at that with the solar tariffs.
Let me be clear, President Trump's comment that "trade wars are good and easy to win," is so clearly ignorant that it is scary to hear a President of the United States say something like that. It's so ignorant that one has to wonder if he's really that ignorant or "unglued." I guess that's not really clear.
For the President to say something like that, even if you don't like him, you have to think there is another motive. Wholesale changes to trade policy can't be among them, because that would be so disruptive as to be economically destructive and we know that the President values having a strong economy to brag about.
Keeping those he would negotiate with off balance might be a good negotiating strategy. There is massive inertia which keeps America from gaining much in trade deals after decades of helping the rest of the world with soft deals to help them grow.
The President clearly believes it is time for a more level playing field on trade. Does he define that right? I don't know yet, it's hard to know how he defines anything. But maybe, in the end, some improvements at the margins of trade deals can be achieved. And maybe that's all the President is really working for, some minor improvements, something to brag about and eventually a narrative to pitch on his family's media network likely set to launch the minute he is out of office (yeah, that's probably not fake news).
Then again, maybe the President and his man Peter Navarro are just ignorant. That is a distinct possibility. Keep an eye on the NAFTA negotiations, we'll know soon if we should really be scared.
Tariffs, Energy, Inflation and the Dollar
This weekend, in preparing for an appearance with Shale Boom, Shale Bust author and energy analyst Dan Dicker, I updated my energy report "The Peak Oil Plateau"that I have been maintaining since December 2014. In the updated version (available to Margin of Safety Investing members), I discuss the impact of the "Trump tariffs," not only steel and aluminum, but also solar, have on oil and inflation.
Click to enlarge
The tariffs on solar, steel and aluminum are all inflationary on the cost of energy, oil in particular. Because oil is cited as a key transitory reason that inflation is subdued, if oil rises, then inflation rises. Let's break that apart.
The first important tariff was on solar panels. According to Greentech Media, a Wood Mackenzie company, "the U.S. solar market will see a net reduction in installations of around 11 percent as a result of the new tariffs. That translates to a cumulative 61.3 gigawatts of solar deployed over the next five years compared to an original projection of 68.9 gigawatts, for a 7.6-gigawatt reduction in installed solar PV capacity between 2018 and 2022."
Less energy produced by solar will increase the demand, and price, for natural gas for electricity generation. In 2017, manufacturers already sounded the alarm that growing natural gas exports were going to harm their ability to produce in America. Cheap energy has been an offset for higher American wages relative to labor in other nations.
The steel tariff directly impacts the expansion of oil and gas infrastructure. Already the transport of oil and gas out of the critically important Permian Basin is challenged. An increase in steel prices used in tubing and pipes exasperates both the infrastructure problem and drilling in general.
According to CNBC: "When it comes to making pipes of increasing size and more stringent specifications, the number of American providers shrinks quickly. Only eight factories make pipes 30 inches in diameter or larger, and just three churn out pipes that meet certain thickness standards. No American companies make pipes of the highest grade, size and thickness."
As I recently discussed in Here's Why Oil Is Going Much Higher Soon, the Permian is the linchpin to U.S. oil production. If anything disrupts it, then too U.S. oil production, oil workers suffer.
Further, as the tariffs pass through the economy, costs on everything that uses energy, steel or aluminum will see cost increases, so in other words, everything manufactured in the United States will see cost increases.
Already, the U.S. has been seeing inflation pick up. CPI data shows that inflation is trending above 2%. The PPI (Producer Price Index) is up nearly 3%. Anecdotal evidence of increasing costs can be seen in corporate reports, financial articles and now the grocery store where inflation has picked up lately.
In a country where GDP was just revised flat to down, the scary thought of "stagflation" comes to mind. This only seems likely if a trade war breaks out, but that is clearly something we have to monitor now as President Trump continues his assault on the liberal global order.
Ultimately, if the Fed has to be aggressive to fight off rising inflation, such a fight would cause the dollar to rise, which in turn lowers asset prices, particularly financial asset prices.
Coming out of the Global Financial Crisis, Warren Buffett suggested that loose monetary policy would eventually have the side-effect of inflation. He's been wrong about that so far. Even the uptick in inflation now barely overcomes the deflationary forces of aging demographics, global debt and technology. I have discussed those ideas in depth in my articles on "slow growth forever" (which are due for an update).
If we see an uptick of inflation due to tariffs and then a response from the Fed, we could see a resumption of a massive deflationary problem two or three years down the road. Right now, it seems the economy faces a major challenge to avoid both stagflation and deflation, which appear to be coming to a "T intersection" at increasing velocities. I hope we can navigate this intersection without a crash, but we seem to be driving a bit recklessly.
Accumulating dollars (UUP) seems to be a prudent idea. If stagflation rears its head, then the Fed has no choice but to bring inflation down by tightening monetary conditions. Continuing to shrink the Fed balance sheet and raise interest rates would do that.
In a deflationary scenario where the global economy slows, the dollar would become a safe haven, in which case U.S. Treasuries (TLT) become valuable. The same is true if there is a broader outbreak of war potentially in the Middle East.
Jim Rogers has discussed scenarios where the dollar becomes more valuable short-term before an eventual reckoning. Dale Pinkert, over at Forex Analytix, who I have interviewed with a few times (coming up again soon), is projecting a rising dollar into autumn.
I agree with Dale. The dollar decline is likely done for now, for a while. As I discussed last week, we are in a sell the rips market. Yes, the SPDR S&P 500 ETF (SPY) might crack 300 on momentum, but it might see the 2200s as well per my anticipation, in the next year or two. If we don't navigate the "flation" intersection well, then an S&P 500 down in the 1600s seems plausible within a few years.
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