The Trump Trade War Is A Side Show - Part 2

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by: Alan Longbon
Summary

A week on from the last article more has happened in the trade war.

China is not half so vulnerable to a trade war as many might think; China's current account is less than 2% of GDP.

America has a larger exposure to external trade than China does; the current account is over 2% of GDP.

The Eurozone has the most to lose with a current account balance of some 3.5% of GDP. None of them are large though.

This article will show that worries about the trade war are overblown in context with the GDP of each country involved.

In my last article, many were surprised at how small the impact of the trade war and tariffs are when compared to how much press coverage and headlines the trade war has commanded.

Others filled the comment section with comments about education, the weather and the World Cup Final. Still more turned the article into a rant about Republican and Democrat policies as if both parties were not representative of the same ruling elite and not controlled by Wall Street and big business.

This article takes this theme further and provides more data to provide investors with a clearer picture from a macro perspective.

Trade as a Percentage of GDP

The charts below show the current account as a percentage of GDP for each major "combatant" in the trade war relative to their share of GDP to their current account. The current account is where the crosscurrents of imports/exports and financial flows are reconciled into an overall figure. This list is ranked by the size of GDP from largest to smallest.

America has a relatively low percentage of GDP to current account trade. It might be leaking $450B a year; however, with a GDP of over $20T that is not a lot. There are certainly larger problems in America to worry about such as the extensive slums, trailer parks, no universal healthcare, class D infrastructure and mass shootings to name just a few.

The Federal Government could make good the leakage of money overseas for foreign goods simply by spending 2.4% of GDP back into the economy on schools, healthcare, and infrastructure. If one matches an outflow, it cannot be inflationary. Also if one spends to improve the public purpose, this lifts productivity and lowers the cost of living and doing business and so is also deflationary. It could well work out that countering the deflationary effect of the current account deficit with spending on infrastructure might need to be greater than the current account deficit to counteract the deflationary impact of a more efficient public infrastructure system.

A more efficient public realm in turn makes the economy more efficient and may lead to the current account deficit becoming a surplus that needs to be taxed out to control inflation. Imagine that: sending out goods and services to foreigners and then losing the income to increased taxation at the macro level.

This will surprise a lot of readers. China's current account balance is less than America's. At one time, trade was a big component of GDP, however, this changed after the GFC in 2008.

Would the rest of the 98.7% of GDP notice if 1.3% were no longer there? It is unlikely.

The Eurozone is known as an export champion; however, the current account is only 3.5% of GDP. While certain nations within the Eurozone are more export-dependent than others, the big picture overall is that Europe is not dependent on trade for much of its GDP.

Japan is another country commonly held to be an export superstar; however, the chart above shows that only 4.02% of GDP comes from trade.

Canada too does not have a great reliance on international trade at just 3% of GDP. Canada is in a similar situation to America where the national government has the fiscal space created by the leakage of dollars overseas, in return for real goods and services, to spend more into the domestic economy without it being inflationary. Most governments do not have the wisdom to see this and instead have an internal austerity bias that leads to a run down in public services and ultimately a less competitive and less efficient economy.

Mexico also has a low exposure of only 1.6% current account to GDP to foreign trade.

Putting the Trade War in Perspective

The chart below is an update of the chart presented in the last article and now shows the prices of the increased trade threats between America's major trading partners. China and Canada have been updated with the latest tariff threats.

(Source: Trading Economics dot com plus author calculations for 2017)

Note that the USA will run out of firepower against the Chinese soon as the threatened tariffs exceed the value of goods exported to China.

All the trade deficits added together still do not add up to much as the chart below shows:

The recently increased tariff threats between America and China have upped the ante to $200B apiece to make a 60% extra cost impact on trade. This extra cost is paid for by the customer and goes to the national government and works the same way as a tax in that the money is removed from the system and aggregate demand is reduced. Because money is removed from circulation, the overall impact is deflationary.

An interesting anecdote is a recent story about Harley-Davidson (NYSE:HOG) where to overcome European tariff increases, it may move a portion of its American production to Europe to cater for sales to Europe that were formerly produced in America.

The net result of the American and European tariffs is that the respective countries move their production to overcome the tariff. In the case of Harley-Davidson, jobs are lost in America but gained in Europe. Not quite the intended impact of the American tariff.

One could well imagine that if BMW (OTCPK:BMWYY), Mercedes, and VW (VLKAY), for example, moved more of their production facilities to America to cater to American customers, free from tariffs, that overall the impact would be more jobs in America. More investment too.

While trade is a popular issue at present, I am more concerned about bigger issues that bring on recessions such as:

1. Fed rate rises.

2. Oil price rises.

3. Expiration of Federal tax exemptions in late 2018.

4. Falling forward earnings expectations in the latter half of 2018.

5. The impact of central banks across the world reducing their balance sheets all at once by selling their stocks, bonds, and other securities at the same time.

These real concerns are documented in this recent article.

This was brought to my attention by Seeking Alpha Marketplace Contributor Mr. Robert P Balan and his PAM team. Mr. Balan's latest public article on this subject is located here. And this very important chart is reproduced from it below:

The simple takeaway is that when the Monetary Base of the big global Central Banks falls, so does the stock market and it is going to fall into the future like nothing we have seen before. This is the fifth horseman with Thor's Hammer.

Every recession is different from the one before and catches most by surprise. If that were not so, mainstream economists could recognize them a long way off. The fact is they cannot because their models and paradigm are still stuck in the days of the gold standard that ended back in the 1970s and no longer apply.

It has never occurred before that the world's central banks have unloaded their balance sheets all at the same time. QE has never occurred before on a global scale. QT has never occurred before. This is new territory. The way this is being mishandled by the politicians and central bankers is a guarantee of a recession and stock market panic "that no one could foresee". They have to be different each time; otherwise they would not occur. It will be glibly termed a "Black Swan" event, an external shock that no model could predict except for Professor Steve Keen's Minsky Model.

The mainstream economists will go back to their broken DSGE models and add one more extenuating conditionality that makes their model seem plausible again: **Does not apply when global central banks sell their balance sheet assets all at the same time.

There will be three broad effects:

1. Paper asset prices will generally fall as support is withdrawn.

2. Bond yields will rise and face values fall. The yield rises only because the face value has fallen.

3. The US dollar will soar as liquidity gets soaked up by the bond buying despite the "twin deficits".

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.