Tariff, Tariff Man!!
December 6, 2018
Looks like Donald Trump has a catchy new theme song for his nonstop campaign rallies:
Tariff, Tariff Man! I want to be a Tariff Man! Tariff, Tariff Man! I want to be a Tariff Man!
(To the tune of “Macho, Macho Man” by The Village People)
The song has several advantages: it will fire up the Base, there are lots of exclamation points (VERY VERY GOOD!!!), and Trump doesn’t have to use a Teleprompter to stay on message.
The only problem is, Wall Street hates Trump’s tariffs and trade wars. This time, Wall Street is right. But the Tweeter-in-Chief Is not listening to critics of his trade policies.
Literally. In one of the many scary passages in Fear, Bob Woodward’s inside look at the White House, economic adviser Gary Cohn tried repeatedly to explain the basics of international trade to Trump. Cohn, the former #2 exec at Goldman Sachs, knew something about economics, the markets and trade relationships.
Woodward reported that Cohn made the briefings shorter and shorter, trying to convince Trump that trade deficits were not a very useful indicator and, in any case, one should include services as well as manufacturing in calculating them. (On that basis, for example, the US has enjoyed a trade surplus, not a deficit, with Canada.)
All to no avail. Trump simply would not listen to his economic advisers, convinced that he knew more than they did. Finally, after another desperate attempt at educating the president, Cohn noticed that Trump had written on the margin on his one-page briefing memo “trade is bad!”. Cohn gave up the battle and resigned his post.
Making Investors Quake Again
Why is this important? It has dawned on the Wall Street crowd—by which I mean investors as well as bankers—that Trump’s tariffs aren’t based on a rational approach to trade issues. Instead, Trump is engaged in magical thinking that is divorced from mainstream economics and reality (which in this instance are the same). Trump is right to challenge the Chinese, who have not played by the rules with the U.S. and other trading partners. They have stolen trade secrets, forced firms to transfer technology to Chinese companies, and subsidized domestic manufacturers with cheap loans. That should all change. But using tariffs is the wrong approach. They distort competition, as the government picks "winners" and "losers", and they crimp economic activity. The trade war has damaged the Chinese economy more than ours, so far, but it is inflicting harm on us, too. American companies purchase materials from around the globe, and tariffs hurt them by raising the prices for foreign materials. Tariffs are a "tax" on American consumers, because they must pay higher prices for imported goods. Auto makers like GM quickly warned that tariffs could cut their profits. Americans farmers worried that China, their largest customer for soybeans, would retaliate by slashing its purchases. Both predictions have proved accurate. Leaders in the manufacturing and agricultural sectors have lobbied the White House to stop the trade wars, but their pleas have fallen on deaf ears.
Here's an example of the chasm between the White House and the business community. General Motors announced last week that it would close several plants in the U.S. (partly in reaction to problems caused by the tariffs). In response, Trump airily announced that he had told GM CEO Mary Barra to stop producing cars in China and build new plants in the U.S. However, GM sells four million cars in China—which it produces THERE for the domestic Chinese market-- versus three million in the U.S. When a president displays such gross ignorance and incompetence, it’s not surprising that investors are upset.
Despite a strong U.S. economy, investors have had a lousy year, as stock prices reflected their worries that the trade wars would cause the global economy to slow down….which it has. The S&P 500 Index is flat year-to-date. The index has see-sawed most of the time, rising along with investors’ hopes for a “truce” in the trade wars and then falling when tensions with China re-emerge.
Even worse, the stock market has dropped almost 8% since mid-September, as Trump has revved up the conflict with China. Trump has increasingly lost credibility on trade issues, as investors grow tired of the he said/Xi said conflicting accounts about what, if anything, the U.S. and Chinese leaders have “agreed” upon at some summit meeting.
The Tax-Cut Sugar High Is Fading
Stock markets move for many reasons, of course, and no one has a crystal ball on how the markets will perform in the future. But here are some other important pieces of the puzzle. Last year, Trump’s tax cuts set the equity markets on fire, as investors anticipated that sharply lower corporate tax rates would improve companies’ profits. This helped fuel a huge rally in 2017, as investors anticipated, correctly, that firms would use the increased earnings to buy back stock and increase their dividends in 2018.
But the tax cut was a one-time benefit for corporate earnings, and analysts focus on year-over-year comparisons in profit growth. In 2019, companies will have to raise their profits the old-fashioned way, by increasing their sales or margins. However, firms did not use much of their tax cuts to invest in their businesses, which could have improved their operating performance.
The tariffs can put pressure on companies' margins, by disrupting their supply chains. Furthermore, many U.S. companies generate a lot of their profits abroad (yes, even in China, which is one of Apple's biggest markets). So the slowdown in global growth is hitting tech companies, Caterpillar, consumer goods companies, etc.
The tax cuts were like a sugar high for the market, but now we’re coming back to earth. The cuts were so large that the government’s deficit has exploded, rising about 17% from $665 billion in fiscal year 2017 to $779 billion in fiscal year 2018. The deficit is projected to exceed $1 trillion in fiscal year 2019. As a percentage of gross domestic product, that would be an increase from 3.5% in fiscal year 2017 to about 4.5% in fiscal year 2019, which is probably not sustainable on a long-term basis. So the government has had to ramp up its sales of bonds, which is helping to cause higher interest rates. The rate on the 10-year Treasury bond has jumped from 2.4% to about 3% this year. Higher rates are anathema to the stock market, because they raise companies' financing costs and bonds become more attractive vs. equities. Democrats had supported a more reasonable corporate tax cut to about 25%, rather than the low 20s, and opposed the reductions for very wealthy individuals. Their tax proposals would have benefited the economy without blowing up the deficit.
It doesn’t help that the Chinese and Japanese, the two largest foreign holders of Treasuries, don't have incentives to buy a lot more Treasuries. In fact, their purchases have been flat or even down at times over the last one to two years. That’s not a political ploy. Their trade surpluses with the US have not increased much, so they have fewer “excess” dollars and less need to purchase Treasuries. In any case, the imbalance between supply and demand puts more pressure on interest rates.
Here’s the final twist. Because of the huge deficits, the U.S. government may face severe constraints on its ability to combat the next recession, whenever that happens. Normally, a government can ramp up its spending, as President Obama did in 2009, to offset a downturn, on the assumption that economic growth will bring any deficit back to a reasonable level. But not this time.
So this Christmas, we don’t have to worry about the Grinch. We have Trump.
The Wall Street Democrat