"Now there's a wall between us, somethin' there's been lost I took too much for granted, I got my signals crossed" - Bob Dylan, Shelter from the storm
The 800Ib gorilla
Increased US tariffs on imported solar panels and washing machines. A week of ‘America first’ from her emissaries to Davos. Have we finally begun to see President Trump’s protectionist bark correspond to his bite?
The idea that, as a country, you weaken your corporate sector by shielding it from the white heat of global competition may seem unintuitive. The same probably applies to the ‘law’ of comparative advantage – David Ricardo’s theory that countries should specialise in what they are relatively most efficient at doing, meaning that all actors, at all times, can mutually benefit from cooperation and voluntary trade. However, these keystones of free trade are almost universally agreed upon by economists, a group that seemingly exists to squabble . The incredible post Second World War proliferation in free trade has not been victimless all the same. Rust belts throughout the western world pay visible testament. Meanwhile the Great Financial Crisis further exposed the plight of those already left behind, so giving space for more nativist ideologies to return to the political foreground. These forces tend to portray global trade as a zero sum game, an arm wrestle to be won or lost. Other countries and regions are blamed for distributional problems at home – China stole your factory jobs, globalisation everything else.
A real threat?
The aforementioned tariffs mark the first of several potential trade actions the US administration could take in the coming weeks. Soon, President Trump will also have to decide whether to take steps to reduce or block imports of foreign steel and aluminum. China is the world’s largest producer of both. US barriers to their imports will hurt Chinese companies, some of which are owned by the Chinese government.
However, two points are worth remembering here. First, the decision wasn't taken unilaterally by the President or his inner cohort. Rather, it was based on the recommendations of the US International Trade Commission – an independent, bipartisan panel. That panel was tasked with both measuring how the influx of foreign solar panels had affected domestic manufacturers, and submitting recommendations for tariffs based on their assessment of the damage. The resulting recommendation for c.30 percent tariffs were followed by the administration.
Second, unlikely as it sounds, the US has merely followed the EU’s lead on this matter. The EU set minimum import duties for Chinese solar modules and cells in September that price them up to 30 percent above market levels – a level consistent with where the US is now.
Could this escalate?
For the moment, Asia’s response to these actions has been measured. Counter investigations could be launched, concessions suspended and domestic access restricted. However, a steeper escalation and reprisals cannot be ruled out. As we’ve pointed out before, constitutional restraints can be of little solace to us here. The US President has multiple legal statutes at hand granting him considerable leeway in setting trade policy, without the need for congressional say so. Economic self interest on all sides is therefore our only real bulwark.
The fact that the world economy is now so tightly intertwined and global supply chains so complex suggests that the costs of a material increase in protectionism would be both high and immediate. These costs would admittedly be most concentrated in Asia, which is not only responsible for over two thirds of the US trade deficit in goods, but accounts for a third of global exports (compared to 26% for the Euro area, 9% for the US and 6% for Latin America). Nonetheless, all would suffer in this scenario. The current market calm would be shattered. Risk assets such as equities and junk credit would sell off, safe havens would return to popularity. A US and global recession could even ensue.
We continue to see Emerging Asia as an attractive area to take equity risk, even after the incredible rally seen from the lows of 2016. The continuation of current trends in global trade and IT heavy investment are central to this attraction. We currently do not see sufficient evidence to argue that a more pronounced rise in protectionism is about to upset this story. Absent such an escalation, Emerging Asia is a region that offers strong earnings growth at a reasonable valuation, something that is becoming a little harder to argue of US equities.