Posts tagged ‘free trade’
January a Ball After Year-End Fall
Investors were cheerfully dancing last month after the stock market posted its best January in 30 years and the best monthly performance since October 2015 (see chart below). More specifically, the S&P 500 index started the year by catapulting +7.9% higher (the best January since 1987), and the Dow Jones Industrial Average climbed 1,672 points to 25,000, or +7.2%. But over the last few months there has been plenty of heartburn and volatility. The December so-called Santa Claus rally did not occur until a large pre-Christmas pullback. From the September record high, stocks temporarily fell about -20% before the recent jolly +15% post-Christmas rebound.
Source: FactSet via The Wall Street Journal
Although investors have been gleefully boogying on the short-run financial dance floor, there have been plenty of issues causing uncomfortable blisters. At the top of the list is China-U.S. trade. The world is eagerly watching the two largest global economic powerhouses as they continue to delicately dance through trade negotiations. Even though neither country has slipped or fallen since the 90-day trade truce, which began on December 1 in Buenos Aires, the stakes remain high. If an agreement is not reached by March 2, tariffs on imported Chinese goods would increase to 25% from 10% on $200 billion worth of Chinese goods, thereby raising prices for U.S. consumers and potentially leading to further retaliatory responses from Beijing.
When it comes to the subjects of intellectual property protection and forced technology transfers of American companies doing business in China, President Xi Jinping has been uncomfortably stepping on President Donald Trump’s toes. Nothing has been formally finalized, however Chinese officials have signaled they are willing to make some structural reforms relating to these thorny issues and have also expressed a willingness to narrow the trade deficit with our country by purchasing more of our exports. Besides procuring more American energy goods, the Chinese have also committed to buy 5,000,000 tons of our country’s soybeans to feed China’s hungry population of 1.4 billion people.
Reaching a trade settlement is important for both countries, especially in light of the slowing Chinese economy (see chart below) and the dissipating stimulus benefits of the 2018 U.S. tax cuts. Slowing growth in China has implications beyond our borders as witnessed by slowing growth in Europe as evidenced by protests we have seen in France and the contraction of German manufacturing (the first time in over four years). Failed Brexit talks of the U.K. potentially leaving the European Union could add fuel to the global slowdown fire if an agreement cannot be reached by the March 29th deadline in a couple months.
Source: Wind via The Wall Street Journal
While the temporary halt to the longest partial federal government shutdown in history (35 days) has brought some short-term relief to the 800,000 government workers/contractors who did not receive pay, the political standoff over border security may last longer than expected, which may further dampen U.S. economic activity and growth. Whether the hot-button issue of border wall funding is resolved by February 15th will determine if another shutdown is in the cards.
Despite China trade negotiations and the government shutdown deadlock placing a cloud over financial markets, brighter skies have begun to emerge in other areas. First and foremost has been the positive shift in positioning by the Federal Reserve as it relates to monetary policy. Not only has Jay Powell (Fed Chairman) communicated a clear signal of being “patient” on future interest rate target increases, but he has also taken the Fed off of “autopilot” as it relates to shrinking the Fed’s balance sheet – a process that can hinder economic growth. Combined, these shifts in strategy by the Fed have been enthusiastically received by investors, which has been a large contributor to the +15% rebound in stock prices since the December lows. Thanks to this change in stance, the inverted yield curve bogeyman that typically precedes post-World War II recessions has been held at bay as evidenced by the steepening yield curve (see chart below).
Source: Calafia Beach Pundit
Other areas of strength include the recent employment data, which showed 304,000 jobs added in January, the 100th consecutive month of increased employment. Fears of an imminent recession that penetrated psyches in the fourth quarter have abated significantly in January in part because of the notable strength seen in 4th quarter corporate profits, which so far have increased by +12% from last year, according to FactSet. The strength and rebound in overall commodity prices, including oil, seem to indicate any potential looming recession is likely further out in time than emotionally feared.
Source: Calafia Beach Pundit
As the chart above shows, over the last four years, spikes in fear (red line) have represented beneficial buying opportunities of stocks (blue line). The pace of gains in January is just as unsustainable as the pace of fourth-quarter losses were in stock prices. Uncertainties may remain on trade, shutdowns, geopolitics, and other issues but don’t throw away your investing dance shoes quite yet…the ball and music experienced last month could continue for a longer than expected period of time.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 1, 2018). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Don’t Fear the Free Trade Boogeyman
Are you having trouble falling asleep because of a ghostly nightmare? Donald Trump, along with a wide range of pundits and investors have been afraid of globalization and the free trade boogeyman. Donald Trump may or may not win the presidential election, but regardless, his inflammatory rhetoric regarding trade is way off base.
Free trade has been demonized as a job destroyer, however history paints a different picture. I have written on the subject before (see also Invisible Benefits of Free Trade), but with Americans digesting the current debates and the election only a month away, let me make a couple of key points.
Standard of Living Benefits: For centuries, the advantages of free trade and globalization have lifted the standards of living for billions of people. There is a reason the World Trade Organization (WTO) has united more than 160 countries without one country exiting since the global trade group began in 1948. Trade did not suddenly stop working when the Donald began lashing out against NAFTA, TPP and Oreo cookies. Trump rails against trade despite Trump ties being made in China.
Job losses are easy to identify (like the Oreo jobs moved to Mexico from Chicago), but most trade benefits are often invisible to the untrained eye. As Dan Ikenson of the Cato Institute explains, if low-wage labor was not used offshore to manufacture products sold to Americans, many amazing and spectacular products and services would become unaffordable for the U.S. mass markets. Thanks to cheaper foreign imports, not only can a wider population buy iPhones and use services like Uber and Airbnb, but consumers will have extra discretionary income resources that can be redeployed into savings. Alternatively, the extra savings could be spent on other goods and services to help spur U.S. economic growth in various sectors of our nation.
It doesn’t make for a nice, quick political soundbite, but Ikenson highlights,
“The benefits of trade come from imports, which deliver more competition, greater variety, lower prices, better quality, and new incentives for innovation.”
Strong Companies Hire and Grow: Plain and simply, profitable businesses hire employees, and money-losing companies fire employees. Business success boils down to competitiveness. If your product is not better and/or cheaper than competitors, then you will lose money and be forced into stagnation, or worse, be forced to fire employees or shut down your business. Free trade affords businesses the opportunity to improve the cost or quality of a product. Take Apple Inc. (AAPL) for example, the company’s ability to build a global supply chain has allowed the company to offer products and services to more than 1 billion users. If Apple was forced to manufacture exclusively in the U.S., the company’s sales and profits would be lower, and so too would the number of U.S. Apple employees.
Fortunately, no matter who gets elected president, if the rhetoric against free trade reaches a feverish pitch, investors can rest assured that the president’s powers to implement widespread tariffs and rip up longstanding trade deals is limited. He/she will still be forced to follow the authority of Congress, which still controls the nuts and bolts of our economy’s trade policies. In other words, there is nothing to fear…even not the free trade boogeyman.
Other Trade Related Articles on Investing Caffeine:
Jumping on the Globalization Train
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and AAPL, MDLZ, but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The Invisible Benefits of Trade
Before the Brexit, 28 countries joined the European Union since its inception in 1957, without a single country leaving. The story is similar if you look at the World Trade Organization (WTO), which has witnessed more than 160 countries unite, without one country exiting since it began in 1948. Are the leaders of these countries idiots and blind to the benefits of trade and globalization? I think not.
For centuries, the advantages of free trade and globalization have lifted the standards of living for billions of people. However, pinpointing the timing or attributing the precise actions leading to these tremendous economic advantages is difficult to do because most trade benefits are often invisible to the naked eye.
Today, populist sentiment on both sides of the political aisle has demonized trade, whether referring to TPP (Trans-Pacific Partnership), NAFTA (North America Free Trade Agreement), trade with China, or announcements by corporations to manufacture goods internationally.
Although it would be naïve to adopt a stance that there are no negative consequences to globalization (e.g., lost American jobs due to offshoring), myopically focusing on job displacement is only half the equation.
While I can attempt to articulate the economic costs and benefits of free trade, and I’ve tried (see Productivity & Trade), Dan Ikenson of the Cato Institute explains it much better than I can. Here is a more eloquent synopsis of free trade (hat-tip: Scott Grannis):
“The case for free trade is not obvious. The benefits of trade are dispersed and accrue over time, while the adjustment costs tend to be concentrated and immediate. To synthesize Schumpeter and Bastiat, the “destruction” caused by trade is “seen,” while the “creation” of its benefits goes “unseen.” We note and lament the effects of the clothing factory that shutters because it couldn’t compete with lower-priced imports. The lost factory jobs, the nearby businesses on Main Street that fail, and the blighted landscape are all obvious. What is not so easily noticed is the increased spending power of the divorced mother who has to feed and clothe her three children. Not only can she buy cheaper clothing, but she has more resources to save or spend on other goods and services, which undergirds growth elsewhere in the economy.
Consider Apple. By availing itself of lowskilled, low-wage labor in China to produce small plastic components and to assemble its products, Apple may have deprived U.S. workers of the opportunity to perform that low-end function in the supply chain. But at the same time, that decision enabled iPods and then iPhones and then iPads to be priced within the budgets of a large swath of consumers. Had all of the components been produced and all of the assembly performed in the United States — as President Obama once requested of Steve Jobs — the higher prices would have prevented those devices from becoming quite so ubiquitous, and the incentives for the emergence of spin-off industries, such as apps, accessories, Uber, and AirBnb, would have been muted or absent.
But these kinds of examples don’t lend themselves to the political stump, especially when the campaigns put a premium on simple messages. This is the burden of free traders: Making the unseen seen. It is this asymmetry that explains much of the popular skepticism about trade, as well as the persistence of often repeated fallacies.
The benefits of trade come from imports, which deliver more competition, greater variety, lower prices, better quality, and new incentives for innovation. Arguably, opening foreign markets should be an aim of trade policy because larger markets allow for greater specialization and economies of scale, but real free trade requires liberalization at home. The real benefits of trade are measured by the value of imports that can be purchased with a unit of exports — our purchasing power or the so-called terms of trade. Trade barriers at home raise the costs and reduce the amount of imports that can be purchased with a unit of exports.
Protectionism benefits producers over consumers; it favors big business over small business because the cost of protectionism is relatively small to a bigger company; and, it hurts lower-income more than higher-income Americans because the former spend a higher proportion of their resources on imported goods.
…Even if there were a President Trump or President Sanders, rest assured that the Congress still has authority over the nuts and bolts of trade policy. The scope for presidential mischief, such as unilaterally raising tariffs, or suspending or amending the terms of trade agreements, is limited. But it would be more reassuring still if the intellectual consensus for free trade were also the popular consensus.”
Fortunately, Ikenson supports the case I’ve made repeatedly. The power of presidential politics is limited by the Congress (see Politics and Your Money). Frustration with politics has never been higher, but in many cases, gridlock is a good thing.
The destructive impacts of protectionist, anti-trade policies is unambiguous – just consider what happened from the implementation of Smoot-Hawley tariffs in 1930 around the time of the Great Depression. U.S. imports decreased 66% from $4.4 billion (1929) to $1.5 billion (1933), and exports decreased 61% from $5.4 billion to $2.1 billion. GNP fell from $103.1 billion in 1929 to $75.8 billion in 1931 and bottomed out at $55.6 billion in 1933.
It’s important to remember, any harmful downside to trade is overwhelmed by the upside of growth. Greg Ip of the WSJ used Doug Irwin, a trade historian at Dartmouth College, to make this pro-growth point:
“If two million American workers lose $15,000 in annual income forever—an extreme estimate of the impact of trade with China—while 320 million American consumers gain just $100 from trade, the benefits to all of society still exceed the costs.”
The benefits of free trade may be invisible in the short run, but over the long-run, the growth advantages of free trade are perfectly visible, despite protectionist, anti-trade rhetoric and propaganda dominating the presidential election conversation.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), and AAPL, but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Productivity & Trade: Pins, Cars, Coconuts & Chips
The concepts of productivity and free trade go all the way back to Adam Smith, widely considered the “father of economics,” who wrote the original capitalism Bible called the Wealth of Nations. Many of the same principles discussed in Smith’s historic book are just as applicable today as they were in 1776 when it was first published.
Economics at its core is the thirst for efficiency and productivity for the sake of profits. Ultimately, for the countries that successfully practice these principles, a higher standard of living can be achieved for its population. For the U.S. to thrive in the 21st century like we did in the 20th century, we need to embrace productive technology and efficiently integrate proven complex systems. To illustrate the benefits of productivity in a factory setting, Smith wrote about the division of labor in a pin factory. Murray N. Rothbard, an economic historian, and political philosopher summed up the takeaways here:
“A small pin-factory where ten workers, each specializing in a different aspect of the work [18 steps], could produce over 48,000 pins a day, whereas if each of these ten had made the entire pin on his own, they might not have made even one pin a day, and certainly not more than 20.”
Dividing up the 18 pin making steps (i.e., pull wire, cut wire, straighten wire, put on head, paint, etc.) lead to massive productivity improvements.
Another economic genius that changed the world we live in is the father of mass production…Henry Ford. He revolutionized the car industry by starting the Ford Motor Company in 1903 with $100,000 in capital and 12 shareholders. By the beginning of 1904, Ford Motors had sold about 600 cars and by 1924 Ford reached a peak production of more than 2,000,000 cars, trucks, and tractors per year. Although, Ford had a dominant market share here in the U.S., the innovative technology and manufacturing processes allowed him to profit even more by exporting cars internationally. This transformation of the automobile industry allowed Ford to hire thousands of workers with handsome wages and spread 15 million of his cars around the globe from 1908 to 1927.
Comparative Advantage: Lessons from Smith & Ford
Foreign trade has continually been a hot button issue – especially during periods of softer global economic activity. Here is what Adam Smith had to add on the subject:
“If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.”
Smith believed that parties with an “absolute advantage” in manufacturing would benefit by trading with other partners. Today, it’s fairly clear the U.S. has an absolute advantage in creating biotech drugs, Hollywood movies, and internet technologies (i.e., Google), however in other industries, such as industrial manufacturing, the U.S. has lost its dominant position.
David Ricardo, an English economist who authored the famous work On the Principles of Political Economy and Taxation, is attributed with extending Smith’s “absolute advantage” concept one step further by introducing the idea of “comparative advantage.”
Producing Coconuts and Computer Chips
Let’s explore the comparative advantage concept some more by investigating coconuts and computer chips. As we hemorrhage jobs to other countries that can accomplish work more cheaply and efficiently, increasingly discussions shift to a more protectionist stance with dreams of higher import tariffs. Is this a healthy approach? Consider a two nation island able to produce only two goods (coconuts and computer “chips”), with the U.S. on one half of the island, and the Rest of the World (R.O.W.) on the other half.
Next, let’s assume the following production profile: The R.O.W. can choose to produce 10 coconuts or 10 chips AND the U.S. can produce 4 coconuts or 8 chips.
Scenario #1 (No Trade): If we assume both the R.O.W. and the U.S. each spend half their time producing coconuts and chips, then the R.O.W.’s production will create 5 coconuts/5 chips and the U.S. 2 coconuts/4 chips for a combined total of 7 coconuts and 9 chips (16 overall units).
If we were to contemplate the ability of trade between R.O.W. and the U.S., coupled with the concept of comparative advantage, we may see overall productivity of the nation island improve. Despite the R.O.W. having an “absolute advantage” over the U.S. in producing both coconuts (10 vs. 4) and chips (10 vs. 8), the next example demonstrates trade is indeed beneficial.
Scenario #2 (With Trade): If R.O.W. uses its comparative advantage (“more better”) to produce 10 coconuts and the U.S. uses its comparative advantage (“less worse”) to produce 8 chips for a combined total of 10 coconuts and 8 chips (18 overall units). Relative to Scenario #1, this example produces 12.5% more units (18 vs. 16) and with the ability of trade, the U.S. and R.O.W. should be able to optimize the 18 units to meet their individual country preferences.
If we can successfully escape from the island and paddle back to modern times, we can better understand the challenges we face as a country in the current flat global world we live in. Our lack of investment into education, innovation, and next generation infrastructure is making us less competitive in legacy rustbelt industries, such as in automobiles and general manufacturing. If the goal is to maximize productivity, efficiency, and our country’s standard of living, then it makes sense to select trade scenario #2 (even if it means producing zero coconuts and lots of computer chips). The coconut lobby may not be happy under this scenario, but more jobs will be created from higher output and trade while our citizens continue on a path to a higher standard of living.
The free trade strategy will only work if we can motivate, train, and educate enough people into higher paying jobs that produce higher value added products and services (e.g., computer chips and computer consulting). There is a woeful shortage of engineers and scientists in our country, and if we want to compete successfully in the modern world against the billions of people scratching and clawing for our standard of living, then we need to openly accept the productivity and trade principles taught to us by the Adam Smiths and Henry Fords of the world. Otherwise, be prepared to live on a remote, isolated island with a steady diet of coconuts for breakfast, lunch, and dinner.
Read Full NetMBA Article on “Comparative Advantage”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and GOOG, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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