- Sep 22, 2018

Circle of Competence Issue #30

Quote of the week: "A brand for a company is like a reputation for a person. You earn a reputation by trying to do hard things." Jeff Bezos

FOOD FOR THOUGHT

Since tariffs are such a hot topic lately given President Trump's recent rhetoric on waging a trade war with China, I decided that I would explore the topic more in depth in this week's column. I am not as interested in the partisan politics behind the protectionist vs. free trade debate, but rather more interested in the current policies' effects on American industry and the global economy.

The Why

First a little history. A big part of President Trump's campaign platform was getting tough on China's deceptive trade practices and the large trade deficit (-$375B last year), and it is well known that he has been anti-China for a very long time. Many believe that Trump's tariff tactics are a short term means of bringing China to the table on their intellectual property and technology practices, a way of creating a more level playing field in terms of global industry and trade, and a way to protect American industry and jobs. Others, like Alibaba's founder Jack Ma, sees this as the beginning of a very long trade war between the world's two largest economies. Either way - the 'why' is clear from the Trump administration: they view China as 'cheating' the free trade system by keeping its currency 'artificially' devalued (which makes their exported goods far cheaper than other countries' goods and harms other nations' industries) and for their deceptive trade practices.

The What

Given where things stand with relations between China & the US, what can we deduce as possible outcomes of a US-China trade war? To do this, it is always instructive to look at history. One potential historic example that is interesting is the 1930 Smoot-Hawley tariffs . I found this interesting article overlaying the passage of the Smoot-Hawley Tariffs on top of a chart for the Dow Jones Industrial Average as it declined into the Great Depression beginning in 1929. Clearly, Mr. Market was not fond of such high barriers to free trade and economic activity. In the aftermath of the tariffs, they initially seemed to work as industrial production increased, but once the depression began and a great deleveraging began to unfold, the tariffs were generally viewed by most economists as exacerbating the problems. Eliminating the tariffs and stimulating broader, more open economic activity became a core plank in Franklin D. Roosevelt's 1932 platform, and led to his victory over incumbent Republican Herbert Hoover.

If Trump's plan is simply to force China's hand and bring them to the negotiating table, the tariffs may be smoke and mirrors, with little economic effect on either China or the US. In this scenario, there may be public market volatility until negotiations are completed, but fundamentally, the tariffs would probably not alter much of the underlying economics of industries who would have been affected otherwise.

However, if the long term trade war scenario unfolds, there may be more economic uncertainty and potentially more pain for both sides. I shared a great interview on The Investors Podcast last week where Stig Brodersen and Preston Pysh interviewed Richard Duncan. He explains how the trade war could spiral out of control quickly. First, he makes the point that China is a communist country, with the controlling party unwilling to back down because it needs to save face with the populace. Given that they most likely won't back down, he thinks that we could see Trump provoked to such lengths as tariffs slapped on all imported goods from China ($505B in 2017) at up to a 25% rate. If this happens, his posits that inflation will kick in, leading to higher interest rates, which will lead to higher costs of debt and less credit in the economy, less investment, higher unemployment, and lower asset prices across the board. Couple this with a Federal Reserve who has been tightening the monetary supply by $40B per month and raising the base discount rates already, and you can see why the tariffs have some businessmen and economists raising red flags.

I certainly don't want to be the boy crying wolf, but history does have a way of rhyming with previous verses. Is it possible that a longer trade war could sow the seeds for a broader economic slowdown? Sure. Is it possible that these policies could lead to a change of the guard in Washington in 2020? Sure. Is it possible that President Trump is simply using tariffs to take China to task over free trade practices (while satisfying his ego and accomplishing a platform promise)? Sure. Only time will tell which case ensues.

In your opinion, where does this leave us in terms of which industries will be impacted and longer term potential consequences of the current protectionist measures? What are your thoughts on the current policies' economic effects? If you have solid (preferably non partisan) articles or pieces on the economics of how the tariffs will affect industries and the economy as a whole, please send them to me. I'd love to share more next week.

DEPARTMENT OF GENERAL FINANCE

- Jeremy Grantham's January 2011 letter on the making of an asset bubble (H/T Jim)

- GMO's Q2 2018 letter to investors on emerging markets (Ben Inker)

- Aswath Damodaran on Apple and Amazon's Trillion Dollar evolution

- John Hempton on late stages of economic cycles and the crockery it produces

- Jamie Catherwood on the cannabis bubble

- Howard Marks speaks at Wharton

DEPARTMENT OF TECHNOLOGY

- An inside look into Ninja's professional gaming life (ESPN)

- ARK Invest on air taxes and the future of transportation

- How to ensure integrity in sports with legalized gambling (Dealbook)

- Amazon considers opening up to 3000 cashierless stores by 2021 (Bloomberg)