Thinking through the cacophony

To say that the last week was wild would be an understatement. We are only 18 days into the second Trump administration, with 1442 days still ahead of us. The week started with US President Donald Trump imposing hefty 25% import tariffs on Canada and Mexico and 10% tariffs on China.

The market reaction was understandably negative. After talks between Trump and his Mexican and Canadian counterparts, the implementation of the tariffs was put on hold. Mexico City and Ottawa promised to better police their borders, a small price to pay to avert the potentially catastrophic impact on their respective economies. Both countries send around 80% of their exports to the US.

The tariffs on imports from China remain in place and will be added over and above those Trump imposed in his first term which were retained by Joe Biden. China retaliated with some tariffs of its own, but it has more to lose from a trade fight than the US does, so didn’t push things too far. For instance, it could easily allow the renminbi to weaken to offset the tariff impact, but doing so could further antagonise the US and send the wrong message internally, potentially leading to capital flight.

Trump also lashed out at South Africa, to the surprise of many who weren’t sure he even knew the country existed. His comments on the new Expropriation Act are completely misguided, since the constitutional protection of property rights remains unchanged, but could hurt sentiment towards South Africa. Other Trump associates also attacked the country’s black empowerment policies and perceived anti-American stance. Trump suspended American funding to South Africa, most of which goes for HIV/Aids treatment, but it should be noted that US aid and development funding to other countries has also been cut. Tragically so, since it is a small fraction of the overall US budget but makes a big difference in many poor countries.

The two Trumps
Complicating things for investors across the globe is that we don’t know (yet) which version of Trump we’re getting. Is it the ‘Art of the Deal’ or ‘Time to get Tough’ version, to quote the titles of two of the books he wrote (or rather, books that were ghost-written for him).

‘Art of Deal’ Trump was on full display last week. The tariffs were quickly put on hold when Mexico and Canada made very small concessions. As long as he can claim victory, it seems that friend or foe can strike a deal with him. This version of Trump will cause volatility and uncertainty, without necessarily changing much.

‘Time to Get Tough’ Trump might still wait in the wings. If he is serious about a fundamental reordering of the US economy and its relationship with the rest of the world – and some of his key advisers certainly are – it points to downside risk for global and US growth.

The US imports more than it exports and therefore runs a massive trade deficit. Trump and many of his advisers sees this as the US “subsidising” other countries that are taking advantage of the situation. While there might some truth in this view, it misses the bigger picture. The US deficit reflects the voracious consumer appetite of US households while also being the mirror image of the massive US capital account surplus. While the US buys goods from other countries, it sells them financial assets. To put it very simply, it imports iPhones but sells Apple shares to the rest of the world.

When the US put tariffs on China in 2018, imports from China dropped, but imports from other countries increased. The overall deficit continued growing relentlessly, in line with growth in consumer spending.

Chart 1: US trade balance

Source: LSEG Datastream

To reduce the overall trade deficit, US consumers will therefore have to spend less and save more, and foreigners will have to reduce purchases of US shares and bonds, a massive shift in the trends of the past few decades.

A weaker dollar would also help by discouraging imports of goods and foreign purchases of financial assets. Instead, the dollar is extremely strong. On a real trade weighted basis, the dollar has only been stronger 23 of the 647 months since it started floating freely in 1971.

At this stage, almost everyone will welcome a weaker dollar. It will make US firms more competitive and relieve pressure on other countries saddled with dollar-denominated debt.

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