It would be hard to top 2017.
You saw Britain vote to exit the European Union. You saw the most unlikely man claim the US presidency. You even saw North Korea shock the world with weapons testing.
But so far, 2018 hasn’t disappointed.
Global growth is back, according to central bankers. It’s caused investors all over the world to shudder, believing bond yields will finally rise higher.
Governments are condemning Facebook and other platforms for lax use of users’ data.
And now we could be looking at a full-fledged trade war.
God knows we need a bit of volatility after such a long period of little to nothing. Take a look at the All Ordinaries (the 500 largest Aussie stocks) below. Our market still hasn’t recovered from the highs of October 2007.
Source: Google Finance
[Click to enlarge]
But those who bought during the lows of 2009 have made more money than they know what to do with. And if we continue our exciting run in 2018, you might be able to do the same.
Protectionism protects no one
A trade war is on everyone’s mind.
Even central bankers, who usually don’t comment on such events, are talking about the dangers of such a scenario.
Head of the Reserve Bank of Australia, Philip Lowe, said Trump’s tariffs on Chinese steel and aluminium were ‘highly regrettable and bad policy.’ European central bank president, Mario Draghi, also gave his two cents:
‘If you put tariffs against what are your allies, one wonders who the enemies are…We are convinced that disputes should be discussed and resolved in a multilateral framework and unilateral decisions are dangerous.’
Of course you should always take whatever central bankers say with a grain of salt. But the general idea that tariffs are bad is hard to argue with.
Tariffs are usually used by politicians to prop up domestic industry. For example, say Australia put a tariff on wool.
It would cause the demand for imported wool to fall and demand for domestic wool to rise. To use Lowe’s words, this is bad policy.
But what’s so bad about helping out domestic industry? It retains Aussie jobs, maintains Aussie production, and would keep those employed spending on more goods and services in our economy.
A win for Australia right?
Yet all this does is prop up an industry doomed to fail and force consumers to pay higher prices. Such a policy might also tick off other countries, causing them to tax Australian exports in turn.
To see what really happens in a trade war, let’s look at the US and Canada from 1866–97.
Let me set the scene.
A decade before 1866, Canada and the US were happy to reduce taxes on goods traded. Both nations knew the benefit of free trade — more goods at lower prices.
As a result, both nations boomed.
But over time, nationalists began to murmur. They thought the other side was benefiting at their cost.
The US was first to tear up the treaty. They imposed taxes on Canadian goods to ‘level’ the playing field. Take a guess at what Canada did?
They, of course, soon followed with their own taxes.
Canada applied a 35% tax on US manufactured goods entering their borders. For many US companies like Singer, International Harvester and Westinghouse, the economics were better to simply pack up and move to Canada.
And that’s exactly what they did.
The US came back with a 50% import tax.
Both nations weren’t just limiting consumers’ choices. They also forced citizens to pay higher prices through tariffs.
The trade war was a lose-lose situation.
It took nearly a century for both countries to resume the free trade they once had.
But could the US be entering into another trade war with the largest global trader?
Is the Trade war on?
China applies multiple import taxes to US goods. They limit ownership of foreign companies coming into the country. They’ve even been accused of stealing proprietary technology from Western businesses.
Then again, can you expect anything less from a communist country?
Surely you can understand where Trump is coming from.
It’s why Trump first slapped 25% and 10% taxes on steel and aluminium, two products China exports a whole lot of. Now, Trump is planning to slap a further 25% tax on Chinese imports relating to aerospace, information, and communication technology and machinery.
Just like in 1866, Trump is seeking to ‘balance’ the unfair practices between the US and China. Could we see the same 1866 situation play out over the coming year?
It’s definitely possible. China was quick to warn the world it will tax 128 US products if need be.
Yet I doubt things will escalate much further.
China has said they are not afraid of a trade war. But I bet they’ll be running scared when they see massive declines in exports stunting their precious economic growth.
It seems like we’re too far ahead to have countries knowingly reduce living standards for citizens.
Then again, we continue to make past mistakes over and over again. When asked what people would learn from the financial crisis, GMO’s Jeremy Grantham said:
‘In the short term a lot, in the medium term a little, in the long term, nothing at all. That would be historical precedent.’
Ways to profit
As I mentioned in the introduction, this might be exactly what we need for volatility to kick up. When US and Australian bond yields spiked in February this year, the All Ordinaries fell almost 5%.
If murmurs of a trade war linger in investors’ minds, we could see a similar, maybe even bigger drop in the coming weeks.
On Friday, we also followed US stocks down as investors digested Trump’s further tariff plans.
If China retaliates, investors could assume the worst. Investors might rush out of multiple Aussie stocks in droves. For many Aussie businesses, prosperity is pinned to the success of China.
Our miners, farmers and tourism industry are all heavily exposed to China. If China was to take a turn for the worse, it would be reasonable to look in these industries for bargains.
Editor, Money Morning