Tariff Madness - a Q & A

Is It Time to Take Leave of the Market?

Photo by Nong on Unsplash

Economics Matters — the Newsletter/Podcast/Financial Riddler

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Q: Are Trump’s Tariffs for Real or Just Bargaining Chips?

A: Trump’s policies are a series of three steps backwards and, occasionally, one step forward. On every issue — human rights, rule of law, habeas corpus, respect for science, basic research, vaccines, higher education, freedom of the press, diversity, equity, inclusion, Social Security, basic research, support of our allies, women’s rights, national security, and, free trade, competent leadership, international respect, pls continue — we are now permanently in the Twilight Zone.

The Zone includes a full blown trade war with tariffs as high as the last ten decades record. The stock market keeps praying for rational negotiated settlements. Every mention of a country holding back retaliatory tariffs to see if it can close a deal leads to a market rebound. These upticks are closely followed by another precipitous drop based on another otherworldly statement from one of Trump’s trade numskulls. Today’s doozy was from the Moron in Chief, himself, in the form of a public threat to China.

“If that tariff isn’t removed by tomorrow at 12 o’clock, we’re putting a 50 per cent tariff on above the tariffs that we put on.”

“That tariff” refers to the 34 percent tax that China announced after Trump levied, on “Liberation Day,” an additional 34 percent tariff on Chinese imports. The 34 percent added to the prior 20 percent tariff, raising the total tariff on all Chinese products to 54 percent. The Chinese aren’t going to lose face by publicly kissing Trump’s ring. Hence, by the time you read this, Chinese imports will face a 104 percent tariff. Since China has other customers, almost everything we buy from China will cost twice as much.

Q: Does the Formula for Setting Tariffs Make Any Economic Sense?

A: None. Here’s an analogy. I run a balance of trade deficit with my barber, Tony. I buy his haircuts. He buys nothing from me. He must, therefore, be taking terrible advantage of me. If we apply the tariff formula, we set a tariff on each haircut at the ratio of my trade deficit — what I pay Tony, call it $X, — to my imports — what I pay Tony, namely $X — divided by two. I.e., we divide 1 by 2 and levy a 50 percent tariff on Tony. Tony now needs to pay Uncle Sam $20 for every $40 haircut he gives me. But Tony has other customers, so he’d charge me $60, which would net him $40. Tony’s ok, but I’m not. I’m paying 50 percent more for each haircut. That looks like inflation, but it’s simply a tax. The price of my importing a haircut from Tony embeds the tariff. This does nothing to rectify the terrible injustice — my buying from Tony and Tony not buying from me, but it does shoot me in the economic head. Bravo!

Q: Why Is Trump Fixated on Tariffs?

A: First, Trump needs to show fiscally conservative house Republicans that he’s coming up with enough revenue to justify their voting to renew the 2017 Tax Cut and Jobs Act — due to expire this year. (Btw, Trump’s Trade War, Trump’s Inflation, and Trump’s Recession will do far more harm to his MAGA supporters than will retaining the TCJA.) Second, Trump thinks we’ll miraculously become a manufacturing country even though a) only 8 percent of our workforce is in manufacturing, b) dramatically and quickly expanding manufacturing would require importing huge quantities of capital goods, and c) any expansion of manufacturing would entail the use of lots of robots and other smart machines, who, at least for now, don’t vote.

Q: Won’t the Market Eventually Rebound? Isn’t It Safe in the Long Run?

A: Apart from its sizable 6.8 percent average real return, the stock market evolves as random walk, producing, on average, a 20 percent swing (standard deviation) around the 6.8 percent trend. Hence, if the market drops, say, 30 percent, we can expect it to grow at 6.8 percent, on average, from its 30 percent lower value. There is no reason to expect it will recoup the 30 percent loss. Wall Street is fond of proclaiming that the cumulative 30-year return on the S&P has always been splendid. But we only have 3 independent observations on 30-year U.S. market returns. The cumulative returns between 1929 and 1959 and that between 1930 and 1960 have 28 annual returns in common. Hence, they aren’t statistically independent. The Japanese market provides a fourth observation of a 30-year return. Between November 1989 and November 2019 the Nikei fell by 35.5 percent.

Q: Are We Heading Toward Recession?

A: That’s everyone’s growing bet unless they are part of the Trump brain trust. The recession will likely be global. It could be very deep. The stock market has lost almost 20 percent of its value since mid February. Consumer confidence is down roughly 30 percent since last year. Prices are edging up with consumers expecting inflation to equal 5 percent over the next 12 months. And the VIX, the measure of uncertainty, has doubled in the last two weeks. People put off buying and businesses put off hiring when things are risky. Things are damn risky.

Q: Could We Have a Trade War Even Without Tariffs?

A: Yes. Trump is not just levying insane tariffs. He’s also insulting millions of our country’s customers on a daily basis. The result? — A growing international boycott of American products as well as tourism to the States. What Chinese citizen will be likely to order Jack Daniels at the local bar? What German will be seen dead driving a Tesla? What Dane will choose an iPhone over a Galaxy? What French citizen will frequent any of France’s 1,500 McDonald’s? What Canadian will willingly place a product with a black (for American-made) dot on a checkout counter? What Latin American will visit Disneyland when there’s a chance they could end up in a brutal El Salvador jail for life? In short, Trump, himself, represents a major barrier for foreigners to buy anything made in America let alone visit, work in, or study in America. This is no different from a tax levied by Trump on our exports. We can call it the Obnoxious Trump Export Tax.

Q: Should I Get Out of the Market?

A: The inmates are running the asylum and their terrible policies, trade and otherwise, can be expected to worsen. Bill Ackman, CEO of Pershing Square, the storied hedge fund manager, just wrote the following: "By placing massive and disproportionate tariffs on our friends and our enemies alike and thereby launching a global economic war against the whole world at once, we are in the process of destroying confidence in our country as a trading partner, as a place to do business and as a market to invest capital."

We’re not in Kansas. We’re in a dark place that can get darker. Basic finance says to decide how much of your wealth to hold in the safe asset and how much to hold in a diversified portfolio of risky assets. If the risky portfolio gets riskier, you should move more of your investments into the safe asset. This has, to some extent, already happened on its own via the stock market’s recent crash. But the market has a long way to fall if it continues heading south. It could, for example, fall by 53 percent, which is the decline in the Great Recession. Or it could fall by 50 percent, which is the drop in the Dot Com Bubble. Or if could fall by 86 percent, which is the decline in the first four years of the Great Depression.

If you are young and have a stable job, your wages are akin to holding a safe asset. Hence, your answer may be to stay the course. But if you are retired, a good rule is to put at risk only what you are prepared to lose. Please view this podcast on Upside Investing to learn how to use my company’s MaxiFi Planner software to set a living standard floor while still investing in the market. The secret to Upside Investing is to spend only out of your safe assets, which we take to be a ladder of Treasury Inflation Protected Securities or TIPS. In this podcast, I discuss building a TIPS ladder with the developer of the free, fab tool, tipsladder.com, Keith Esler. If your risky assets do well, you will, down the road, be able to sell them, buy TIPS with the proceeds, and raise your living-standard floor. This combined spending/investing strategy — spend only out of TIPS, treat your risky assets as lost until they are found, and only spend out of risky assets after they have been converted to TIPS — is, in my view, the best way to weather Tariff Madness.

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