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Even if Trump Is Right, He Could Still Trigger Another Depression Lombardi Letter 2018-10-04 11:52:44 us economy tariffs adam smith protectionism trade economic slowdown NAFTA USMCA free trade President Trump may be right about tariffs, but his offensive against free trade itself and the principles of a free-market economy (which Adam Smith outlined in The Wealth of Nations over 240 years ago) could trigger another depression Analysis and Predictions 2018,Global Economy,Inflation,News,Stock Market Crash,U.S. Dollar,U.S. Economy,U.S. Politics,World Politics https://www.lombardiletter.com/wp-content/uploads/2018/10/Stock-market-Depression-150x150.jpg

Even if Trump Is Right, He Could Still Trigger Another Depression

Stock-market-Depression

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Could Trump Trigger Another Depression, or Is He Right About Tariffs?

Lately, the media circus has been focused on the Supreme Court confirmation hearings of Judge Brett Kavanaugh. When that ends, the media will likely resume attacking Donald Trump over free trade and tariffs, suggesting that the president’s protectionism will cause an economic depression.

The mainstream pundits and politicians alike have delivered just such a unanimous warning over the White House’s plans to revive higher-paying U.S. jobs.

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In fairness, President Trump did not dillydally. Since his inauguration on January 20, 2017, he has been determined to encourage a re-industrialization of the United States.

And that must have scared a lot of people. After all, for the past three decades, free trade has been all the rage. Lifting trade barriers and tariffs has been one of the mantras of the international economy for the past few decades.

It’s no wonder that Trump’s policies have triggered fears of an impending economic slowdown, if not a veritable depression. And there is an argument to be made for tariffs producing negative outcomes.

The Potential for a 1930s-Style Depression Does Exist, But. . .

In the interest of full disclosure, I believe that Trump’s intention to turn the tables on almost four decades of pro-free-trade economics will not be painless. The potential for a recession, or even a full-on depression, exists.

But Trump does have a point about tariffs, especially when it comes to renegotiating the North American Free Trade Agreement (NAFTA), now dead and replaced by the U.S.-Mexico-Canada Agreement (USMCA).

Trump may have been even more right about his assertions that the United States’ trade agreements with China and the European Union (EU) are lopsided, and not in Washington’s favor.

But as Trump started to unleash his protectionist economic program, focused on the renegotiation of trade agreements, fear spread throughout halls of government and business.

Interestingly, that same fear barely made any dents–and timid ones, at that–to stock valuations on Wall Street. If you are concerned on that front, aerospace and defense stocks offer the best protection. These industries have export restrictions, rarely questioned budgets, and strict protections from international competition.

Trump has done nothing short of challenging the influence and authority of the World Trade Organization (WTO) itself. He did this by killing any chance that the Trans-Pacific Partnership might ever see the light of day, even before tackling NAFTA, China, and the EU.

Economic Match of the Century: Donald Trump Vs. Adam Smith

The overall impression is that Trump has launched a veritable offensive against free trade itself and the principles of a free-market economy that Adam Smith outlined in The Wealth of Nations over 240 years ago.

In that sense, Trump has proven to be a revolutionary. His offensive on the WTO and the free trade agreements it has encouraged has raised bigger questions about the viability of the free market in the 21st century.

The idea of free trade and free markets is no mere theory. In the eyes of many economists, social scientists, and political leaders, the two concepts have become the single most important ideology driving global relations and the advancement of humanity.

Perhaps what has caused such fear and downright objection, even from the most unlikely circles—that is, among so-called liberals—is that a capitalist real estate tycoon of the greediest order, Trump, should be the one to challenge key pillars of capitalism.

Trump, regardless of the motivations lurking behind his protectionism, is challenging economic orthodoxy. He is not unlike Galileo Galilei disputing the Aristotelian order of the universe before the Church.

Just as Galileo faced the wrath of the Holy Inquisition in his day for saying the sun does not rotate around the Earth, Trump has come under fire from several big names, including some enriched by Nobel Prize honors, like Paul Krugman.

Krugman has charged Trump with launching a veritable trade war. (Source: “Trump’s Taking us from Temper Tantrum to Trade War,” The New York Times, July 2, 2018.)

Here’s Where Trump Is Right

Trump’s embrace of tariffs (or at least the way he has exploited tariffs for political purposes) challenges classical economics and its aversion to protectionism, especially as explained by such figures as David Ricardo (and more recently, Krugman).

It’s classic economics that drives concerns of a full-on depression. Instead of barriers, said Ricardo, open trade gives economies more flexibility, increasing the size of the market for its participants.

Barrier-free international trade also exposes companies and their goods to the vagaries of competition, which helps weed out the strong from the weak. That same competition also helps improve productivity.

Ultimately, the competition translates to much better prices for consumers, multiplying the selection and lowering prices.

Furthermore, international competition has a selective effect on companies that improves resource allocation and aggregate productivity. Only the most productive companies, in fact, survive foreign competition and benefit from the opening of new markets.

This international openness can therefore bring both benefits and threats to an economy and its companies. For example, the aforementioned increase in productivity threatens weaker economies.

The World Has Not Developed at the Same Pace

The original capitalist powers like France and Great Britain encouraged free trade, so long as it was for their own benefit.

London used special tactics when weaker powers, like China in the 19th century, resisted free trade (retaliating against Chinese restrictions on tea exports by flooding the country with opium and then taking over Hong Kong).

In a more recent example, Japan and South Korea would never have developed their industrial and financial strengths by opening their markets to free trade in the 1950s and 1960s.

Protectionism and consumer sacrifices were necessary to nurture local manufacturing capabilities before opening themselves to foreign competition.

Certainly, had the WTO existed in the immediate post-World War II period, it would have stifled the likes of Toyota, Sony, and Samsung, to name a few, from becoming what they are today. The general idea of protecting American industry from foreign competition, therefore, makes healthy economic sense.

Trump Is Merely Putting America First

Stephen Moore, Arthur B. Laffer (informal economic advisers to the president), and Steve Forbes (of Forbes Media) have argued that Trump has merely adopted and adapted Ronald Reagan’s nationalist playbook when it comes to tariffs and import duties. (Source: “How Trump Could Be Like Reagan,” The New York Times, July 31, 2018.).

In other words, Trump is merely putting America first (or his understanding of what that implies). And that’s what he promised during his election campaign.

Too Many Foreign Cars?

Trump’s threats to impose tariffs and other trade barriers against China, Mexico, Canada, and the EU have their sound logic. Most goods enjoy relatively tariff-free trade. It’s roughly five percent or less worldwide.

Some goods, prioritized according to national interest, are subject to special tariffs to protect strategic industrial or agricultural interests.

Therefore, the EU slaps American cars with a 10% duty, even if the U.S. applies only 2.5% duty on European cars. In fairness, Ford Motor Company (NYSE:F) and General Motors Company (NYSE:GM) do own large sections of the EU market, with respective factories and design facilities in the U.K. and Germany.

Trump’s anger over the numbers of BMW and Mercedes-Benz cars in Manhattan traffic is not wholly misplaced. (Source: “President Trump Says There’s TOO Many German Cars In The US — Do YOU Agree?,” Auto Spies, June 12, 2018.)

For the time being, Trump has spared cars from increased tariffs, yet he has already taken significant protectionist steps. He has applied tariffs of 25% on steel and 10% on aluminum, while applying some $200.0 billion in tariffs against China.

Here’s Where Trump is Wrong

The world of today is not like the one from 200 years ago, when colonial powers encouraged free trade to the tune of gunfire.

Today, there are many more industrialized powers around the world, and new ones have been emerging aggressively. Therefore, the global exchange of goods, even if some tariffs should be enforced, is desirable—if not even necessary.

Then there’s the reason for Trump’s view on tariffs. While the political Trump has encouraged tariffs to address the expectations of his voters, the cutthroat entrepreneur Trump probably has a less humanitarian conception of business and economics.

Trump sees international trade as a winner take-all game. You win this game when you export more than you import. And no doubt, today, as seen through this lens, the United States has lost.

The U.S. does have a trade deficit with China and Europe, partly thanks to the “bad deals” made by Bill Clinton, George W. Bush, and Barack Obama. Trump wants, correctly, to secure better trade deals. Perhaps the USMCA, which has effectively replaced NAFTA, might work out better.

Trump is certainly right to impose more controls on Chinese use (or “theft,” as he puts it) of intellectual property. After all, it’s more than an open secret, given that American companies have complained about the issue for decades.

Tariffs Hurt Those Whom Trump is Trying to Help

Trump’s tariffs hurt American consumers and companies that they are supposed to protect. That’s why the tariffs could cause serious damage to the U.S. economy, not excluding a full-on depression.

There are no more local or even national production chains. The damage has been done, and economies work at a global level now.

Raising barriers in order to encourage producing goods locally could mean that the United States will be making goods at a much higher cost than the international competition.

When it comes to steel for cars, for example, consumers will pay more at the dealership. Add to that the strength of the U.S. dollar, and prices could spiral out of control.

The poorer Americans, whom Trump claims to be helping through tariffs, would be the ones to suffer most.

Editor’s Note: Hi, Alessandro Bruno here. If you enjoyed this article, you can get more of my opinions and commentaries in our popular newsletter, Lombardi Letter. Published daily, it’s FREE! Join us when you click here now.

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