Thursday, June 21, 2018

Stock market volatility mostly due to 

talk of a global trade war

By James R. Kee, Guest Columnist

Volatility has certainly returned to the stock market this year, largely due to growing fears of a global “trade war.” A trade war means that each country seeks to restrict imports from other countries by placing tariffs or restrictions (quotas) on them. It is feared that each such effort by one country will lead to “retaliatory” measures taken by other countries. 

We have seen some of this in the rhetoric between the U.S. and China this year. When President' Donald Trump's administration proposed tariffs on steel and aluminum imports from China, China in-turn threatened to place tariffs on U.S. agricultural goods going to their country.

A great historical example of a trade war occurred after the Tax Act of 1930, also known as the Smoot-Hawley tariff, which was sponsored by Sen. Reed Smoot and Rep. Willis Hawley. Jude Wanniski, an associate editor of the Wall Street Journal in the 1970s, chronicled how the stock market crashed in 1929 after the Senate coalition to block the Smoot-Hawley tariff from passing fell apart (also published in his 1978 book, "The Way the World Works"). Thirty-five nations opposed the legislation and threatened retaliation, which they did as a trade war ensued. Between 1929 and 1932 imports fell by two thirds and exports fell even more, according to economist Charles Kadlec’s unfortunately titled 1999 book, "Dow 100,000." So markets react poorly when the interconnected global web of production and exchange gets threatened.

That’s because stock markets price future wealth creation, and wealth is created through production and exchange. Of these, exchange is the most import. Value can be created through exchange merely by moving resources to their most highly valued uses. Not so with production. When global exchange is lessened, people, plants and firms (i.e. production) that made sense in a global economy become redundant in a local economy. That is, they are no longer needed. That is why stocks sell-off when trade-war rhetoric heats up.

Most presidents have dabbled with tariffs from time to time, but usually as temporary and/or one-off actions. On the blackboard, free trade always has winners (consumers get cheaper goods) and losers (displaced workers), but it tends to be wealth enhancing because the winners gain more than the losers lose. But because the losers are easy to identify (e.g. steelworkers) while the winners are diffuse (U.S. consumers), there is always political pressure to help the losers without fear of retribution from the winners. That’s why talk of trade restrictions never really goes away. 

Plus, many countries do cheat on trade agreements, at least by U.S. standards. For example, China heavily subsidizes many industries and often requires technology transfer (sharing) as a pre-condition for doing business there. More subtle ways of cheating include failure to comply with World Trade Organization environmental and labor rules, subsidizing or propping up “zombie” companies, and passing government procurement laws (which are almost universal) that require buying from domestic (local) producers. 

Let’s hope the current trade rhetoric results in better trade law compliance by all counties, not in a trade war.

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of South Texas Money Management or TEXPERS.

Jim Kee
About the Author
Jim Kee is president, chief economist and a partner with South Texas Money Management. He joined the firm at the beginning of 2009. He was named the president of the firm in April 2011. Kee's expertise lies in combining top-down, macroeconomic insights with bottom-up stock selection tools. He works with both the investment research group and the investment advisors at South Texas Money Management.

No comments:

Post a Comment