Credit Writedowns daily, sanctions and tariff edition

The overarching theme of today’s daily post is post-globalization. I hadn’t intended to have a single theme as I started writing the morning daily posy for today. But there are so many interlocking news items around the breakdown of global cooperation and of global trade that I decided to make this a thematic post.

The way to think about this is as Donald Trump best representing those who believe globalization has gone too far and want to ratchet back its impact, by force if necessary. And part and parcel of that anti-globalization movement is unilateral action premised on a “might makes right” ethos.

The way I think of it is as Trump abrogating America’s pledge to be a benevolent superpower that maintains a global world order. Instead, under Trump, the US will be one of many global actors looking to make the best deals for their own national interests. But, in Trump’s vision, the US will be first among those many because of its size and might and ability to bend others to its will through force.

This gives an umbrella under which similarly-minded politicians can also act unilaterally, where success depends chiefly on negotiating advantage and the ability to bend other nations to their will.

1 Big Thing: US international might

Reading a German account of the coming re-imposition of US sanctions on Iran gives you a sense of the broad power of the US government to impose its will on foreign actors.

The Trump Administration position is that the deal the Obama Administration worked out with Iran – hammered out with near complete opposition by Republicans – never should have happened. And so, he is in his right to rescind it and reimpose a sanctions regime to bring Iran to heel.

Goals: The question is what the objectives of the re-imposition of sanctions are. The Trump Administration says it wants to prevent the Iranians from acquiring nuclear weapons. However, the German-language article says quite clearly the purpose is regime change in order to stop Iranian actions in the Middle East in support of Assad’s Syria, Hezbollah in Lebanon, Hamas in the Gaza Strip, militant Shiite groups in Iraq and Houthi rebels in Yemen. By making the economic lives of ordinary Iranians so difficult that they elect new leaders, the Trump Administration believes it can force regime change from the outside.

What are the likely sanctions? Details are coming this week. But expect the following:

• Sanctions on Iranian purchases of US dollars
• Sanctions on Iranian dealings in gold and other precious metals with anyone
• Sanctions on Iranian dealings with metals, coals and software related to industrial production with anyone
• Ban on the import of Iranian rugs and food into the US
• In 90 days, a reduction of oil imports from Iran by anyone

Why this matters: As the German article says, the US is the largest market in the world. And companies that do business in Iran, do business globally. They do not want to lose access to the US market by flouting the US sanctions regime. So they are forced to comply, even though they are not under US jurisdiction. That’s the power of the US.

Moreover, the US dollar, as the world’s reserve currency, adds an extra measure of power over actors in the financial system because the US can cut off actors who deal with Iran using the American currency. BNP Paribas’s $8.9 billion fine, imposed in 2014 and upheld in US court in 2015, serves as a warning to all comers.

Deeper dive: This is the genesis of Trump’s uncompromising positioning on international issues. He rightly believes the US has unparalleled power not just because of its military but also because of the size of its economy and the US dollar. And he is willing to use coercion to get what he wants by using this power as weapons against perceived enemies and allies alike.

2. Trump’s broadest set of tariffs ever

Thinking about the Iranian situation helps understand where Trump is coming from on tariffs. Yesterday, Axios reported that leaked Trump Administration documents show plans by Trump trade advisor Peter Navarro for “the United States entering simultaneous trade wars with China, India, Pakistan, Thailand, the Philippines, Singapore, Ukraine, Mexico, Saudi Arabia, Chile, Hong Kong, Brazil and Turkey”.

The sanctions were intended as an executive order in order to bypass the need for Congressional approval. And the tariffs would have been very large, with a ratcheting up over time to as high as 45%.

Why this matters: Since Trump has come to office, people have quoted Maya Angelou’s life lesson “When people show you who they are, believe them.” In Trump’s case, he is telling us he is a protectionist because he believes in America’s might and right to force others to its will.

So far, Trump has negotiated and found reason to think the US can reach an equitable deal with both Mexico and the EU. A Canadian deal remains elusive. And the rift with China now seems to be escalating. Navarro has already laid out the blueprint for more tariffs. All President Trump has to do is sign the Executive Order.

Deeper dive: We now see that the imposition of tariffs, of sanctions — and even the threat of military action — are all not just believable but likely. We already have tariffs. We are about to get punitive sanctions. And these sanctions follow from the course of action that Trump national security advisor Bolton advised in August one year ago.

The potential that Trump will eventually use military force is high, particularly in North Korea since Bolton has already told us preemptive strikes are on the table. Now that North Korea is openly re-engaging in nuclear activity, Trump will have to decide if further talks with North Korea make sense.

“When people show you who they are, believe them.”

3. The costs of tariffs are adding up

Tariffs are a tax that domestic consumers pay on foreign-produced goods to encourage them to favor domestic producers. So, while the foreign producers lose customers, they don’t pay the tax. Domestic consumers do through the increased costs of the products on offer to purchase.

Tariff losers: One US consumer is the auto industry, which buys imported steel and aluminum that is now subject to tariffs. During earnings season, Ford and GM both lowered their profit forecasts for 2018, specifically citing higher steel and aluminum prices. And Fiat Chrysler cut its 2018 revenue forecast because of falling sales in China as Chinese consumers delayed purchases, hoping (in vain) for tariffs to decrease. This is why the auto industry is negative on the tariffs.

Tariff winners: US steel producers are in favor of the tariffs. And they have an especially close relationship to the Trump Administration. Here’s how the New York Times puts it:

Two of America’s biggest steel manufacturers — both with deep ties to administration officials — have successfully objected to hundreds of requests by American companies that buy foreign steel to exempt themselves from President Trump’s stiff metal tariffs. They have argued that the imported products are readily available from American steel manufacturers.

Charlotte-based Nucor, which financed a documentary film made by a top trade adviser to Mr. Trump, and Pittsburgh-based United States Steel, which has previously employed several top administration officials, have objected to 1,600 exemption requests filed with the Commerce Department over the past several months.

To date, their efforts have never failed, resulting in denials for companies that are based in the United States but rely on imported pipes, screws, wire and other foreign steel products for their supply chains.

The ability of a single industry to exert so much influence over the exclusions process is striking even in Mr. Trump’s business-friendly White House, given the high stakes for thousands of American companies that depend on foreign metals. But the boundaries of trade policy are being tested by the scope of Mr. Trump’s multifront trade war with allies and adversaries alike, which includes tariffs on up to $200 billion worth of goods from China and possible tariffs on automobiles and auto parts.

Overall costs: the BBC has put together a list of tariffs proposed and actually enacted that is very useful. Global growth cost estimates vary. But we’re talking less than a 1% hit in the worst case scenarios. Morgan Stanley says 0.81% loss for the US in a full-blown US-Chinese trade war. And the IMF is saying a loss of 0.5% for global growth by 2020.

These costs are relatively large but manageable in a growing global economy. The worry is that global economic growth wanes just as the costs of tariffs are hitting.

4. Tariff impact on the US federal budget deficit

The Washington Post has a piece up about Trump’s worldview on tariffs as it relates to the budget deficit. Here’s what they say:

President Trump tweeted Sunday morning that his tariffs are “working big time” and made a bizarre claim that the money raised from these new import taxes will go a long way to helping pay down America’s large debt. (Short answer: That’s not what will happen).

Trump portrays the tariffs as a tax on foreigners, but the reality is that tariffs are taxes on U.S. companies and consumers. When a big U.S. retail chain or an equipment manufacturer has to pay 10 or 25 percent more to get steel from Canada or a certain part from China, that U.S. company has to pay the tax when it imports that item. U.S. businesses either eat that extra cost or pass it along to consumers.

Why this matters: I don’t like the fixation on the budget deficit. While its Trump who brought the deficit into the conversation, with his tweet, what matters is longer-term sustainable growth. If the Trump Administration’s policies boosted growth sustainably, not only would they boost the economy, but also tax revenue.

Deeper dive: So far, tax revenue has declined. But the unproven theory is that because private sector money earners know better how to allocate capital than the government, the recent (corporate and upper-income) tax cuts will boost growth in the long-term. And that is supposed to be good irrespective of whether the ‘tax cuts pay for themselves’.

I don’t buy into this thinking. For me, middle class wages and consumption dominate the path of sustainable growth. If middle class wages are rising, the level of household consumption can rise in concert without the use of debt or leverage. Ultimately, higher wages mean a higher taxing capacity for the government too. So I focus on wage growth. The deficit issue is a side show.

Contrarian take: Many Democratic politicians are focusing on the deficits Trump’s tax cuts have created. But there’s no evidence that American voters are more concerned about the deficit than they are about wages and wage growth. Voters care about being able to afford basic necessities and having enough left over to create a reasonable ‘middle class’ lifestyle they can be proud of. If the Democrats try to make deficits an issue in the midterm elections, it will muddle their message, working against them.