Trade wars with China, Canada, how this expansion collapses, Tesla and Google

1 Big Thing: The trade war with China will escalate

The latest from the White House is the threat to kick China out of the World Trade Organization. And while the news in Turkey is dominating the headlines, this is potentially more important because it signals how aggressive the Trump Administration will get in its trade war with China.

The only paper I have seen covering this is the conservative Washington Examiner. They write:

The chairman of the White House Council of Economic Advisers suggested Monday that the U.S. and other members of the World Trade Organization may have to kick China out of the world trade body if it doesn’t start playing by the rules.

Kevin Hassett said China for too long has flouted intellectual property rights rules, and said it could find itself outside the WTO if it doesn’t start respecting those rules.

“China really needs to make up its mind,” Hassett said on Fox Business News. “Do they want to be in the community of nations, do they want to be part of the WTO and just behave like everybody else, or don’t they?”

“And if they don’t, then we, the community of nations, are going to have to think about what are we going to do about that?” he asked. “Are we going to let them stay in the WTO?”

Why this matters: It is doubtful that the US would be able to get China ejected from the WTO. So this is just rhetoric meant to intimidate. But Trump’s strategy on trade is not clear. He has raised the rhetoric on multiple fronts – Mexico, Canada, the EU, Turkey and China in particular. But which concessions can US trading partners make to de-escalate the potential for a trade war? I don’t think anyone knows. And because it’s not clear which concessions are the right ones, trading partners with their own domestic constituencies to placate will be less likely to make any concessions.

I think the likelihood of a protracted and acrimonious trade war between the US and China is high. And we should expect the hit to global growth to happen just as the world economy is slowing in 2019 and 2020. How much of a hit global growth takes depends on how China reacts to the provocations from the US.

Deeper dive: And let’s remember that Trump will do anything he can to sideline Congress, even though both houses are controlled by Republicans. The President will continue to use Section 232 of the Trade Expansion Act 1962 under the guise of national security concerns to justify any and all trade decisions. And that’s because Article XXI of the General Agreement on Tariffs and Trade (GATT) says:

Nothing in this Agreement shall be construed to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests.

The reduction in tariffs globally over the past several decades was a voluntary multilateral move. Trump has now shown us that any nation can unilaterally move the pendulum in the other direction. And because the US is so large, it will have a big impact on the pendulum swing.

Corollary: The trade war may spawn a currency war too. Yesterday, amid the turmoil surrounding Turkey, the Chinese yuan depreciation went relatively unnoticed. The onshore yuan dropped 0.51% to 6.8810 yuan per dollar. That’s the biggest drop since 1 July, putting the Renminbi at a 3-week low.

To the degree market forces are moving the yuan due to a strengthening dollar, China can simply let it happen. And if the yuan falls, other Asian currencies will fall in tow. We have a very precarious situation here, because, eventually, the strong dollar will claim victims outside of Turkey. I will have more to say about this later in a separate investment-oriented post on Turkey.

2. Trade war with Canada seems more likely than with Mexico

For now, let’s stick with the trade theme. In the NAFTA saga, the unexpected has happened with Mexico now Trump’s favored negotiation partner over Canada. The Trump Administration, close to an agreement with Mexico is now threatening Canada with new auto tariffs. From Canada’s National Post:

Donald Trump launched a fresh auto-tariff threat against Canada late Friday at a time when Ottawa finds itself in a holding pattern on NAFTA negotiations as it awaits the completion of one-on-one talks between the United States and Mexico.

In a tweet that appeared to reference NAFTA’s renegotiation, the U.S. president said the “deal with Mexico is coming along nicely” and that “Canada must wait.”

Trump then sent a warning to Ottawa: “Their Tariffs and Trade Barriers are far too high. Will tax cars if we can’t make a deal!”

Why this matters: The developments with Canada go to Trump’s negotiation style. Mexico has apparently made concessions, flattered Trump. And that approach has won them plaudits. Canada, on the other hand, has stuck to its guns. And the result is an escalation of rhetoric and of potential tariffs. For Trump, it seems as though it doesn’t matter what the pre-existing relationship was. What matters is the details and negotiating position of each individual transaction.

Deeper dive: Canada and Mexico are inextricably intertwined with the US on trade because of proximity. There are always going to be disputes as a result because of the concerns of special interests. That puts both countries in a tricky spot dealing with Trump transactionally.

For example, last week a story emerged where “The Trump administration’s decision to impose tariffs on Canadian newsprint is hastening the demise of local newspapers across” the United States. That’s how the New York Times put it. But, in the Canadian press, there was less alarm about the tariff’s impact, with the Globe & Mail running a story about the “impact of newsprint tariffs being exaggerated by Canadian critics“.

US trade partners simply don’t know how to respond on individual trade issues. Nor do they know which issues will create a response from the US.

3. Economists predict how this cycle ends

When you look at how this business cycle ends though, it’s not trade that gets the nod. It’s the Fed.

• Dean Baker: “A recession caused by the Fed over-reacting to a temporary uptick in the inflation rate.”
• David Blanchflower: “My suspicion is it’s probably going to be a relatively shallow [dip], but it’s probably going to be made worse by the fact that the policymakers will look like blinded lunatics.”
• Steve Keen: “The Federal Reserve will likely respond to rising inflation by putting up interest rates, without being aware of the danger that this might cut demand from credit substantially”
• Steven Kyle: “A normal sequence of events would be interest rates go up, they pull back on investments, inventories start piling up, then we start to have a downturn.”
• Peter Schiff: “And the central banks around the world are going to have to raise interest rates. And that’s when there’s really a disaster, because we can’t afford the higher interest rates. We can barely afford the higher interest rates we have now, and we’re at 2 percent.”

Why this matters: these prognostications are coming from very different schools of thought. But the underlying connector is the rate cycle ending in recession. Trade, by contrast plays almost no role in their thinking. Hit up this link for the full article.

4. The Tesla saga has become parody

I almost don’t even want to discuss Tesla because it’s become a soap opera. The latest are a blog post on Tesla’s site explaining more about the company going private and a follow-on tweet from Elon Musk.

I’m excited to work with Silver Lake and Goldman Sachs as financial advisors, plus Wachtell, Lipton, Rosen & Katz and Munger, Tolles & Olson as legal advisors, on the proposal to take Tesla private

— Elon Musk (@elonmusk) August 14, 2018

That all sounds good. But, a New York Times article and Instagram posts by rapper Azealia Banks have blown up this crafted follow-on by Tesla.

First, the New York Times article says the Tesla board of directors was blindsided by Elon Musk’s tweets. Far from being a deliberative process,

Two people familiar with the chain of events said that in a conversation with an informal adviser about the mess he had gotten himself into, Mr. Musk said he had taken to Twitter impulsively. He said he had done so because he was not the kind of person who could hold things in, and was angry at the company’s critics.

What’s more, Azealia Banks blasted Musk on Instagram, writing that she was at his house waiting on his girlfriend, Canadian singer Grimes, when Musk posted his tweets. And she makes it seem like he was under the influence of drugs at the time.

Why this matters: can you imagine any other major technology CEO getting embroiled in this kind of situation? Picture Bill Gates or Mark Zuckerberg, for example. It’s crazy stuff.

And, by the letter of the law,  it’s clear from the chain of events that the take Tesla private, funding secured tweet was misleading. The funding was not secure. We will have to see what the SEC finds and what Tesla board does about this situation. However you look at it, Musk’s judgement is questionable.

5. Google and European regulation

On the same day that it emerged that Google tracks user location even if one has used privacy settings that say they will prevent it from doing so, I caught an article condemning Europe’s regulation of Google.

Here’s the key point of the article:

Google’s critics would define a monopoly as any firm that has a 100% market share, or at least a share large enough to make credible competition seem impossible. Traditional economic theory holds that a monopoly can take advantage of consumers by imposing higher prices than would otherwise be possible under conditions of “pure and perfect competition.” By this simple reasoning, legislators and judges must rein in monopolistic “despoilers” by imposing heavy fines, or by breaking them up, as has happened many times throughout history.

But to follow to this line of thinking, one must ignore a fundamental distinction between two kinds of monopolies: those that emerge from the free operation of the market; and those that are a result of state coercion. Traditionally, “pure and perfect competition” is taken to mean that many firms are producing the same good with the same techniques. But this definition takes a static approach, measuring market outcomes at a single point in time, even though the economy itself is dynamic.

Consider the case of a firm that is launching an innovative product. By definition, its market share will be 100%, at least for a while. The firm owes its “dominant position” to merit, and to the fact that consumers appreciate its product.

Why this matters: Don’t dismiss this line of argument out of hand. It is likely to be what US officials say when condemning the EU too. The argument is that IBM and Microsoft were hounded for antitrust violations just as their monopoly power was waning due to changes in the tech space. Equally, Google defenders will say, Google’s monopoly power is fleeting. And “Google should not be punished for this success”, as the article puts it.

I think the power of the tech giants and the differential treatment regarding privacy between the US and the EU will pit the two economic blocs in a regulatory battle over the coming years. Knowing how US President Trump operates, this battle will be acrimonious with threats of escalation.

I had three more topics to add today. But this post is getting long in the tooth so I am going to hit send. More is coming later today though.

Cheers,

Edward