… But, It Will Be Tweeted

Tariff by bloody tariff apparently.

Yes folks that’s right, despite all the talk of North Korean nukes, the Singapore summit, and “historic” de-nuclearization agreements reached (which were apparently the same as previous historic agreements); something far more sinister and much less subtle occurred recently — and I’m not talking about U.S. -sponsored human rights abuse committed along the U.S.-Mexico border either. No, I refer to the fact that U.S. President Donald Trump, and his team of economic advisors (and I use that term loosely), saw fit to consummate the trade war they’d been threatening since early 2018 … with the entire world!

In the last weeks of late-May and first weeks of early-June 2018, President Trump canceled all country-based exceptions to the 25% steel and 10% aluminum tariffs he imposed earlier in 2018. This move angered long-time allies and trading partners around the world including our North American Free Trade  (NAFTA) Partners Canada and Mexico; the European Union (EU); and other countries such as Brazil, Japan, and India. In retaliation, the EU  enacted counter-tariffs on U.S. imports; prompting further tariffs threats from President Trump on European cars. The EU also lodged an official complaint to the World Trade Organization (WTO), and Harley Davidson announced it is transferring some production to Europe to avoid the tariffs on its motorcycles sold in Europe.

But Wait, That’s Not All The Trade War News

President Trump also firmed-up the list of  Chinese goods that the U.S. would hit with 25% tariffs starting 06 July 2018. China subsequently retaliated with a final list of American goods upon which they will impose 25% tariffs. The total price tag for each list is approximately $68 billion ($34 billion each). According to reports, the Trump administration is now contemplating $200 billion more of trade tariffs on Chinese goods. Since China only imports $130 billion of goods from the U.S., they are threatening to tariff the remainder of U.S. goods coming into the country, along with other “qualitative measures” — which probably means erecting even more barriers to U.S. companies operating in China. This back and forth has a name among game theorists and economists alike. It’s called tit-for-tat. It doesn’t usually end well for either party involved.

In conjunction with all of the above, President Trump caused the Quebec-based G7 summit to fail after launching a personal attack via Twitter on Canada’s Prime Minister, Justin Trudeau. He also refused to sign the summit’s joint communique. President Trump’s anti-free trade tariff’s had already angered the other G7 members. However, his un-diplomatic behavior towards a friendly head-of-state sent the remainder of the G7 flocking to the defense of Mr. Trudeau. More importantly, Canada, India, Japan, and others have all announced retaliatory tariffs of their own on American goods.

How’d We Get Here?

Are you are scratching your head on all this trade talk? Are you confused about the U.S.’s current (lack of) foreign trade policy, the apparent U-turn the U.S. made in the last few years on free-trade, and the reaction by our closest allies and trading partners? Do you feel lost because you don’t have a degree in economics or foreign policy? If so, I’ve linked to a great Marketplace radio article below that covers the last 30 years of U.S. trade policy in eight minutes and in extremely easy to understand terms. I’d advise listening to it, as opposed to reading it. The President Reagan excerpt pops when you hear what he says in his own voice.

https://www.marketplace.org/2018/06/08/economy/how-us-trade-policy-has-changed-over-30-years

The above news article covers NAFTA, but NAFTA is only part of the story when it comes to foreign trade over the past 30 or so years. The other part of the story is, of course, China. In the case of China, the U.S. has far more legitimacy for enacting tariffs against Chinese goods. For years, China dumped its glut of steel and aluminum onto the world market, driving down prices, and undermining domestic production capabilities in the U.S., Canada, and Europe. Had tariffs stopped with Chinese goods, the U.S. may have received support from numerous allies and the EU.

China also has a nasty record of forcing international companies to hand over their technology in order to access Chinese markets. This allows Chinese companies to compete directly with international companies using their own industrial secrets against them. That doesn’t even include the state-sponsored Chinese program to steal U.S. industrial secrets in order to advance its own industrial and technological base.

A Three Front War

Funny story, I have a masters degree in Military Studies. One of the maxims I learned in my master’s course was to never start a two-front war, when you only need to fight on one. Apparently the Trump administration isn’t up on military studies, since they are fighting a three front war. If the NAFTA partners are the first front, and China the second, then the other front is the EU.

It’s difficult to say if the EU was an intended target in this trade war from the outset, or simply drawn into it by the wide-net that the Trump administration cast with its tariffs aimed at China. In some ways, it doesn’t truly matter. The trade war is now “on like Donkey Kong” with the EU. The EU based tariffs officially started this week, 22 JUN 2018. Apparently, the Trump administration is now considering tariffs on EU made automobiles in retaliation. The EU is, of course, planning a response to the Trump counter-response. C’est la Guerre commerciale — that’s trade war!

Does it Matter?

That said, since the U.S. undertook its tariffs unilaterally against China, and hit the rest of the world in the process, it’s likely that the U.S. will lose the complaint the EU sent to the World Trade Organization (WTO) for adjudication. Should that happen, it’s completely feasible that the Trump administration might choose to ignore the WTO’s ruling; placing the entire rules-based, free-trade system that the U.S. has championed since the end of World War II at risk.

Now, some folks may not care about U.S. trade or foreign policy. They might even question what it has to do with personal finance, pensions, and Financial Independence (FI). Some people might think that foreign policy and trade don’t impact their bottom line — especially as they plot a path to FI and execute their retirement plan. However, I would argue that my readers are smarter than that. They may not be able to articulate why all of this “foreign trade stuff” matters; but they know it’s important. Just for the sake of argument though, let’s see if I can lay out a coherent argument why everyone should care, whether they be part of the Golden Albatross community, or not.

The Trade War vs. Your Retirement Portfolio

The truth is, that those of us close to retirement, or already in retirement, will need more than just our pensions to live on. That means a reliance (up to a certain point) on our personal savings and investments in conjunction with our pensions. This is what I’ve referred to in several previous articles as the Gap Number.

Now, as Kai Ryssdal, the host of Marketplace likes to say, “the stock market is not the economy, and the economy is not the stock market”. Tariffs and trade policies are about the economy, not stock markets. However, over the long-term, the U.S.economy and stock markets tend to travel in tandem. For example, look at the following chart:

In Defense of Free-Trade

Thus, the performance of the economy, the effect of trade policies, and the impact of tariffs should matter greatly to anyone planning for retirement. The performance of our investment portfolios are inextricably linked to the economy. Investment performance also matters a great deal to the health of most pension funds that Golden Albatross members rely on in retirement. So it should come as no a surprise, then, to discover that companies these days (the ones we invest in through the stock market, and the ones we work for) depend on smooth functioning international markets that hinge on free trade.

As a result, everyone in the Golden Albatross and personal finance community, should want to see policies enacted that promote international free-trade, engender stronger relationships with U.S. trading partners, and see that markets operate on the rule-based system that the U.S. established after World War II. Certainly, the system isn’t perfect, but it’s delivered the U.S., the West in general, and much of the developing world, unprecedented levels of prosperity. It rebuilt and re-united a devastated Western Europe after WWII; won the Cold War; and lifted billions out of poverty in the last several decades.

Friends Matter Too

There’s another reason why this stuff matters, and it has to do with the actions of our trading partners and friends during a global recession. You may not realize this, but the Great Recession of 2008 could have been a lot worse. Yes, the 2008 recession was deep and long, but it wasn’t nearly as bad as the Great Depression. A large reason for this was that the U.S. led, prodded, cajoled, and arm-twisted the international community to act in near unison through mechanisms like the G7, G20, and the International Monetary Fund (IMF). In numerous cases, we had built up the goodwill with our international counterparts over the previous decades and called in the favor when it was needed. Doing so limited the worst effects of the Great Recession through the employment of massive amounts of government capital, lower interest rates, and synchronized monetary policy.

The international community didn’t have to react together. It could’ve taken the “every person (or country) for themselves” approach. That’s what happened during the Great Depression. Countries enacted trade barriers and tariffs; raised taxes; forced austerity upon its institutions, and generally shot themselves in the foot. However, economists from many of world’s governments and major financial institutions took the lessons learned from the Great Depression and applied them during the Great Recession in order to keep things from getting worse.

A Recession is Coming!

Those are my two main selling points. International trade is important because it impacts all of our investment portfolios. International trade also promotes strong economies, builds-up economic institutions, and engenders goodwill in advance of global economic calamities. That may lead you to ask whether or not an economic recession is coming? Unequivocally yes! The trick, as JL Collins loves to point out, is that no one knows exactly when. Technically, the average business cycle in the U.S. lasts roughly six to eight years from peak-to-peak or trough-to-trough. In other words, there’s a recession once every six to eight years. Guess what that means? We are overdue for one.

What will be the cause? Who knows! The Great Recession of 2008 was caused by a crisis over sub-prime mortgage lending, the effects of which of which were felt all over the world. The bursting of the “irrational exuberance” tech bubble caused the 1999 – 2000 recession. Savings and loans failures caused a recession in the 1980s. Stagflation and an oil embargo caused one in the 1970s. And let’s not forget the great run-up in stock market value and the banking crisis which caused the Great Depression in 1929.

What Worries Me

The key takeaway here is any number of issues could trigger the next recession, and much like the last one, it will probably be felt worldwide. As a result, the U.S. will need all of its economic trading partners, especially its long-established friends, when the next economic downturn hits. Instead of punching our long-time allies, neighbors, and trading partners in the face for China’s intransigence; the U.S. should be teaming up with them to change China’s behavior. Yet, that’s not what the U.S. is doing. Instead of gathering our allies close, and placing more tools at our disposal; we seem to be doing the opposite. As result, the U.S. is not only creating the conditions for the inevitable next recession to appear faster; but it is also creating conditions to make the after effects much worse!

Now, I’m not a trained economist, but the following list of macroeconomic actions taken by the current U.S. administration concern me a great deal. They concern me most because they seem designed to make the next downturn that much worse for a retiree. I listed them in order of importance, and with a small explanation as to why they worry me.

Tax Cuts

Late business cycle tax-cuts put me on edge. This is the sort of stimulus the economy needs early in an economic recovery, when the unemployment rate is high. It’s not what the economy needs with unemployment at record lows. Running massive federal deficits in order to deliver tax cuts will most likely increase upward inflationary pressure. This, in turn, places more pressure on the Federal Reserve Bank (the Fed) to raise interest rates at a quicker pace, in order to keep the economy from overheating.

That’s a fine line to walk, which equals room for miscalculation. Raise rates too fast, and the Fed stalls the economy; causing a premature recession. Raise interest rates to slow, and inflation runs rampant; causing consumer prices to rise faster than wages. I’d much rather see inflation creep upward as a result of higher wages, caused by a healthy job market; rather than an ill-advised tax cut.

Tariffs

Protectionist policies hurt the consumer by making the things they buy more expensive. This drives up inflation faster; which again drives the need to raise interest rates faster. Tariffs also kill productivity, which in turns kills wages and jobs. Productivity means increasing the amount of stuff a worker produces over the same measure of time (i.e. per hour, per day, etc.). In theory, more productivity means more money to pay workers, but productivity hasn’t risen significantly in over a decade in the U.S.; which parallels the story of U.S. wages. By raising tariffs, the administration just made the input cost for goods created that much more expensive; which means productivity just went down instead of up!

In order to combat the rising costs associated with producing their goods, businesses will for a time attempt to cut costs; rather than pass on increased costs to consumers. However, there is only so much slack in business cost cycles. At the end of the day, businesses are forced to enact some combination of the following three choices when tariffs get out of hand: raise prices, cut costs (i.e. lay-off workers,) and/or shift production overseas to places not impacted by the tariffs. None of these options are good for the U.S., and any one of them could start a recession.

Financial De-Regulation

As if the Great Recession wasn’t a reminder enough of the potential for a less-regulated financial industry to screw up the U.S. and world economy; the U.S. Congress recently voted in some changes to the Dodd-Frank Act. Dodd-Frank was the legislation passed after the Great Recession to curb the banking practices which caused the downturn.

In some cases, Dodd-Frank merely re-instituted post-Great Depression regulations which were eliminated from the 1980s through the 2000s. This includes strict capital requirements for banks that lend money; including Systemically Important Financial Institutions (SIFIs). These banks are otherwise known as “too big to fail banks”. The recent reform of Dodd-Frank changed the measurement used to label banks SIFIs, from $50 billion to $250 billion in total assets. This now means less than 10 banks in the U.S. are subject to the most stringent Dodd-Frank lending rules.

Reform

Now, I’m willing to concede that for the local and regional banks in the U.S. that hold way fewer assets than $50 billion, complying with all of Dodd-Frank proved onerous. In those cases, I believe the reforms will help increase lending at the local level. However, moving the SIFI designation for the largest lending institutions in the U.S. from $50 billion to $250 billion seems dangerous. Especially at a time when the average U.S. household debt to GDP  ratio remains way above historical norms. Not to mention at a time when total U.S household debt continues to hit all times highs.

While it certainly appears that when everyone is working, U.S. households can sustain large amounts of debt; what happens when price increases from tariffs and inflation start to hit without significant wage inflation? More importantly, what happens when job losses start as the result of the aforementioned policies? Recession, that’s what happens. At that point look out for tidal (or should I say title?) waves of defaults, foreclosures, and bankruptcies.

Legal Immigration

Quiz time! I bet you didn’t expect one so late in an article, did you? Let me ask you a question. What happens to a pension fund with more retirees drawing benefits than workers contributing? As my readers know from my article on the Pension Benefit Guarantee Corporation (PBGC), that pension fund enters a death spiral. Let me ask another question. What’s happening to Social Security currently? If you said, “it’s got retirees drawing more money out than what workers are contributing”, then have a beer on me. Make it a good one.

One more question, how does the U.S. find more workers to replace retirees at a time when U.S birth rates are so low? Psst. The answer is in the title of this sub-section. That’s right, legal immigration. Unfortunately, the U.S. administration is currently engaged in a serious battle over legal immigration. But wait you say, “the controversy at the U.S.-Mexican border is about illegal immigration and asylum seekers, is it not?”. Yes, the current dispute is. However, in the background of all that commotion, the Trump administration is engaged in a quiet but nasty campaign to limit legal immigration. Don’t take my word for it though, even USA Today picked up on this fact recently and listed all the ways the administration is limiting legal immigration.

Economics 101

From an economic standpoint, limiting legal immigration makes absolutely no sense. The U.S. not only needs workers desperately, in an assorted number of industries, but it needs the tax revenue those workers generate to shore up programs like Social Security and Medicare. Instead of limiting immigration, we should be opening our arms and legalizing as many immigrants as we can, as quick as possible. As the U.S. Treasury pointed out in 2011, there are numerous sound economic reasons for encouraging immigration to the U.S., and the economic pros far outweigh the cons. And as I pointed out at the beginning of the article, what’s good for the U.S. economy is good for our retirement portfolios and pension funds!

But hey, on the plus side, the current U.S. immigration policy should technically drive up wages. Of course, it will only do that in job markets that 1st generation immigrants typically work in. Usually, those are lower paying jobs like farming and healthcare, or selective high-end jobs like Information Technology. Good luck in finding 2nd generation and beyond Americans who either want, or are qualified for those, jobs. It’s probably why my Facebook feed is flooded with gifs of crops rotting in the field at the moment.

Inflation and Interest

One more point on immigration. How do businesses cope with the added costs of a limited labor pool? You guessed it, charge more for goods and services so they can pay workers more. What does an increased cost of living equate to? Higher prices. What do higher prices lead to? Higher and faster inflation. How do you fight higher inflation? Higher interest rates.

So while on one hand, if you have a lot of money in savings accounts accruing interest, as long as it’s keeping pace with inflation, you’ll be OK. Your pension fund will also see it’s funding percentage go up! On the other, if your pension isn’t inflation adjusted, you’re hosed at a personal level. Not to mention the fact that a rapidly rising interest rate environment tends to dampen stock market returns. Maybe not such a bad thing after a 10 year Bull Market, but then again you got to live off of those investments!

The Bottom Line

My long-winded point to this article is that at this stage in the economic cycle the U.S. government should be adding as many economic tools to the war chest as possible in preparation for the next recession. This means gradually hiking interest rates; freeing up labor markets; promoting international trade to increase GDP; and gathering trading partners and allies near so they’re ready to respond to the next worldwide economic calamity. Doing so is not only good for the nation, and the world, but it’s good for our retirement prospects!

Instead, the Trump administration seems intent on doing the opposite. It’s enacting policies that rapidly increase inflation through tariffs and tax cuts which leave interest rates playing catch-up. One major interest rate miscalculation, and we’ll either get runaway inflation or recession … or both. The administration is driving away friends and allies by shutting down international free trade through tariffs. It’s creating a false driver of tightness in the labor market through baffling legal immigration policies; which again drive up costs and inflation. Almost everything it’s doing will decrease productivity as well.

OK, The Real Bottom Line

Most importantly, the Trump administration’s policies will negatively impact your and my retirement. The amount of inflationary pressure the administration injected into the economy since December 2017 will lead to increased economic volatility and destabilization. Maybe not right away, but in the long run almost certainly. In fact, the administration’s actions may mean the next recession is right around the corner. As a result, I cannot help but conclude (in my completely non-professional opinion) that the hang-over from the next recession will be that much worse than the last one.

But wait, before you go and sell all your assets; stock up on gold, platinum, and lead; and move to your mountainside redoubt, it’s worth noting there are prudent things a person planning for retirement can do. Unfortunately, though, you’ll have to tune into a future edition of the blog to find out what those are.  At 3500+ words, this rant is long enough. Ta ta for now, and let me know what you think of this wonkish article in the comments below.