We know what ‘MAGA’ stands for, but only a few understand or have even heard of ‘Xi Jinping Thought’. The latter is the doctrine introduced by President Xi and can be simplistically explained as the Chinese version of ‘MAGA’. In a nutshell, the doctrine’s overarching ambition is to 1) establish the ‘iron fist’ of the Communist Party, and 2) to re-build China back to the superpower status that it was for almost a millennium. This includes taking the lead in technology, trade, and military, among many other things.
So, two of the largest global economies are now inward focused (in some ways rightfully so), and globalization is now moving in reverse. And, trade-related rhetoric has escalated over the past two months, starting with Vice President Mike Pence’s speech at the Hudson Institute. I would highly encourage you to watch the speech in its entirety - HERE. There are two possible ways to think about this escalation: 1) the disagreement runs much deeper than trade deficits, or 2) this is an elaborate poker game to out-think and out-negotiate the Chinese into a deal. The financial markets are pointing to the former. So, what are the consequences?
The total goods under the threat of tariffs are less than 1% of the overall US economy. Businesses will pass on higher prices, and consumption in some categories will slow. As always, there will be winners and losers. Companies that have moved their procurement away from China have the upper hand and can offer better relative prices. Don’t underestimate the creativity of businesses in solving tough business problems either. While the markets will over-react, the probability that escalating tariffs lead to large problems for the U.S. economy right away is low.
Supply chains are another important consideration. If tariffs persist, companies will be forced to invest capital in plants and equipment in new geographies. New facilities also require new logistical capabilities to transfer goods. This change is disruptive and introduces large inefficiencies which will only time can solve.
The last but most unpredictable impact is the one of ‘knock-on effects’. Will tariffs be a crushing blow to China, and how will that impact trading partners in South East Asia and Europe? While the severity is hard to predict, the outcomes are generally bad.
But to boil it down, this entire disruption reduces corporate earnings and returns on invested capital. Without any real precedence, markets are struggling with handicapping the odds of success and failure. How will the U.S. consumer handle higher prices? Could the disagreement escalate? This uncertainty leads to sell-offs.
This weekend, President Trump and President Xi meet in Argentina. Hopefully, they can find a durable solution where everyone wins.
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I am an investor and these are my personal thoughts on investing, behavioral finance, markets, and sports viewed through the prism of a Latticework