And I Think to Myself, What a Wonderful World

It is Thanksgiving week in America; typically a quiet period in the equity market, which we can confirm, it was a quiet week. Underneath the surface, however, we started the week with a big pill to swallow: the inevitable threats of tariffs from President-Elect Trump.

Background

The incoming President has long lamented the trade imbalances between the United States and its trading partners. A little bit of history: between the 1970ies and late 90ies, free trade forces saw a large shift of manufacturing and materials sourcing move form the North American market to lower cost producers all over the world but especially in China (which by the 70ies had begun to integrate itself with the global economy). This change was not without consequence; many jobs were lost in rural areas where it was more difficult to find the service jobs that the economy was orienting towards. Here in Montreal, we lost our textile and garment industries for example but we also had growth in the finance, law and engineering fields. Both Canada and the United States found themselves wealthier from globalization trends, however the wealth was not equally distributed with many amongst the middle class being dealt a losing hand while fewer people were winning more.

Over time, this trend has made both nations more dependent on foreign countries to produce the goods that we use on a daily basis. In the mid 2010s, the United States realized this and also took note of China, at this point the manufacturer for the world, becoming more ambitious with its newfound wealth and power. No longer content with simple manufacturing, the country wanted to see its own brands become globally relevant and was able to use its infrastructure and knowledge (as well as foreign companies’ proprietary data) to launch competing firms in almost every industry. Under Trump 1.0, he focused aggressively on the trade imbalances between the two countries and placed tariffs on the import of Chinese goods in the hopes that it would influence consumers to alter their consumption behaviors.

Today’s Story

Beyond America's (and the rest of world’s) discomfort with China’s new economic direction, the pandemic brought forward an uncomfortable consequence of the globalized supply chain which led to high inflation and supply shortages that have only recently improved. Under President Biden’s administration, there was a renewed focus on bringing back high quality manufacturing jobs in critical industries such as semi-conductor, renewables and electric vehicle production. It’s been an immense success and contributed to the country's economic resilience of the last three years.

In anticipation of his second term, Mr. Trump has decided that they need to build on this progress and has threatened to add an additional 10% tariffs on Chinese goods but he also suggested 25% tariffs on Canada and Mexico. Canada and Mexico are the largest and third largest exporters to the United States, the largest and second largest importers of US goods and services and the two countries have small trade surpluses with the US - $152B for Mexico and $64B in Canada as of 2023. The volume of trade between all three partners means millions of jobs attributed to said trade; 2.4 million jobs for Americans and 7 million jobs for Canadians and Mexicans for the more than $1 trillion of goods and services exchanged. On Monday, when the incoming President announced these tariffs on his social media platform, investors, politicians, and entrepreneurs were left scrambling to come up with contingencies and strategies and also mobilized Prime Minister Trudeau and President Sheinbaum to try and mitigate some of the threat. He did not highlight trade imbalances this time, instead he lamented the flow of migrants and drugs into America. Although these tariffs would hurt all three countries, the only significant response was in the currency market as the stock market shrugged this off.

What’s next

The markets response tells us that investors are not taking these threats seriously, with many suggesting this to be a negotiation tactic. I’m not entirely sure what Mr. Trump will get out of Canada with these threats, the flow of people and drugs across the northern border is negligible. As for Mexico, they’ve already been working with the US at reducing border crossings; land border encounters are down 70% from the peak. Regarding the flow of drugs into America, President Sheinbaum said the following “seventy percent of the illegal weapons seized in Mexico come from your country. We do not produce these weapons, nor do we consume synthetic drugs. Tragically, it is in our country that lives are lost to the violence resulting from meeting the drug demand in yours". Both trading partners will try to please the incoming President by pledging further commitments and assuaging American concerns; to be seen what that will look like.

What this kind of politicking risks accomplishing is pushing America’s largest trading partners to look elsewhere for a more reliable partner. Europe is looking to become less dependent on America and it may approach both countries to reinforce trade between themselves. Mexico is already growing closer with China and these threats will likely bring them closer. As for America, it simply does not have enough workers or the current infrastructure to produce more of the goods that its citizens consume. Beyond the fact that shifting production from low cost countries is inflationary, many low paying manufacturing jobs in America are occupied by the same people that Mr. Trump wishes to deport.

Right now, nothing has fundamentally changed but this week’s events are a reminder of what the next four years could look like. While getting global leaders to grovel makes the President look strong amongst his supporters, it diminishes confidence in doing business with the world’s largest economy. If America’s consumers have an appetite that goes beyond its own borders, countries will have to accommodate any new requests but if trade between America and the rest of the world stalls, so does the incentive to try to accommodate.

Healthy Distraction

Sticking with our theme of tariffs, I wanted to highlight some goods that we consume, whose production cannot be shifted across borders despite the threat of tariffs:

Parmigiano: it can only produced in the Emilia-Romagna region. Anything else that is not from there, is simply not parmigiano.?

Champagne: true Champagne can only be produced in the Champagne region in France.

Darjeeling tea: a popular tea in Europe and America due to its distinct taste, it too can only be produced in the Darjeeling district of West Bengal.

Coffee: while there is some small production in America and Canada, the climate makes it difficult to produce a large enough quantity at reasonable cost for the markets to supply themselves.

Maple syrup: this one is a little different. Here in Quebec, we are producing 70% of the world’s output. If trade became more difficult, fewer people around the world would get to enjoy the goodness that our maple trees produce every winter. Also, the 15000 producers in the province would face significant risks if unable to export to other countries.

As a foodie, my passion risks becoming more expensive if globalization retreats. I do not think it is healthy to assume the worst-case scenario from here but if you do like certain goods and if they are easy to store, it may not be a bad idea to stockpile a few of them.

Have a great weekend!

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