Merlin Weekly Macro: Trump follows through on tariff pledge

Liberation Day! For us, it will be the one on which we can write this weekly column without once mentioning Donald Trump, particularly when he has single-handedly wiped billions off the value of global equity markets. But he is the rainmaker, the creator of thunder and lightning in global economics and looks set to remain so for the next three-and-three-quarter years. The moment he stops being the story, he is history. Quod erat demonstrandum.

10%: he said he would and he did

Trump’s ‘Liberation Day’ tariff programme has inevitably provoked howls of indignation from America’s trading partners given that every single one of them is immediately subject to a minimum blanket rate of 10% with targeted discretionary surcharges (often on top of existing tariffs already announced). But they all knew it was coming. It was explicit, a cornerstone policy he spelled out very clearly last year on the stump and in his victory speech in November. We wrote about it at the time, more than once. What those professing surprise or disappointment have not yet fathomed is that Donald Trump is a phenomenon in western politics: he says what he means and does what he says. However casual, random and off-the-wall some of his comments, only a fool would discount them as either unintentional or inconsequential.

The Law of Consequences

But while Trump is responsible for this reordering of the worldwide economy, it does not mean that he is in control of its evolving shape. New alliances are forming directly as a result of the tariff programme he has introduced since his inauguration. As well as taking reactive retaliatory action against the US with tit-for-tat trade barriers which escalate tensions, China is being proactive in strengthening its strategic sphere of influence. At the end of March it led a three-way convention with South Korea and Japan to seek out common grounds for a free trade agreement which would dominate trade in the Far East. China is on the wrong end of a 54% tariff from the US, Japan is incurring a 24% wrath rate and South Korea 25%. Despite Japan and South Korea both being officially designated Major non-NATO allies of the United States, and China being seen as the greatest threat to US supremacy, Trump is driving what should be natural US bedfellows into the open arms of America’s biggest geostrategic rival. The EU too has been ‘reaching out’ to Beijing in recent days (one can only assume that given his contempt for the EU, such Euro-Sino discourse will cause Trump no loss of sleep).

After the initial harrumphing, countries exporting to the US will hone their national responses: some will negotiate (e.g. the UK), others retaliate (e.g. China, the EU and Canada) and/or seek alternative alliances; others will consider the path of least resistance and invest directly in the US to avoid the tariffs entirely. For fear of not wanting to appear either weak or supplicant, and with too much at stake with their own domestic economic circumstances, few are unlikely not to respond or react at all.

Trump is certainly a nationalist. But is he an isolationist? It is a moot point but it seems unlikely with $600 billion of annual duty revenues riding on it to fund his tax cuts. That his highly corrosive and divisive means of achieving his goal of ‘America First’ and the ‘Most Dominant Civilisation the World Has Ever Seen’ potentially leaves the US isolated is a different argument. We are ringside participants to a great big geostrategic experiment where a chain reaction has been induced but nobody is entirely sure of the result.

Upsetting the global apple cart

As we have discussed in previous columns on this subject, tariffs are barriers to trade which cause trade flow patterns to alter. Goods which are displaced still need to be sold and will find new markets potentially creating disruption in doing so (‘dumping’ at discounted prices to get rid of the stuff is a risk); on the other hand, assuming the demand remains, there are opportunities for domestically made substitute goods to replace those imports which have been discriminated against. Market forces determine the extent to which the importer can recover the cost of the mandatory duty through higher selling prices, or absorbs some of the cost which is reflected in an erosion of profits and margin. It is where no domestic substitute products exist that the importer has the greatest chance of recovering the duty in full by passing it on in a higher selling price.

In this game of swings and roundabouts the inflationary calculation is complicated by this being a multi-layered and highly complex tariff structure. The global floor of 10% then has selected national surcharges on top, to which add duties on specific manufactured goods ranging from individually identified raw materials (e.g. steel) to some finished goods (e.g. cars). There can be little doubt that there will be inflationary pressure immediately. But in the event there are then no new higher tariff rates and all other things stay equal, by year two the inflationary effect has passed as the mathematical comparative time series moves on and the ‘base effect’ comes to the fore. Consider: a (tiny) car today costs £10,000; a 25% tariff is imposed and recovered and the total price of the car is £12,500; next year the inflation rate on that good will register as 25%; if in 2027 the duty is constant and so is the underlying price, the 2027 inflation rate is zero notwithstanding that the car still costs a quarter more to buy compared with today; from a cost-of-living point of view the car remains ‘expensive’ until real wages have caught up to neutralise the effect of the tariff.

This is part of Trump’s political calculation: he promised US voters that he would deal with inflation and create jobs. He knows he is likely to create inflation and acknowledges the economic risk (‘we can take a little pain’, he said in a news interview, ‘it’s about a much bigger picture’). What he is banking on is that by 2029 and the next election, the inflationary effect will have passed as too will the cost-of-living factor through real wages catching up, and investment will be flooding into the US. Where this potentially falls apart is if the frictional inefficiencies induced by tariffs create such a hiatus that the US economy grinds to a halt or goes into recession, wage rises are unsupported and jobs are lost. In which case ‘Make America Wealthy Again’ has exactly the opposite outcome.

The core of Trump’s strategy is Made-in-America-with-American-Sweat. To that overarching extent it is no different from what Joe Biden was trying to do also. But the approaches are entirely different. Biden’s industrial strategy was focused on accelerating the conversion to the green economy. His was a simple but effective ploy: ‘green’ products (heat pumps, solar panels, insulating materials, electric vehicles and many more) would attract significant tax incentives for consumers and businesses but only if the goods were stamped ‘Made in America’. Cue a big shift in global capital flows especially in sectors such as automotive where German manufacturers could see themselves cut off from their biggest export market, taking in a brand new technology in a virgin field, unless they opened EV production capacity in the US; with limitations on the capital available, investment originally planned for Germany was diverted. But essentially, Biden’s was an entirely protectionist strategy but using the tax incentives as a big carrot. Trump’s is also a totally protectionist strategy but one in which foreign companies invest in the US to avoid being hit with a big stick. Business is pragmatic and responds to the new circumstances; what is challenging for companies is the never-ending flip-flopping of national policy which can change on a whim, while long-term capital planning requires at least a modicum of stability and predictability.

The Brexit dividend

The United States is the UK’s biggest national trading partner. While the UK has escaped neither the specific taxes on products such as cars and steel nor the blanket 10% national tariff, we have avoided the 20% rate applicable to the EU. The 27 member states of the European Union and its Customs Union have ceded sovereignty on all trade matters to Brussels. It will be the Commission which will determine the Bloc’s response to Trump’s tariffs. Removed from the action, individual governments have to pitch to the Commission to ensure their own national interests regarding domestic exports to the US are heard. Our individual freedom to negotiate and Trump’s visceral hatred of the EU (‘the EU is an atrocity’ and ‘the EU was invented to screw us’) and support for Brexit are working in our favour. However uncomfortable as he tries to reset the UK’s relationship with the EU, Keir Starmer must be thanking his lucky stars that against his better judgement as an arch-Remainer and the one who led the Opposition in trying to overturn the referendum result, at least on this occasion he is in the driving seat. Which way his satnav is telling him to go is another matter.

Merlin philosophy

‘Challenging’ is an over-used word. But these are indeed challenging times for investors. We always sign off these columns with the same paragraph. There is the danger that in doing so it becomes a bit like wallpaper: there but barely noticed. But it is intended to remind investors of what the Jupiter Merlin Portfolios are there to do: to compound investors’ wealth over time taking the rough with the smooth. They are not intended to be spectacular but we do try our level best to make them as dependable as we can. They are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. Much might be changing around us to which we adapt and react as necessary but our philosophy remains a constant.