Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

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Trade Wars

The concept of free trade has been around ever since Adam Smith wrote about it in his dissertation, “The Wealth of Nations”, in 1776. The global economy has enjoyed sequential bouts of globalisation followed by periods of consolidation or restricted trade ever since.

The same pattern has been seen in the broader global economy with periods of economic expansion followed by recessions. The expansions have generally lasted for years rather than months while the recessionary phases have tended to be short and sharp.

One of the biggest disruptors of free trade is war or conflict. Enemies tend not to trade with each other, access to customers can be restricted, the availability of raw materials can decline, and trade routes can close. This environment is also negative for inflation with prices rising along with shortages of goods and services. War, either hot or cold, is one of the biggest barriers to free trade.

Business cycles often get interrupted by intervention (government policy) or moderation (monetary policy). The more open and free an economy is, the greater the incentive for businesses to get on with making and selling goods and increasing prosperity for everybody.

Sometimes political intervention is positive (protection of property rights, security, provision of welfare and public access to healthcare and education). At other times, intervention will have unintended consequences. The Trump administration has announced a range of tariffs on steel and aluminium imports (subsequently lifted for a number of favoured trading partners). It has also announced a range of levy tariffs to a maximum of 25% on US$150 billion of goods imported from China.

China has responded in kind with its own proposed tariffs on US imports on steel, aluminium and soy beans as well as more than 1,000 others. Since the initial announcements, there has been no escalation while negotiations take place. This is as significant as the insignificance of the initial proposals. A 25% tariff on US$150 billion is US$37.5 billion. While that may be a large number for most economies, it is only about 0.2% of US GDP or 0.3% of China’s GDP.

The lesson politicians should be aware of and the one that most investors worry about is the impact of The Tariff Act of 1930 in the US. The US economy was already entering a recession in early 1930 when two politicians with the names Reed Smoot and Willis Hawley promoted a bill which increased nearly 900 American import tariffs. The bill was passed in June that year. The agriculture sector was a larger part of the US economy in the 1930’s and while a series of droughts had turned the mid-west into a dust bowl and decimated production, one of the goals of the Tariff Act was to introduce duties on agricultural imports to protect local farmers. The Smoot-Hawley Act, as it came to be known by, extended the duties to manufactured goods as well.

Following the passing of the Act, the value of US imports fell over 40% in the following two years. This decimated global trade and was a major contributor to the world entering a global Depression.

The terrible lessons of the 1930’s are unlikely to be experienced again. Globalisation is irreversible with the benefits of free trade increasing prosperity around the world evident to all. President Trump wants “fair” trade. The average US tariff on imports is currently around 3%. New Zealand imposes tariffs of between 5-10% on around 40% of our imports (clothing, footwear, machinery and Ambulances) but have zero tariffs on our other 60% of imports.

With globalisation has come cross-border manufacturing and supply chains. It is no longer a simple process to impose a tariff on one sector and expect the impact to be isolated. The complexity of global trade and the impact of competition and technology will ensure talk of tariffs is noise only. Any attempt to dismantle a rules-based trading system would be enormously costly.

Kevin Stirrat
Head of Investment Strategy

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