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Affluent Investor | June 29, 2017

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What if They Had a Trade War and Nobody Came?

060906-N-4856G-040 Pearl Harbor, Hawaii (Sept. 06, 2006) - Local spectators wave aloha to the Chinese Navy destroyer Qingdao (DDG 113) while mooring at the pier in Pearl Harbor. Two ships representing ChinaÕs Navy, the destroyer Qingdao (DDG 113) and the oiler Hongzehu (AOR 881) arrived in Pearl Harbor for a routine port visit. During their visit, ChinaÕs sailors will have the opportunity to interact with their U.S. counterparts and experience the unique culture of Hawaii. U.S. Navy photo by Mass Communication Specialist 3rd Class Ben A. Gonzales (RELEASED)

Chinese warship leaving US naval base 

For those of us who cut our teeth on classical economics, it does seem a bit unusual for global stock markets (including Asian markets) to rally right after a new US administration pulled the plug on decades of Asian trade diplomacy. It also seems unusual for the Mexican peso to rise against the US dollar a day after the White House rumored a 20% tariff on Mexican imports to pay for a border wall. Back in the day, antiwar activists used to ask, “What if they had a war and nobody came?” The same applies to the supposed trade war.

“US Edges Toward Trade War as Trump Clash With Mexico Escalates,” Bloomberg News blared Jan. 26. Like all the other 293,000 stories about “trade war” listed by Google, this is fake news. The mainstream financial press presumes that the new U.S. president is a dangerous trouble-maker and that his machinations will bring down the world economy. The trouble is that stock prices are going up rather than down, and the price of risk (for example option hedges against stock prices) is going down.

Ignore the fake news from the mainstream media and watch the markets. Of course, everyone is entitled to an opinion, but there are two kinds of opinions. The first is the kind you talk about, and the second is the kind you bet money on. People like to ridicule Donald Trump when it costs them nothing to do so, but they put their money on his success.

This isn’t a trade war. This simply is a different kind of negotiation than we have come to expect from an American president. Mr. Trump does not want a trade war with Mexico or with anyone else. He wants to win, and he wants to be seen to win.

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Whether the Trump Administration’s boisterous style will produce better results than other kinds of negotiation or not remains to be seen, but it is a negotiation, not a war.

Trump wants to add 25 million US jobs during the next decade. Under the best of circumstances, shifting employment from Mexico to the United States might account for about 1% of that total.

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According to its official data, Mexico has gained about 1 million industrial jobs during the past ten years, an increase of perhaps 10%. The Mexican data include estimates for a lot of small-scale manufacturing and almost certainly exaggerate the total, but the trend probably is right: Mexican manufacturing employment has grown at about 1% per year. 900,000 Mexicans are employed in auto parts manufacturing or assembly. The US meanwhile lost nearly a fifth of its manufacturing jobs. Nothing Mexico might do can move the needle for US factory employment.

American workers earn much more than their Mexican counterparts (who average about $8 per hour), but labor costs are just a tenth of the overall cost of a car. By easing emission standards and allowing US automakers to make more profitable large cars and trucks, the Trump Administration easily could offset the additional expense of hiring more expensive American workers. It could restore some jobs without squeezing automakers’ profit margins or forcing up car prices.

There are more worrying issues for the United States. By most estimates Mexican drug cartels make $30 billion or so per year selling cocaine, crystal meth and marijuana to Americans. $20 billion of that probably is profit. To put this in perspective: that’s roughly a fifth of the $100 billion in total profits earned last year by Mexican companies represented in the country’s broad stock exchange index. $30 billion is about a tenth of Mexico’s legal exports to the United States. Big exporters like Cemex or Grupo Alfa have a gross margin of 20% to 30%, and the gross margin of the drug trade is closer to 300% –which means that the profitability of the illegal drug trade is in the same ballpark as the profitability of all of Mexico’s legal exports to the US combined.

No Mexican government has been able to root out the drug traffic: it provides employment directly and indirectly for very large numbers of people with poor economic prospects, and can draw on a vast army of prospective soldiers willing to die trying if not to get rich, then at least to eat regularly. Mexican officials whom I have consulted off the record say that there is nothing to be done except to legalize drugs in the United States to eliminate the cartels’ profits. This is something the United States should not and will not do, for it would lead to vastly more drug consumption.

The intractability of the drug traffic mirrors the problem of illegal immigration: Mexico has failed to offer a livelihood to tens of millions of its citizens. According to the authoritative Pew Survey, there were 6.9 million Mexican illegal aliens in the US at 2007, a number that has declined to 5.6 million (due to shrinking job opportunities in the US).

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Building a wall won’t stop Mexican drugs coming into the US or American money and guns coming into Mexico. They are not carried by illegal aliens in their hand luggage, but packed into tractor-trailers carrying seemingly legitimate goods into the United States. The way to reduce the drug traffic is to wage relentless and brutal war on the drug traffickers. That would entail horrendous loss of life and a prolonged period of civil instability in Mexico. If that is what the United States wants, there are ways to accomplish it, none of them appetizing. The Mexican government is outgunned and outspent by the traffickers. By way of example, in 2005 I had dinner in Mexico City with an old friend, the then chief of Mexico’s foreign intelligence service, the Centro de Investigación y Seguridad Nacional (CISEN). At the time I headed fixed income research at Bank of America. Comparing notes, we found that both of us had roughly the same budget — about $70 million a year.

Otherwise the economic and social benefits to be gained by shifting the marginal job from Mexico to the US and reducing the already-shrunken count of illegal aliens are tangible but relatively small.
Although illegal immigration from Mexico has declined, it is an important symbol of elite disregard for the interests of ordinary Americans. Because its impact is highly visible, it became an acid test issue in the Republican primaries. Trump the candidate promised to deal with it, and Trump the president feels obliged to make good on these promises — even if the expenditure of energy seems out of proportion to the potential benefits.

China understands that Trump wants a deal, not a war. That is why Alibaba’s Jack Ma came to Trump Tower in early January to promise a million new American jobs among small businesses exporting to China via his e-commerce platform. There will be many more such Chinese proposals. China has been attempting to shift its economy away from export dependency to domestic consumption for the past five years, in what may be the best-publicized and most-discussed economic policy shift in modern economic history. Like B’rer Rabbit in the Tarbaby story, China will tell Washington, “Please don’t throw me in the brier patch!” There will be plenty of body blows and flying kicks, but the contending parties will emerge as intact as the stuntmen in a Kung Fu movie. The negotiation between Washington and Beijing will look something like this.

 

Originally published on Asia Times.

 

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