“You realise that all the lines on the maps really do not exist. You can’t even tell where one country starts and the other one stops. All those things that create conflict just melt away, and you can see our planet as one home for all of us.” – Anousheh Ansari, Iranian-American astronaut’s reflection upon seeing the earth in its entirety
“No nation was ever ruined by trade.” – Benjamin Franklin
“The whole is more than the sum of its parts” – Aristotle
“We can only see a situation with true clarity when we take the time to carefully consider the interests at hand. And we understand it even better when we consider how the situation might be different if the underlying interests were different.” – Excerpt from Pebbles of Perception: How a Few Good Choices Make All the Difference by Laurence Endersen
The government of Israel has for many years placed a complete ban on trade with Iran. In fact, Israeli law stipulates the penalty for violating the ban on Iranian imports can be as high as imprisonment of up to two years. Despite this, Iranian marble, it turns out, is a notable feature of some of the most prominent buildings in Israel.
A complex adaptive system is a system in which a complete understanding of the individual components does not directly translate into a comprehensive understanding of the system’s behaviour as a whole. The global trade system that enables the cross-border exchange of goods and services is a type of complex adaptive system. It is the adaptive nature of this system that enables the availability of Iranian marble in Israel.
President Trump and his posse of international trade warriors is, by unveiling their first wave of import tariffs, attempting to change the dynamics of the global trade system. How the individual and collective components of the system mutate in response to the Trump Administration’s policies is anyone’s guess. What is an almost foregone conclusion, however, is that system’s response will include second and third order effects – the so called unintended consequences – that US policymakers will not have anticipated.
Our rudimentary attempt at diagnosing some of the potential unintended consequences of the Trump Administration’s protectionist theatrics is based on identifying how the prominent players within the global trade system are incentivised. The European Union is one of the major players within the system we consider to be trapped by a complex web of incentives. The predicament faced by the bureaucrats in Brussels is of an existential nature. Existential threats activate the most basic of human instincts – the instinct of survival. And the thing about basic human instincts is that they can cause the most rational of agents to behave irrationally.
The bureaucrats in Brussels are unelected officials. Their only claim to legitimacy comes from the existence of the European Union. These bureaucrats it leads are incentivised to ensure the survival of the European project. This survival depends on the union members maintaining their memberships. It is therefore in this context only rational for the bureaucrats to heavily punish any wantaway member even if said wantaway member happens to be running a huge trade deficit with Europe. The bureaucrats in Brussels, we believe, want to severely punish the UK for the British populous’ decision to exit the European Union.
We fully expect the leaders of the European project to continue to drive a hard bargain in the negotiations on the terms of UK’s exit from Europe – at least in the short-term. The bureaucrats may or may not realise it but the protectionist turn in President Trump’s policymaking has tilted the balance in the UK’s favour and the British government now has the upper hand when it comes to the Brexit negotiations.
The Trump Administration placing tariffs on steel and aluminium imports will increase cost pressures faced by US auto manufacturers – making their vehicles, in all likelihood, uncompetitive in relation to imported vehicles. German automakers exported more than half a million vehicles to the US in 2016 and Germany runs, what we suspect to Mr Trump’s international trade warriors is, an unpalatable level of trade surplus with the US. Should the metal import tariffs be successfully enacted by the Trump Administration, we suspect that German automakers will find themselves at the centre of the next round of Mr Trumps’ protectionist theatrics.
In 2016 the UK ran a GBP 82 billion trade deficit with imports from EU representing 54 per cent of the UK’s imports during the year. German automobiles represented a not so insignificant share of those imports.
Now consider the incentives for the German government. After months of uncertainty Germany has a new government with the Social Democratic Party of Germany (SPD) finally agreeing to a coalition with Chancellor Angela Merkel’s Christian Democratic Union of Germany (CDU). Chancellor Merkel in a bid to secure a fourth-term had to relinquish control of the finance ministry to the SPD. For the SPD the coalition offers an opportunity to position itself as a viable alternative to the CDU for the next election. The CDU on other hand does not want to lose any further ground to the SPD. Collectively the parties want to stop the rise of the nationalist Alternative Party of Germany party. The closure of factories operated by German automakers serves neither party’s objectives. The rational course of action for the German leadership in this context is to reach an amenable trade agreement with the British.
What the bureaucrats want and what Germany needs may test the cordial relationship that may exist between Brussels and Berlin today. The fact, however, remains that there is no European project without Germany and the Germans will eventually get their way. For this reason, we expect Brexit negotiations between the UK and Brussels to turn decidedly in the favour of the British.
Investment Perspective
The time, we think, to buy UK stocks is coming. Exporters benefited at the cost of domestically focused companies as the British pound fell sharply following the Brexit referendum. The tide, in our opinion, is turning and we favour more domestically focused British companies over exporters. We also think the sterling should strengthen relative to the Euro.
Domestically focused British companies may, in our opinion, be amongst the best available hedges to the rising level of protectionist rhetoric coming out of the US.
On the European front, we favour domestically focused automakers in France and Italy over the more export oriented German auto manufacturers. The domestically focused automakers, we think, should benefit from lower steel and aluminium prices as non-US based steel and aluminium producers redirect their supply toward Europe and Asia.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.