Tariffs and Trade Deficits
The US trade deficit in February 2018 increased to US$ 57.6 billion according to the Commerce Department. The US trade gap in 2017 was US$ 566 billion. Economic logic would entail a tail spin for the US dollar, which has not taken place thanks to the dominant position of the greenback as the world`s primary reserve currency. Several market observers have now noted that the petrodollar is threatened by the Shanghai oil futures market, but the general consensus is that the dollar will not succumb any time soon. The rate of change could accelerate though.
Yet the trade gap has riled President Trump to the extent that a trade war with China might take place even though administration officials claim that the tariffs are only at the stage of being proposals. The Chinese replies to American announcements are extremely hard and aggressive. What the Americans do not seem to realize is that the imposition of tariffs will not substantially reduce the trade gap. What will happen is that the cost of importing goods will be passed on, resulting in inflation increasing more than the Fed has calculated.
This in turn could lead to faster and higher increases in the basic interest rate that in its turn would lead to credit tightening and very quickly bring about a recession. As the US economy is based on consumption for 70% of its GDP and consumer credit is stretched to the limit, increased inflation due to tariffs together with a credit squeeze along with a weakening dollar could lead to a very serious economic downturn.
The stock market has already witnessed heightened volatility, and it remains to be seen whether extremely high-priced equities can climb still higher. Wall Street hawkers will insist on buying every dip, but many asset managers are preparing for hard times. In any case US stocks are still expensive.
Cash and precious metals at the present time will be helpful if equities tank since investors may find themselves in an environment where certainty appears to become ever more elusive. A contrarian position betting on renminbi strength with some distribution also allotted to rubles could be highly rewarding if the US dollar continues to weaken. Occasional dollar gains may be ephemeral, and China could decide to unload large quantities of Treasury notes if the trade war turns really ugly.
Given all these various factors it is clear that the current environment is extremely challenging and movement in the Forex market will signal the direction things will be taking. Defensive measures should be taken while there is still time.
Walter Snyder
info@swissfinancialconsulting.ch
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