The past few weeks have created market turmoil that has got markets and many people either spinning or confused, with most simply trying to understand what is happening.
The most obvious observation to make, is that there is conflict and tension and turmoil. Why this was initiated and where it is likely to end up however has generated wild speculation with many coping by simply pointing the finger at what they perceive to be the source of the disruption – the US administration.
However, this is not nearly the full story, and to understand this better one has to go back into a bit of history to unpack why this type of disruption was almost inevitable.
Background – Clash of Ideology
Academics who study history have a term – End of History”. The “end of history” refers to a theory, popularized by Francis Fukuyama, suggesting that liberal democracy and free-market capitalism represent the final stage of political and ideological evolution, with no viable alternatives left to emerge.
This was the theory that drove the democratic Western nations to relax their strong position against authoritarian regimes such as those found in the Soviet Union and Eastern Europe after the fall of communism in the 1980’s.
The belief was that with communism now effectively “dead” there was opportunity to allow these nations to thrive under a more democratic state with people within these nations expected to appreciate and prefer the freedoms that democracy would bring them and so sustain democracy as a way of life.
This led to many western nations, including the USA and Western European nations to start outsourcing basic low-level manufacturing to places such as China and Vietnam and India, where there could be greater profits made due to lower employment rates and in some cases lower energy costs such as in China.
Development and Value Destruction
The theory however failed, from a Western democracy perspective, in that the developing nations were not happy to simply stop at producing low-price goods such as toys and garments, but used the gains from these sectors to build massive and sophisticated industrialised economies that could now compete with top-end products such as IT hardware, automotive and high-end electronic goods that were the main source of income revenue in the developed Western nations.
These high-end products were also often produced using technology “stolen” or copied from the products made in the West. But without conventions on Intellectual property between the likes of China and the West, this tech was developed at a fraction of the cost that was needed in Western Nations.
Western nations also gladly, in the spirit of helping these nations to evolve, gladly educated young people from these nations, sharing expertise and intellectual progress along the way.
As it stands, there is now little produced by western nations, including the latest in AI chips and tech, that can now compete fairly against goods, products and tech, from the likes of China, Taiwan, Vietnam and India. On both the technical and quality standards they have pretty much reached parity, however on price its is advantage to the developing nations all the way, due to their low production in-put costs.
Inflations, Jobs and Tariffs – Taking its Toll
A few things have compounded the clash between the Developed western nations and the developing eastern countries, but none so much as the prospect of high inflation and low job creation, that is busy wiping out the prosperity of the American and western European middle-class.
America has had a long-standing working class that has been reliant on manufacturing in the automotive, electronics and property sectors. There are however growing clusures of manufacturing in the US, particularly in the automotive sector where cheaper auto imports from developing nations are threatening jobs. Added to this risk now is high inflation that has over the last few years increased sharply with interest rates remaining at historically high levels. This in turn has reduced the impact of that big economic driver in the USA – property.
New houses have become increasingly expensive to build, and property prices are too expensive to afford due to high interest rates.
Add high energy and fuel prices and you have an economy struggling to maintain itself and an economy that cannot sustain the enormous debt that the US has built up over the last few years, with the Biden administration merrily increasing the debt every year without a plan to pay this $32,66 trillion headache off.
Tariffs – Predictably Misunderstood
It is understandable that people will react to change and the introduction of Tariffs by the new US administration was a shock to many. However, it should not be looked at that the US was the origin of this trade conflict.
The US has until now charged very low or no tariffs on products imported into the US, however, even some of its largest trading partners have happily charged severe tariffs on US produced products.
Canada, one of the US closest partners and allies in the past has a 25% import duty on all US products and in certain categories this goes as high as 250%. China has always had import tariffs on US goods that averaged around 8% while automotive (a key US export) was charged a 25% import tariff or duty.
South Africa, who’s second largest trading partner is the US, and that were charged little to no import duties on South African goods, are being charged 30% import duties on US produced goods.
This makes for an imbalanced trade structure that in effect punishes the largest consumer economy in the world, and it is not surprising that with a massive trade deficit of money going out of the US economy, the new administration has sought to right the ship in their favour.
Outcome Possibilities:
So where-to from here? – Likely Outcomes:
- 75 nations have already approached the US after Donald Trump paused the tariffs for most countries, with several already agreeing to drop or change their import tariffs on US goods. This is likely to continue with those governments with level-heads understanding the previous system had seen its time and that there is a need to balance the books
- China seems set to try see out the trade war and have said they will continue at all costs. This however does not seem likely to be a winning strategy for them as the US currently imports over $483 billion in goods from China and there is already reports of massive closures of manufacturing facilities and stockpiles of goods already produced as the order books dry up. China’s retaliatory tariffs have only cemented the US position and is likely to do them more harm.
- China will no doubt also try to open up new markets for their products, but replacing your biggest trading partner is no small challenge, particularly at that type of spend, but it will be an interesting play that is likely to see further Geo-political developments and alignments and will test the metal of new political alignment structures such as BRICS.
- Smaller nations such as Kenya and Vietnam will be happy to fill the gap that for now is likely to be left by China in sectors such as clothing production and will benefit by bigger access to the US markets.
- Argentina, that has recently righted its own economy and deficits has agreed to a zero-zero tariff rate with the US – probably the most sensible free market response so far. This poses challenges to other nations to realises that tax constrains economic growth and does not grow economies.
- The US will probably experience short-term pain in some sectors, however consumer prices and oil and fuel costs and inflation is already on the decline, and should interest rates follow, there is likely to be a good outcome for the US with more investments and job creation pushing up earnings and lowering national debt.
- There is also the great likelihood that a whole new level of false invoicing and fake companies will spring-up out of the chaos to try break down the tariff blocks for Chinese goods to reach the US markets. This however will be on the US radar and a big focus of their intelligence agencies.
New World of Free Trade?
While many commentators see what has transpired in the last week as a trade war or a tarrif war or simply a move of protectionism, there is without question a much bigger picture and more at play here. For the US it is about economic survival while for other nations, and particularly those who have benefitted greatly and possibly unduly, from the old global trade structures, it is a fight to maintain the staus quo.
What is clear is that an unsustainable system of global trade has seen its end of history moment and it remains to be seen if calm voices and level heads will find a clear way forward and hopefully a more free-market trading system emerge going forward.
