Tag Archives: trade

Benefits to Trade

What’s your favorite business movie?

Fair Use. Source: Wikipedia

One of the best is “Trading Places,” a modern take on Mark Twain’s Prince and the Pauper starring Dan Ackroyd and Eddie Murphy. It tells the story of a privileged commodities broker and a homeless street hustler who are thrown together when they are made the unwitting subjects of an elaborate bet. Apart from a minor role by now-Senator Al Franken, it also includes a fairly accurate description of the commodities business, with scenes from the open-outcry pits at the New York Mercantile Exchange, formerly located in the World Trade Center.

The Nymex floor used to house precious metals, cotton and sugar, petroleum futures, and – the subject of this movie – frozen concentrated orange juice. Contrary to the story, “FCOJ” was never a major contract. That would have been gold and crude oil. But the movie’s plot-line – involving secret crop reports, the US Department of Agriculture, and circus animals – made for some entertaining scenes, including ones with the Minnesota Senator.

The open outcry system isn’t around anymore. Most futures pits closed in 2015 – a result of computerized screen-trading. Electronic systems were faster and less expensive. They started replacing the open outcry system in the early 00’s. Options trading, which is more complex, still took place in the commodities pits, but that was replaced by automated exchanges late last year. The main reason big stock exchanges still have physical trading floors now is marketing – offering listing firms (and others) an opportunity to “ring the bell” to begin trading on a special day. Open outcry trading now serves mainly as a backup for when computer systems go down.

Source: CME, WSJ

Commodities used to be the other side of the tracks – where someone with ambition and hustle could make it without having to go to college. They also provided a great backdrop for a funny movie. Now, graduate degrees in math, physics, or computer science seem to be necessary. The quantitative, scientific approach to trading has reduced costs and increased market efficiency. But I wonder what we have lost?

Douglas R. Tengdin, CFA

Dangerous Myths

Are some made-up stories hazardous to our health?

Mjöllnir on Tórshavn Coat of Arms. Source: Wikipedia

Some tall tales seem benign – like accounts of Mjöllnir, Thor’s battle hammer that always comes back to him after he throws it. In Norse mythology, Thor is kind of a dumb ox, always misplacing his things. So it’s convenient for him to have something that he won’t lose, even after he gets angry and throws it.

But some stories are dangerous. They shape the way we look at the world and give us false ideas. Such is the case with trade right now. In the long run, our national trade account has to be in balance. Imports must be paid for with exports – plus interest, if any. If we buy a billion dollars in oil from Canada, we might pay for it by exporting a billion dollars of John Deere tractors and Caterpillar bulldozers.

But this truth leads many people to falsely assert that a country can’t run measured trade deficits. That is, if we don’t measure something, it must not be real. (In philosophical terms, they confuse accidents and essence.) For example, Australia always seems to run chronic trade deficits, continually importing cars and TVs from Japan and China. But they’re also selling condos and vacations to their Asian neighbors. The Aussie government reports a trade deficit every year, but that’s misleading. The trade in goods and services is actually balanced; it’s just that condos and tourism aren’t measured, while cars and TVs are.

Why is this dangerous? Because pundits and politicians are confusing the measured trade deficit with the actual balance of trade, especially now, in their discussion of the proposed border adjustment tax. Recently, two prominent economists asserted that “positive net revenues today must be offset by an equal discounted value of negative net revenues in the future.”

This is a common error: to conflate a statistical measure with a theoretical concept. But just because two things have the same name doesn’t mean they’re the same. This isn’t just a matter of semantics. The real strength of the US economy is visible in our exports of services and assets, some of which are counted as manufactured goods, like Boeing airliners, and some of which aren’t, like US real estate and mortgages. China now holds over $200 billion in mortgage-backed securities. Some describe this by saying that the capital account balances the trade account, but this is just another way of describing the same thing.

Source: FRED

This error has led some economists to confuse a theoretically neutral border adjustment tax that applies to all imports and exports with the one actually proposed, which would tax imports more than it subsidizes exports. Chinese buyers of MBS and homes wouldn’t be subsidized under any proposal. Hence, the reform to corporate taxes that the GOP is cobbling together is at least slightly protectionist.

This doesn’t necessarily mean it’s a bad idea. The proposal has a number of good features, like lower marginal rates, or equal treatment of debt and equity, or expensing investment. It’s a truism that you get more of what you subsidize and less of what you tax, and up until now we’ve been subsidizing debt and penalizing investment, which is perhaps why our debt-to-GDP ratio has gotten so big.

Source: FRED

But let’s call things what they are. Trade, like Mjöllnir, always comes back, in one way or another. Subsidies – like persistent favoritism – make us weak, not strong. Thor should have been encouraged to find his hammer. Maybe then he wouldn’t have thrown it away so much.

Douglas R. Tengdin, CFA

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Xi Loves Pencils

Where do pencils come from?

Photo: Daniel German. Source: Wikipedia

In 1958 economist Leonard Read wrote a charming essay entitled “I, Pencil” about the miracle that the humble pencil represents: wood, zinc, glue, and graphite combined in a form that makes writing possible. There’s no hive-mind directing the countless individual actions necessary to bring pencils into being. Rather, individual shippers and machinists and miners and foresters work in their own individual interests, and their know-how is organized to offer a coherent product—at a miniscule price.

Over the years, comparable presentations have been written and produced: “I, Smartphone,” “I Toaster,” even “I, Whisky.” The point is the same: the spontaneous organization of individual interests to create complex products based on what we want is little short of a miracle. Four hundred years ago Thomas Hobbes wrote that mankind’s state of nature would be a “war of all against all,” with people living lives that were poor, solitary, nasty, brutish, and short.

Engraving: Abraham Bosse. Source: Library of Congress

But the lesson of “I, Pencil” is that we have incredibly creative energies that need merely be organized to provide a seemingly infinite number of delightful products.

It’s worth keeping in mind as we look at potential trade restrictions and tariffs. Last week China’s president Xi Jinping made a speech in Davos, Switzerland defending the world’s liberal economic order against the dangers of protectionism. Trade has helped hundreds of millions of people rise from poverty to plenty—and allowed consumers to purchase pencils for a few pennies each.

It may be that the protectionist voices we hear today are just rhetorical devices necessary for driving better deals. But let’s hope the rhetoric doesn’t become reality. An essay entitled “I, Protectionist” would not be so charming.

Douglas R. Tengdin, CFA

Charter Trust Company

Limits to (Trade) Growth

Why is global trade under attack?

Public Domain. Source: NOAA

Global trade has generated an unprecedented level of prosperity. From Foxconn-built iPhones to Novo-Nordisk-designed insulin therapies to Airbus and Boeing and Embraer competing to build and sell airliners, global companies competing in a global marketplace produce an incredibly broad range of goods at reasonable prices.

Trade works because a larger market allows for more specialization, and more specialization enables people to be more productive. Workers can be more focused and more innovative. New ideas generate new products that can be replicated millions or even billions of times in a few years. Companies can go from just a few programmers to multi-billion dollar businesses in just a few years. So why is everyone suddenly suspicious of increased trade?

From Brexit to Trump to the Italian constitutional referendum, opponents of increased trade have used static analysis to make their case. When cheap goods enter a marketplace, domestic producers have to change the way they do things. Wages may fall. The same thing can happen when immigration increases. In the short run, immigrants use public services and may displace local workers.

Indeed, there was a close correlation between how exposed British regions were to Chinese imports and how they voted on Brexit. The less an area was impacted by imports, the less likely they were to vote to leave the European Union. And although correlation doesn’t equal causation, Italian economic growth essentially stopped when that country adopted the Euro in 1999. It has been in decline ever since. No wonder their citizens are suspicious of the elites.

Italy Real GDP since 1970, Source: Bloomberg, IMF. Log scale.

Political turmoil often follows a period of lackluster economic performance. People don’t want to become worse off, and they expect their leaders to have some solutions. Global trade is supposed to make us all better off. But when the facts don’t seem fit the theory’s rosy promises, it’s reasonable to want to try something else.

Douglas R. Tengdin, CFA

Chief Investment Officer

Trade War Worries

Are we headed for a trade war?

Author: Tony Cohen. Source: Wikipedia

The rhetoric from the Presidential election would make you think so. Donald Trump campaigned on renegotiating trade deals with countries around the world. While some of the more extreme measures – like an across-the-board 45% tariff on all imports – would require Congressional action and are therefore less likely, he will have the authority, as President, to pull the US out of the North American Free Trade Agreement or the World Trade Organization without approval from Congress.

And Trump has signaled that he is serious. It appears that Wilbur Ross is likely to be named Secretary of Commerce. Ross has been an outspoken critic of trade deals, saying that they cause the US to import products and export jobs. At the very least, Donald Trump’s election signals an end to any more trade liberalization. Protectionist parties are on the rise around the world, and after the US election and the UK’s Brexit vote, free trade has lost its two biggest national champions.

But there are two sides to every conflict. If we engage in a trade war with China, they will likely retaliate. Punitive tariffs on Chinese electronics would be matched by restrictions on US-made cars and aircraft. And China wouldn’t be limited to tariff increases. In 2010, the dissident Liu Xiaobo was awarded the Nobel Peace Prize. China responded by lengthening quarantine procedures for imported food, causing Norway’s salmon exports to China to fall by 50% the next year. China can also order its state owned enterprises to stop using non-US made goods and services.

Atlantic Salmon. Artist: Tim Knepp. Source: Wikipedia

Donald Trump’s election is just the latest development in the trend of nationalist populism we see growing around the world. While the market has focused on Trump’s stimulus plan and the prospects for increased domestic growth, inflation, and government deficits, the impact of escalating trade hostilities should not be ignored. The Smoot-Hawley Tariff and its aftermath is part of what led to the Great Depression in the 1930s.

Wars aren’t rational. But if our domestic problems refuse to go away, initiating a foreign conflict – even a trade war – has always been a way for politicians to get people’s attention away from home. Let’s hope that it doesn’t come to that.

Douglas R. Tengdin, CFA

Chief Investment Officer

Keep Calm and Stay Invested

The sun will rise again.

Sunrise from space. Source: NASA

That’s what I thought this morning when I read the headlines. Lots of folks – both left and right – are freaking out. I can’t comment on social or political issues – they’re outside of my zone. But I do have one suggestion for investors: stay calm.

When President Obama was elected a lot of people on the right expected that higher taxes and greater regulation would damage the economy. And we saw higher taxes and greater regulation. But the economy still grew. Yes, Trump is anti-trade and anti-immigration, both of which benefit the economy. That’s why almost no economists endorsed him. But the Office of the President is bigger than the person who occupies it. Trump will be constrained by Congress and the Courts. We’re still a narrowly divided nation. Hey, maybe we’ll think seriously now about limiting executive power, the way the Constitution intends.

Source: NY Times

What matters most to markets is company earnings and their long-term growth. Wars, revolutions, cultural shifts, and technological changes have a much bigger impact than politics. Regardless of your political views, life will go on. Governments intervene in their economies. Governments go to war. Governments make policy errors. If you’re a long-term investor, those errors are typically corrected in less than a generation.

We’ve gone through invasion, civil war, depression, and terrorism. The Republic will survive. And I expect the sky to still be blue.

Douglas R. Tengdin, CFA

Chief Investment Officer

Healthy Trade

Are markets and economics a Western creation?

Photo: Leiah M Jansen. Source: Morguefile

Before John Keynes, or Alexander Hamilton, or even Adam Smith—the father of modern economics—markets flourished around the world. They did so because some folks were good at one thing, while other people specialized in other practices. In Europe, British iron ore was traded for Italian wine; in Africa, gold from Mali was traded for salt from Chad. And among Pacific islanders fish from the coast was traded for breadfruit and produce from the uplands.

For all of human history people have exchanged goods that they had in surplus for other items that they wanted or needed. And both sides were better off. Along the Pacific coast a diet consisting of mostly fish was incomplete—fish-based protein needed to be supplemented with starches, fruits, and greens. If the tribes didn’t trade, they’d get sick.

It’s like that with economies. The most open economies, the ones that encourage trade with other nations and other people, tend to be the healthiest. During the classical period all roads led to Rome. Rome was a center of commerce and culture. At its height the Roman economy achieved a standard of living that wasn’t equaled in more than a millennium. In Europe the British Empire was built upon trade. While their mercantilist system of royal monopolies was flawed and inefficient, it was better than the alternative: a closed system shut up in its own poverty. If you want to see what the lack of trade does to an economy, just look at North Korea.

Source: NASA

Trade has been a foundation for human flourishing. When trade increases, economic growth accelerates. For the past 25 years we have seen growth boom because of the fall of the Iron Curtain. As China and India reform their economies, the world will continue to benefit.

Trade isn’t limited to one culture or one time-frame. And as it expands, we all benefit.

Douglas R. Tengdin, CFA

Chief Investment Officer

Trade is Hard

Why is free trade so hard to understand?

Source: Moeconomics Blog

The idea is simple: when everyone does what they do best, we’re all better off. Like a Mark Zuckerberg giving up coding to run Facebook. He knows how to code, by all reports he’s a good coder. But it wasn’t a productive use of his time. His time was better spent acting as Facebook’s CEO—managing his sector leaders, understanding where the business is moving, working out financial issues. So he gave up coding, even though he was good at it.

It’s the same with countries. One country may be better at everything they do than another. But it still makes sense for them to specialize in what they do best—leaving others to do what they do best—comparatively. This is called the “Law of Comparative Advantage,” and it was first articulated by Robert Torrens in 1808, when he suggested that if England traded cloth and lace with France—England’s mortal enemy—both countries would be better off. The idea was further developed by David Ricardo in 1817, in his book “On the Principles of Political Economy and Taxation.”

In this work, Ricardo considers an economy consisting of two countries that produce two goods of identical quality. But the relative costs of producing the two goods differ within each country. If each country specializes in the good for which it has a comparative advantage, global production increases—with no change in technology or labor. The mathematical logic improves conditions on both sides.

Yes, the world is more complicated than just having two countries produce two goods. And yes, the benefits of trade are not evenly distributed. David Ricardo himself discussed technological unemployment in the third edition of his book, published a few year later. But the general Ricardian equilibrium model—which accounts for thousands of goods and hundreds of countries—has been in place for decades, and a lot of folks still don’t get it.

Public Domain. Source: NOAA

Part of the reason is intellectual fashion. International trade isn’t cool—it seems to exploit sweatshop labor and cheap capital. Also, the very fact that free trade has been economic dogma for a long time counts against it. Another of the reason is xenophobia. We all prefer that which is familiar to that which is foreign. It’s why we see a home-bias in many investment portfolios, and grocery stores resist putting country-of-origin labels on their food. And part of the reason is that free trade is a harder idea than it first seems. It’s part of a matrix of concepts like efficient pricing, free exchange, flexible wages, and perfect information that aren’t always intuitive. Just because an idea has been around a long time doesn’t make it obvious.

Free trade rests on a mathematical foundation, and math can be challenging. Calculus was “discovered” centuries ago, but students still struggle with derivatives and integrals. But calculus proved essential to making the modern world. As is free trade.

Douglas R. Tengdin, CFA

Chief Investment Officer

Trading Nations

What effect does trade have on our economy?

Diagram of US trade flows. Author: Tony Cohen. Source: Wikipedia

Of all the issues raised in the current political season, surely the most overrated has been free trade. To hear the candidates talk about it, you’d think the worst issue affecting our economy has been bad trade deals with Canada, Mexico, and China. While these three countries happen to be our biggest trading partners, trade just isn’t that big a deal in our economy. In the $18 trillion of goods and services that we produce and consumer every year, about 20% originated in or were destined somewhere else. By contrast, trade is over 75% of Canada’s economy. And a “trading nation” like Singapore has imports and exports equal to more than 2 times its entire economy.

Certainly, low-skilled labor in the developing world has hurt employment over here. It’s estimated that between 1 and 2 million US workers have lost their jobs over the past decade due to trade with China—about 1% of our workforce. But we have an economy that regularly hires and fires 10 million workers every month. Certainly, the loss of a million jobs is important. A lot more jobs have been lost to technology, though, or due to low oil and natural gas prices.

Employment losses due to free trade with low-wage countries are a subset of the problem of what to do for people who don’t have the skills to find a decent job in the modern economy. Globally, there’s just not as much demand for low-skilled labor as there used to be, so the jobs are migrating to where they can be done the cheapest. China is losing jobs to Vietnam; Columbia is losing jobs to the Philippines.

Long Beach marine port. Photo: William Borg. Source: Wikimedia

The global economy has more workers than it knows how to employ productively. Huge developing economies like China, India, and Brazil are shifting from fast-growing export businesses to more domestic services growth. In order to move them along, we need to trade more with them, not less. In any case, the globalization toothpaste is out of the tube. Global supply chain management is now a smart-phone app.

For fifty years people understood that protective tariffs and trade wars were part of what led to the Great Depression. The Smoot-Hawley tariff didn’t protect American jobs, it destroyed them. The most competitive industries in the US now—software, consumer products, entertainment—also have the lowest level of government protection. If we want a competitive economy, everyone in it—businesses, regulators, and individuals—is going to have to compete.

Douglas R. Tengdin, CFA

Chief Investment Officer

Our Fibers, Our Selves

What do our clothes say about us?

Illustration from “The Penny Magazine,” 1843, Source: Wikimedia

For millenia, clothes have inspired new technology. Cotton has been spun, woven, and dyed since prehistoric times. Marco Polo pioneered the Silk Road and the Age of Exploration. Spinning mills in England and New England were at the center of the Industrial Revolution. Demand for “Basic Black” fashions stimulated the chemical industry in the 20th century.

Everyone’s excited by the latest smart watch or FitBit, but clothes are the original wearable tech. Whether it’s sweats or jeans or khakis, our clothes now combine natural, synthetic, and micro-fibers to make them more comfortable, cheaper, and better looking. But we don’t think of high fashion as high-tech.

Apple watch. Photo: Igor Ovsyannykov. Source: Pixabay.

But tech and textiles have been interwoven ever since the Athena was considered the goddess of both wisdom and weaving. Textiles illustrate a general point about technology: the more we use something, the more we take it for granted. We love and hate our smart-phones, but flat screen TVs are ho-hum.

In the future, we should expect more interaction between our garb and our gear: shirts with biometric sensors built in, or clothes that use our own motion to generate electricity, where the material becomes a wearable textile circuit. These new technologies will arrive because we want them. And they don’t need a massive government program to become reality.

A century ago, a young Oliver Hardy was in a silent film entitled, “The Clothes Make the Man.” Today we might say, “Fashion is the future.”

Douglas Tengdin, CFA

Charter Trust Company

[category Global Market Update]