IN THE run-up to the presidential election of 2016, investors were nervous about Donald Trump. They liked his tax-cutting, anti-regulation promises, but fretted about his foreign and trade policies. Some dubbed the two agendas “Trump lite” and “Donnie Darko”.
Almost as soon as it became clear that Mr Trump would become president, the markets decided to believe in the optimistic version. His tweeting and decision-making may have been erratic, but investors seemed to forgive the president his peccadilloes as a wife might her errant husband: “He may not be faithful but he’s a good provider.”
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Fears about trade conflict almost disappeared. In last month’s survey of global fund managers by Bank of America Merrill Lynch, just 5% regarded a trade war between America and China as the biggest risk facing the markets, compared with 45% who worried about a return of inflation or a crash in the bond markets.
The announcement of tariffs on steel and aluminium on March 1st thus came as a nasty shock, especially as it was followed by boasts about trade wars being “easy to win”. Furthermore, the news came just a few weeks after the stockmarket suffered a nasty wobble as investors worried that higher interest rates might pose a threat to global growth.
Analysts have started to calculate the market consequences if a trade dispute escalates. Erik Nielsen of UniCredit Bank thinks a trade war would reduce global economic growth by 0.5-1% a year and send the stockmarket into a “measurable correction”. This would in turn disrupt central banks’ plans to withdraw monetary stimulus, sending both bond and currency markets on a “rollercoaster ride” for several months. Alan Ruskin of Deutsche Bank thinks that the president’s protectionist rhetoric will be seen by many investors as a sign that America desires a weaker dollar, which is another way of trying to bring the trade deficit down.
Ben Inker of GMO, a fund-management group, says that the rise of economic nationalism has increased the likelihood of a trade war that would be in no one’s interests. It would cause investors to shorten their time horizons—a problem for shares, which depend for their value on an uncertain stream of future profits. “If one wanted to imagine a scenario in which valuations fall not merely to long-term historical averages but right through onto the other side, a global trade war is a strong candidate,” Mr Inker warns.
Clearly, not everyone feels the same way. There was a big fall in the American stockmarket when Mr Trump announced his intention to raise tariffs. But shares quickly bounced back before falling again when Gary Cohn, the president’s economic adviser and a fervent advocate of free trade, resigned. Adding to the uncertainty is the possibility that America will decide to take separate measures against China for intellectual-property theft.
At the time of writing there was still scope for Mr Trump to change his mind in the face of congressional opposition at home or the prospect of retaliation from abroad. And even if tariffs are imposed the dispute could soon subside, as it did when the Bush administration pushed through similar measures in 2002.
But the global economy is in unfamiliar territory. Because restrictions on trade have generally been easing since 1945, investors have no experience of a broad tariff dispute. The Smoot-Hawley Act, which pushed up tariff rates by an average of six percentage points, is regarded as having been an unhelpful act in the midst of the Depression. Congress passed it in June 1930 despite a statement opposing it signed by 1,028 economists published in the New York Times. Although the big crash in the market came in October 1929, the S&P Composite index suffered a further decline of 10% in the month the act passed. (The tariffs were not the only thing driving the market down, of course; the American banking system was collapsing at the same time.)
Even if the world manages to avoid a full-blown trade war, the threat to global markets is clear. Politicians are becoming more nativist, and as they do so, barriers to the free movement of capital, goods and services are likely to rise. Financial markets, with high equity valuations and low bond yields, are currently priced for perfection. But a protectionist world is far from perfect.
If the trend continues, markets are likely to become more risky. After all, when a politician says “America First”, or indeed “Ruritania First”, that suggests that the interests of foreign investors are being left far behind.