Our Suez Moment: The U.S. Tariff Gamble. How a High-Risk Attempt to Re-Establish a Past World Order Could Damage Brand U.S.A., Impact Investments, and Enhance the Speed of a New World Order

A brief history: Egypt was under British control from 1882 to 1954. In 1954, Britian fully withdrew from Egypt. However, it had been a nominally independent country beginning in 1922. In 1956, Egyptian President Gamal Nasser nationalized the Suez Canal (located on the Sinai Peninsula, part of Egypt) which was, at the time, owned by an Anglo-French company. In response, France and the UK invaded the Sinai Peninsula. The invasion was an attempt to show the world that France and the UK remained global powers and could still influence the world (and not allow for corporate assets to be nationalized by newly independent colonies), despite the growing independence of many UK and French overseas colonies during the preceding decade.

Instead, the world watched as the UK and French governments, under international pressure and with little support from the US, were forced to sign a ceasefire and quietly withdraw from the Sinai Peninsula as the economic cost to the UK and French economies increased. Less than 20 years prior to 1956, the UK and France were two of the world’s greatest powers. Yet, this attempt to reestablish control had the opposite impact: it cemented the UK and France as second tier nations essentially overnight.

The ghosts of the Suez are emerging from the shadows as the United States embarks on an attempt at reestablishing a world order from decades past. While we do not anticipate the United States falling from superpower status, the lack of broad-based world support is highlighting the weakness of the US to unilaterally force its will on the world. 

Understanding the U.S. tariff strategy impact on world economies: Who wins?

In our preparation for tariff uncertainties, we researched emerging markets in Asia (some of the most at-risk nations to trade tariffs) and identified Asian economies’ level of dependence on US exports. While almost all countries will be impacted to a certain extent, only one country, Vietnam, is truly at short term risk from the economic fallout of US tariffs. Unsurprisingly, Vietnam has been the first and most aggressive country to negotiate with the Trump administration. The rest of the Asian countries most exposed to the US, we determined, would be able to stomach the volatility by using forex reserves, government deficits, and other actions over the next few days, weeks and months. Although many countries are indicating a willingness to initiate talks with the United States, few are quickly giving into Trump’s demands; they have some financial flexibility, possibly more so than the US. We anticipate many countries dropping tariff rates and Trump declaring victory. However, in reality, the rates are already low, and the marginal difference is negligible. In the meantime, psychological damage will have been done to the perception of the strength and dependability of the US. 

Tariffs and the U.S. dollar: Could unintended consequences of the aggressive U.S. moves benefit foreign investments?

Economically, markets are deciding the Trump tariffs will push inflation higher than it would otherwise be, slowing the US economy, lowering the return on US assets, and making other types of investments more attractive by comparison. Rates will have to be higher to draw investors back into US Treasury securities or any other asset linked to the US economy. These higher rates have potential to slow the US economy, making the US look less exceptional. That, in turn, could increase the rate at which investors move assets to other markets – markets that now could look relatively cheap with lower PE ratios and similar growth rates but lower structural inflation.

The tariffs are all part of the current administration’s attempt to show the world that we can go back 30 years; but, of course, we cannot. We anticipate some of the tariffs will be suspended and “deals” will be reached with the vast majority of countries. Yet, recall that Trump’s previous administration announced a victorious “deal” with China (2018-2022). The “deal” was a very watered-down document with few commitments from China. Consequently, we expect ongoing “performative” events. Essentially, his base requires evidence that he is “fighting” for them and making the evil opponents (foreign countries, globalists, big companies, etc.) “lose.”

We believe no matter what the administration ultimately claims, one clear outcome, and likely unintended consequence, will be a weak dollar policy. A highly likely short-term outcome will be the “temporary” suspension of tariffs for eventual “deals.” The result may be a short-term US market rebound, but permanent damage will be done to Brand USA. A temporary tariff “deal” will not reverse the impact of reduced confidence in future policy from Brand USA created by the tariffs. Essentially, the underlying reason for implementing the tariffs was based on vague and often unclear policy leaving a high likelihood of tariffs returning. Actions that the Fed may take, such as potentially reducing rates or increasing bond purchases later this year to support the economy and US markets, will mostly benefit foreign assets as investors start looking for more attractive opportunities with less policy uncertainty.         

Inflation: Is it a concern? The answer is a solid maybe

The recent tariff increases are creating concerns about reigniting inflation. Obviously, the US imports many goods and, with the rise in tariffs, some of those cost increases will be reflected in inflation data over the coming months. That, combined with the government deficit running north of 5% for almost 10 years, creates concerns about pushing even more stimulus into an overheated economy. The challenge: inflation erodes the value of future cash flows. Therefore, if inflation rises, pressure on markets will increase from a valuation perspective. Our research shows the current 21.5 S&P 500 PE ratio exceeds both the average and median inflation rate range between 2-4%, yet still within a normal range. However, if inflation rises, this could pressure current elevated PE levels because the market will likely start to discount future cash flows and earnings. If that were to happen, it could create challenges for the market at current levels. The current inflation level is not a concern but if inflation begins to creep up it could create a challenge for the markets.

Trade war impact on the world's reserve currency: Will the world lose confidence in the U.S.?

Another concern of the trade war is the impact on the balance of primary income for the United States. One of the benefits of being the world’s reserve currency and having the exorbitant privilege of this position shows up most clearly in our Balance of Primary Income (documented in the FRED Balance of Primary Income chart below). The Balance of Primary Income is a puzzle. Specifically, even though the US has a very large negative net foreign investment position, the US Balance of Primary Income has historically been positive. That relationship existed because generally foreign investors held large amounts of low yielding assets, such as U.S. Treasuries, in disproportionate amounts since these were considered safe haven assets for those investors. Stated another way, think of it as foreign investors having so much confidence in the US that they were willing to accept a lower return if the assets were in the United States denominated in the USD. On the other hand, U.S. investors generally invested in overseas assets that were considered higher risk by offering higher yields or higher potential return since USD denominated assets were considered safe haven investments. This relationship allowed for a positive Primary Income Balance until last year when, for the first time in decades, it turned negative. We will have to see what the breakdown in this trend will mean and if it is temporary. But considering the current environment it raises another concern: Foreign investors demanding higher returns from USD assets if the US loses its safe haven status resulting in higher long-term interest rates on the growing US debt levels.

On the precipice of change: Investment opportunities in uncertainty

The trade war is a concern, but it is primarily a concern for the United States. Clearly, the economic impact of the trade war is being most acutely felt in the United States. The world is moving away from a US-centric model into a more multi-polar model. The greatest cost will be borne by US investments in the long-term if the multi-polar model breaks from the USD as the world reserve currency. Industrial policy moves in years and decades and not weeks or months. History is filled with failed attempts at isolationist industrial shock therapy from Mao’s Great Leap Forward in China to Sukarno’s Manifesto Politick period in Indonesia to Peronist Argentina. We would advise clients to add funds to investment accounts to take advantage of the policy error that has caused these market dislocations. We think, in due order, it will reverse creating an attractive entry point for new money. The focus for the new money is foreign equity positions which we think will benefit relative to US assets as the world sees inflation continuing to drop supporting foreign growth after adjusting for the US uncertainty impact. Although investment opportunities will continue to expand in the US, the opportunities will be much narrower and limited to industries and sectors that will benefit from an inflationary environment and lower interest rates.

If you would like to discuss further in depth analysis, please contact us at chapman@ridgecreekglobal.com or (440) 572-5733.