The Art of the Free Trade Deal

Four weeks ago, Donald J. Trump was elected the 45^th US President.^[i] Since then, the President-elect has made a lot of noise about what he will do once in office-especially regarding trade-triggering pundits' frenzied efforts to size it all up. Many believe Trump poses a big threat to the global economy, particularly through trade policy. And who knows, perhaps that is true. Worth watching! But, while trade is an area where the president has more latitude than, say, tax policy, Trump still doesn't have carte blanche-assuming he even tries anything. Trade could easily be a key area in which the reality of a Trump presidency is better than feared.

Trump has many plans to "improve"^[ii] America's competitiveness and existing trade relationships. He said he will hit China with tariffs early on because of unfair trade practices (e.g., supposed currency manipulation). The North American Free Trade Agreement (NAFTA)? It's a bad deal and must be redone-or else the US will leave it. And don't even think about the US ratifying the Trans-Pacific Partnership (TPP). But don't worry, the Donald says he will negotiate easier-to-enforce bilateral deals. US businesses also need to watch their backs, with Trump threatening a 35% tax on firms exporting US jobs. That's a lot, but how much can he actually do unilaterally?

When it comes to imposing tariffs, the president has broad powers. (Exhibit 1)

Exhibit 1: Some Presidential Tariff Powers

This list isn't even exhaustive. And presidents have used these powers. A few examples: In 1971, Richard Nixon imposed a temporary 10% tariff on imports because American products were at a "disadvantage because of unfair exchange rates." George W. Bush implemented steel tariffs in 2002 to protect against "imports that materially harm domestic industry" (US steel in this case). More recently, Barack Obama slapped tariffs on China for select steel products and solar panels.

While we aren't fans of tariffs because they impede the movement of goods-and risk retaliation, which could further hamper global commerce-a single tax needn't start a big bad trade war. Obama's China tariffs didn't kill this bull market. Bush's steel tariffs lasted from March 2002 to December 2003, a period beginning near the end of Tech-led bear and ending alongside surging stocks in the 2003 - 2007 bull's first year. Nixon's tariff lasted for four months in the middle of the 1970-1973 bull market. This doesn't make tariffs good, but scale matters.

In China's case, Trump's 45% tariff threat stems from currency manipulation accusations. Trump, like many politicians in the last decade, argues China purposely devalues the yuan for economic advantage (via making its exports cheaper). However, these claims are off base. While China arguably did keep the yuan artificially low for a spell, as the US Treasury notes, China is now trying to prevent faster yuan depreciation by selling forex reserves, which neared an eight-year low $3.05 trillion in November. For context, reserves are down nearly a trillion^[iii] dollars from its January 2014 peak. Tariffs today would punish China for strengthening the yuan, so to charge them with a currency-manipulation tariff, Treasury would need to rewrite its rules and definitions for just this one case-which would be bizarre and contrary to pretty much all evidence. Stranger things have happened, but China being dubbed a manipulator doesn't seem assured. As for potential punitive tariffs on US firms, Trump's power is much more limited. He lacks the legal authority to target individual companies, let alone overhaul the corporate tax system, as levying taxes is Congress' domain. Plus, even if some legislators agree with Trump's tax proposals, those ideas will likely hear loud opposition, as House Republicans are currently finding out-taxes have a way of eliciting strong opinions.

As for free trade agreements like NAFTA, the president holds considerable influence. Though Trump can't singlehandedly make new trade agreements-Congress must approve, a big reason the Trans-Pacific Partnership (TPP) already faced long odds-he can affect existing deals. NAFTA says simply: "A Party may withdraw from this Agreement six months after it provides written notice of withdrawal to the other Parties." While there is some debate over this, most legal scholars believe this means Trump can unilaterally withdraw the US from the pact. While there is the potential for legal recourse in the courts for this and other actions, it is an open question of how fast it would move, and whether the court would issue an injunction barring the action quickly enough. All that said, however, just because the president has these powers doesn't mean he will use them.

Despite all the speculation, no one knows what Trump will actually do until he's in office. His rhetoric warrants monitoring, but we recommend against assuming his words will become action. Politicians commonly make big, threatening proclamations before entering office, only to moderate once in power. Obama said almost the exact same things in 2008-renegotiate NAFTA or walk, smack China for currency manipulation, whack companies that outsource jobs-and didn't do any of it. Instead, he reversed course, embracing free trade. Trump, like all politicians,^[iv] has many constituents to answer to-and those constituents' wants vary and sometimes conflict. For example, many of Trump's supporters in the Midwest's Rust Belt got behind him for his opposition to NAFTA. However, other Trump supporters-see these business owners in Texas-are big NAFTA proponents. Tough to see how he pleases both. Also, the president's political capital is a limited resource. Even the most popular presidents don't have unlimited goodwill and can typically get only two or three big things done during their presidency. Trump is entering office with less political capital than Obama and many new presidents, given his loss in the popular vote, slim Senate majority and intraparty opposition from the #NeverTrump Republicans. So while we don't know what he's going to focus on yet, he probably won't have the ability to implement most of his initial proposals.

While it's easy to talk now and point to largely symbolic gestures like jawboning one company into keeping several hundred jobs here, reality can start dampening that enthusiasm quickly. However, here is one potential underappreciated positive: Fears about Trump's impact on trade run deep. If disaster doesn't happen-i.e., Trump talks big but ultimately demurs and doesn't act on many protectionist promises, that could tee up a nice positive surprise for folks expecting the worst. Trump's trade positions are one reason why expectations for his presidency are low-it wouldn't take much for reality to top them, a potential bullish disconnect.