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Why the Trade War Matters

Everett Millman
By Everett Millman
Published August 06, 2019

This is Breaking The Dollar, the podcast that dismantles some of the biggest misconceptions about money. Presented by Gainesville Coins

Hello and welcome back to Breaking The Dollar. I'm your host, Everett Millman.

We're doing something a little bit different for today's episode. There was such a violent reaction in the financial markets this week to some tensions being ramped up between the US and China, that I wanted to stop and just address this kind of news.

There's a lot going on underneath the hood, there's a lot going on underneath the surface that will help you understand ultimately why all of this trade war stuff that's in the news, why it does have an impact on your investments and why you should maybe be a little bit worried about what's in your investment portfolio given what's going on in the world.

So I'm just going to jump right into what's been going on. Why this week was there such turmoil in the markets.

You see that all the financial News Shows broke out their markets in turmoil headlines and everyone is freaking out because stocks are falling, bond yields are falling, meaning there's more demand for safe havens.

What is going on with the trade war?

So if you didn't know, we are engaged in a trade war with China and this has been really the story in the markets for the past 8 to 12 months.

It's really all anyone can talk about because yes, there are very big implications when the world's two biggest economies are throwing up trade barriers and causing tensions between each other based on trade.

The buzzword of this whole trade war situation is tariff and tariffs are somewhat poorly understood. I feel like by not just the mainstream media but the public in general.

So what is a tariff?

And the basic definition is that it is like a tax or a duty on imports.

So when products are coming from foreign countries into the United States, a tariff means that those imports are going to cost more. And the reasoning behind a tariff is simply to encourage people to buy local, to buy domestic products because it is uncompetitive to pay extra for the imported product.

Now that kind of goes both ways. What we've seen in the trade war is that the US has placed these tariffs on Chinese imports to try and get them to negotiate a better deal. And how China has responded is by saying we're not going to buy as much or potentially any US exports.

So really it's just a back and forth tug of war where both sides are saying, I'm going to stop buying your stuff and that is going to hurt your economy.

Tariffs were a very common feature throughout world history. It's sort of the default strategy for countries to use to try and tax imports coming from other foreign nations to encourage their domestic industries. It makes a lot of sense in certain contexts, but right now it's being used as a tool, sort of as a weapon to ramp up the stakes of the negotiation.

One of the sort of unintended consequences of this whole fiasco is that there's a domino effect that every other country has to either put up tariffs or take certain protectionist measures in order to stay competitive in order to keep up with what's going on between the US and China.

At the same time, as you can imagine, if the Chinese and the Americans are squaring off economically, then all of their trade partners and political allies are getting roped into this dispute as well.

So it's having sort of a domino effect of every country becoming protectionist. Now everybody is putting up trade barriers and the result is it disrupts the normal flow of trade throughout the world.

And that can be a very bad thing with how interconnected the global economy is now, you know, exports go all over the place.

Now let me give you the sort of underlying insight about why the timing of all of this is so dramatic and why it potentially is going to have a devastating impact on the global markets.

And that's because it's not happening in a vacuum.

The trade war is happening at the same time as so many other major geopolitical tensions and really in many of the same areas that are being effected by these trade policies.

So one example is the pro democracy protests in Hong Kong.

This is a huge issue for China, and mainland China has been trying to kind of stamp down the level of protests but they can only go so far because Hong Kong is the financial hub of China's part of the world.

It is the entry point for a lot of trade and a lot of financial transactions that would not make it into China from the outside world if not for Hong Kong.

So Hong Kong is a critical piece to the rest of the world. Having access to China's markets, obviously the tensions between Hong Kong and the mainland could potentially throw that whole arrangement out of order.

That's just one example though.

So you have a lot of tensions in the south China Sea, in the southern waters below China. That is one of the most active shipping routes in the world. A lot of trade goes through the South China Sea. But there are competing claims between China and his neighboring countries about who really quote unquote owns those waters or has territorial rights in those waters.

So yet again, we're seeing another important choke point for trade.

Another important place in the world where a lot of trade occurs has these geopolitical tensions hanging over along the same lines in the oil trade.

So much of the world's oil passes through the Strait of Hormuz in the Persian Gulf. This is the body of water that separates Iran from the Arabian peninsula.

And again, this is a place where competing territorial claims, political claims about who is allowed to manage that trade flow coming through the straight are at close to all time highs.

Iran has seized three separate tankers and is claiming that there are oil smugglers and it's just a very cloudy, tense political situation. And of course oil is an important component to the global economy. So if this situation gets worse, it's going to have a major impact, not just on the price of oil but on global trade and global markets in general.

And then you have some smaller but still worrisome political tensions elsewhere in that region.

You have China and Taiwan are in a political dispute that traces back more than 50 years.

Japan and South Korea have ended long standing trade agreements and are in their own sort of mini trade war of putting up barriers between allowing trade between the two countries and obviously not just geographically, but because of the size of their economies, Japan and South Korea, two the biggest economies in the world, that has a major effect on all of their other trading partners.

In basically all of these cases, what we're seeing is diplomacy is failing.

A lot of the normal ways over the past 30 years of negotiating trade deals and getting different countries to cooperate on trade, for whatever reasons they are no longer working.

Everybody is engaged in a fight.

Now everybody is punching back at one another over trade policy. And all of these geopolitical tensions I described are deeply intertwined in that you really can't separate the two.

So the longer that the trade crisis goes on, the more it's going to grow and spread. And the worst the situation is going to become for investors.

And you might say, why is that? Why does any of this geopolitical tension really matter?

And it all comes back to one of our major themes on this show and that is confidence and trust. So just like the value of money and the value of assets is based on perception and trust and public confidence, the same is true to an even greater degree for global trade.

Countries are not going to want to invest across borders if they cannot trust one another. And the same is true not just for those governments, but for the large financial institutions within those countries for whatever it's worth.

One of the main reasons that economic growth has exploded over the past 50 years is that by and large countries get along better than they used to. We've come to the negotiating table and agreed on certain things and what I'm trying to say is that a lot of that is breaking down and it won't take much for it to completely collapse.

Confidence is a tricky thing. It can go away very quickly. And when investment confidence goes, the global financial system will suffer tremendously because we're all so interconnected now. So when one major economy gets sick or sneezes, the whole world is going to catch a cold.

And really that's what you should be taking from these headlines about the trade war and how it's wrecking the stock market or the bond market is melting down.

What's really important in that is that it's part of the bigger picture. It's part of this broader trend where we're seeing trade barriers go up. Countries no longer cooperating with one another and that's gonna hurt the bottom line of your retirement fund.

Make no doubt about it. It can be really easy to lose sight of how all of these separate pieces fit together. That's why I wanted to do this episode because the chances are good that you've heard of or about some of these things, but it's sort of like standing very close to a painting. Like one of those impressionist paintings where everything is a bunch of tiny dots and when you're looking at it from that close of a perspective, you really can't tell what all the dots make up. You just see those little points and that's kind of how all of these global issues that are affecting markets right now appear to the average viewer.

You can't see the bigger picture of what those dots really represent and what image they actually create.

When you step back and gain that broader perspective, when you take that macro view, it's much easier to see how all the pieces fit together.

And that's the important point for your financial decisions is that you need to know not just what is going on in the world, but also the connections between them so you can see where we're going and where that train is headed.

So hopefully that's what you took away from the broader perspective that I'm trying to give on a lot of these issues that are popular in the news right now.

So now's the time where we check our mail bag and we take a question from someone or audience.

This week's question comes to us from Shane in Honolulu, Hawaii. Wow. I'm already jealous. Awesome. Mainlanders can only hope and imagine what it must be like to live there.

So Shane asks us, is copper a precious metal?

It's a solid, solid question because I have seen in some places it is lumped in with the other precious metals, gold, platinum, and palladium. Sometimes it's referred to as a semiprecious metal because copper has a lot of the physical and chemical properties that gold and silver has. But as far as how it is used in the world, that's the dividing line that makes it not a precious metal.

Because copper is not only more abundant in the earth's crust, it's a lot easier to find, but it is used predominantly in industries and in manufacturing.

And so what's kind of interesting that ties this in with some of the topical things I've been discussing in this episode is that the price of copper recently plunged to a two year low, $2.50 a pound.

Typically it's been closer to $3 a pound, but the reason that's important is because the copper prices, are typically a good barometer, they are a leading indicator of how the manufacturing sector is doing.

And a lower copper price means lower demand from industry for copper. So it is a general indicator that you can use to see, that if the copper price is falling, that usually means that manufacturing is going to be in decline and in fact the copper price coming down will happen first.

So you can use that as an indicator.

So good question, good precious metal related question but also ties into, you know, what we're looking at with global markets right now.

As always, I really appreciate everyone tuning in. Thank you for listening and tune in next week, when we discuss some of the ways that the financial media, can be very misleading. So you're going to want to check that out. Don't miss it.

Today's episode was presented by our sponsors, Gainesville Coins. You can find out more at GainesvilleCoins.com

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The views and opinions expressed on this show are for informational purposes only and should not be used or construed as professional investment advice.

Posted In: podcasts
Everett Millman

Everett Millman

Managing Editor | Analyst, Commodities and Finance

Everett has been the head content writer and market analyst at Gainesville Coins since 2013. He has a background in History and is deeply interested in how gold and silver have historically fit into the financial system.

In addition to blogging, Everett's work has been featured in Reuters, CNN Business, Bloomberg Radio, TD Ameritrade Network, CoinWeek, and has been referenced by the Washington Post.