The Wednesday Letter #248 - 11/27/2024
THIS WEEK: The New Geo-Trade Policy; Lebanon After the Ceasefire; CRB Commodity Index; Investment Themes to Watch.
The Wednesday Letter was delayed this morning due to a connectivity issue. Thanks for your patience.
Due to the Thanksgiving holiday, Twelve Charts This Week will not be published this Friday. Happy Thanksgiving to our American readers!
THE NEW GEO-TRADE POLICY
Some of you will recall that in a 1993 televised appearance, Vice President Al Gore presented billionaire and former candidate Ross Perot with a framed photo of Senator Reed Smoot and Representative Willis C. Hawley to poke him on his anti-trade position. A few months earlier, Perot had lost in a three-way presidential race with incumbent George H. W. Bush and challenger Bill Clinton, but Perot’s criticism of NAFTA (North America Free Trade Agreement) and his repeated mention of the “giant sucking sound” that was vacuuming US jobs toward Mexico had resonated with a large segment of the electorate. Gore’s point with the portrait was to remind everyone that trade barriers can ultimately be destructive, as with the Smoot-Hawley Act of 1930 that raised tariffs on imported goods and is widely believed to have accelerated the economy’s downward spiral into the Great Depression.
There is some but not a lot of mention of the Smoot-Hawley Act today. The giant sucking sound, it turned out, was not only in the direction of Mexico, but more importantly in the direction of China. NAFTA was supplemented by China’s joining the World Trade Organization and attaining most-favored nation status with the US, two milestones that allowed it to increase its exports. In the thirty-one years since that Gore-Perot appearance, China has become the largest manufacturer in the world. And in the past few years, China has further boosted its manufacturing capacity in order to stem its economic decline. By doing so, it has put even more pressure on the economies of destination countries, the US and especially Europe.
At the same time, China has used its new wealth to build up its military at breakneck speed and to stake a more prominent role in global geopolitics. China’s intimidation of Taiwan and the Philippines has reached unprecedented levels in the past year. China is also expanding its footprint in Africa, Central Asia and Latin America, through the Belt and Road Initiative, the BRICS alliance, the Shanghai Cooperation Organization and other such efforts.
Today, the US weighs on one hand the lessons of Smoot-Hawley and the perils associated with tariffs, and on the other hand the dangers of prolonging a status quo that is enabling China’s designs against the West. These designs are not hidden or secret but are fully spelled out at every opportunity. They include 1) the unification of Taiwan and China, by force if necessary, notwithstanding the West’s high dependence on Taiwan’s semiconductor production, 2) expansion of Chinese sovereignty into the South China Sea, hundreds of miles from the mainland, 3) the overthrow of the American-led world order, 4) the formation of an axis (or several axes) that includes America’s other adversaries, Russia, Iran, North Korea and Venezuela, and 5) the recruitment of other countries from the “Global South” in support of all the above and against the United States.
Faced with two dangers, one more imminent and more certain, the other less pressing and less certain, it is logical that a country would choose to prioritize the first ahead of the second. This at least seems to be the thinking behind Donald Trump’s proposed tariffs and his lack of concern for a repeat of the Smoot-Hawley debacle. Trump selected as the new Secretary of the Treasury macro hedge fund manager Scott Bessent, someone who has spent his career thinking about the interplay of economics, trade and geopolitics.
Bessent’s appointment marks the return of a more proactive economic policy, and of an economic foreign policy, after Janet Yellen’s tenure. Yellen was effective in containing the regional banking crisis of March-April 2023 and she played a key role in imposing sanctions on Russia. But she was uncontroversial in her handling of China and extended the status quo. Her biggest failure, as Stanley Druckenmiller (Bessent’s former colleague at Soros) has pointed out, was her missing a historic opportunity to roll over the US debt at much lower rates in 2020-21.
Bessent is younger (he is 62, Yellen is 78), brings a breath of fresh air and is brimming with ideas, one of which is to tie trade and geopolitics. Bessent has proposed the creation of a three-tiered system (green, yellow and red) for countries that trade with the US, with the friendliest and most amenable enjoying no US tariffs, and the more hostile and recalcitrant getting hit by US tariffs in proportion to their enmity. This approach uses tariffs as a negotiating tool first, and a cudgel later, and it is meant to encourage cooperation and to deter aggression.
In our view, this new tack is long overdue but it is also fraught with risks. China knows that the US fiscal picture is difficult and that US policy cannot risk the surge in inflation that would follow high tariffs. An aggressive tariff regime would hurt both countries, with game theorists then trying to fathom which side will emerge from the standoff in a better strategic position.
A warning that is attributed to liberal French economist Frederic Bastiat is: “When goods don’t cross borders, soldiers will.” It is easy, but maybe too simplistic, to draw a line from Smoot-Hawley to the Great Depression to World War II. But it is possible in any case that tariffs may lead to more confrontation, instead of deterring aggression. The quality of governance on each side will make a big difference.
LEBANON AFTER THE CEASEFIRE
There is footage from a few years ago of Hezbollah leader Hassan Nasrallah explaining with the use of a map that the entire territory of Israel was vulnerable to Hezbollah missiles. Because Hezbollah had amassed a large number of long-range precision missiles, Nasrallah explained, every city, port, industrial or military installation was within striking distance of his launchers. The Hezbollah chief also said that Israel’s cities and infrastructure assets were concentrated in a relatively small geographic area and that they would be devastated in the event of all-out war. Perhaps Nasrallah believed that he was speaking for the sake of deterrence by painting a dire scenario of widespread death and destruction.
Israel and Hezbollah have been in an all-out war for several months but Nasrallah’s predictions have not come to pass. Nasrallah is dead, as are a large number of Hezbollah leaders. And Hezbollah’s military actions have been largely ineffective. As a result of Israel’s anti-missile defenses and the imprecision of Hezbollah’s missiles, there have been few hits and few casualties in Israel, despite Hezbollah launching thousands of rockets and drones. Meanwhile, some sections of Beirut and of south Lebanon have been leveled by the Israeli Air Force.
A ceasefire between Israel and Hezbollah will soon take effect and will remain in force for at least sixty days. Israel has degraded Hezbollah’s capabilities and has now said that it will turn its attention back to the continuing threats from Hamas and Iran.
But where does that leave Lebanon? Hezbollah is no longer as meaningful a threat to Israel but it is still a force inside of Lebanon. It will no doubt try to re-establish its internal position. One main worry in Beirut is that Hezbollah is weaker but that the war has fractured the country even more. There have been calls for Hezbollah to completely disarm, but history tells us that the group will resist doing so. In a worst case scenario, the Hezbollah-Israel war could be followed by internal fighting or skirmishes between militias inside Lebanon. The country still does not have a president, which means that there is no single unifying voice. A recent Hezbollah member penned an editorial in which he wrote the following (the word ‘resistance’ in the excerpt refers to Hezbollah):
Since Hezbollah launched the Lebanese Support Front in support of the Palestinian resistance in Gaza, the internal political scene has exploded in a big way, and the true positions of all forces towards the resistance have become clear.
There can be a discussion with all those who do not oppose the resistance and with those who oppose Israel... But what is difficult to consider, and may not be useful to enter into, is a discussion or dialogue with those who oppose the resistance, and who today raise the slogan of disarmament, appeasing the international community and the United States.
These people, frankly and without equivocation, do not resemble us at all. In fact, one finds it difficult to even think that one lives with them in this Lebanese house… It is not out of stubbornness or even provocation to be extremely frank in saying that it will be difficult to coexist with this group of people.
You are not like us. What is even more true is that we are not like you, and we do not want to be like you!