I connected a wire to my wall outlet… and sparks started flying everywhere.
It looked like the Fourth of July.
I didn’t burn down my house… but my attempt at being a do-it-yourself electrician ended in spectacular failure.
They say a jack of all trades is a master of none. In most cases, it’s better to specialize in one or two things.
(If I had done that, I would have saved myself a few hundred dollars and hours of time. From now on, I’m going to specialize in financial markets… and let someone else fix my wiring.)
The same can be said on a larger scale… In particular, the way individual countries trade goods and services every day.
Countries produce and export what they make best and trade it to other countries for something they need… but can’t easily produce themselves. This system of trade leaves each country better off.
To date, global trade has contributed to more than a quarter of the $70 trillion in economic growth we’ve seen since the 1950s. It makes up 50% of world GDP today.
But as we’ve noted before, this trend appears to be reversing. In fact, world trade has declined for the past four years in a row.
This signals the world is entering an era of peak globalization.
The United States is the world’s second-largest economy. And it’s leading a major shift in global trade dynamics.
President Trump’s public attack on current trade deals is part of an isolationist trend sweeping across the globe.
This trend could have a wide-reaching impact… one that could make things more difficult for businesses and investors alike.
But before we get to that, let’s break down why one key force of globalization—specialized trade—is so vital to the global economy.
Sell What You Can Make Well, Buy What You Can’t
David Ricardo is one of the world’s most influential classical economists. In 1817, he came up with a revolutionary new theory.
While researching the economies of England and Portugal, he realized that Portugal produced both cloth and wine more efficiently relative to England.
But there was a key difference between the two: England used fewer resources and labor to produce cloth compared to Portugal.
Ricardo called this a “comparative advantage.”
England had the comparative advantage for cloth production… And Portugal had it for winemaking. These “comparative advantages” translate into what we now know as each country’s “specialty.”
Ricardo determined that both countries would be better off if England specialized in cloth and Portugal specialized in wine and then traded one for the other.
This basic principle occurs on both the micro level (i.e., an individual) and at the macro level (i.e., a country).
Saudi Arabia has the perfect conditions for pumping oil. Since that country is the most efficient oil producer in the world, it has a comparative advantage over other countries.
China has a lot of cheap labor. So it has a comparative advantage making labor-intensive products like computers and air conditioners.
Today, Italy has a comparative advantage in winemaking. Mexico has perfect growing conditions for avocados. And Colombia for coffee beans.
I’m simplifying the economies of these countries here… but the lesson stands: These countries don’t try to be something they’re not.
Saudi Arabia doesn’t get into the grape-growing business—the climate is too dry. France doesn’t try to build computers because its labor force requires higher pay.
These countries trade their specialties for products they don’t make. If countries specialize and trade this way, they will be better off.
Our friend Bill Bonner, founder of Bonner & Partners, calls it “the process of making win-win deals.” That’s when both entities win in the exchange.
Switching this formula could have win-lose consequences.
Free Trade Is a Win-Win Deal
For me, hiring an electrician is a win-win deal. My house doesn’t burn down, and the electrician earns money.
Italy can export wine to—and then import computers from—China. Italy comes out ahead and so does China.
If countries stop specializing, there will be fewer goods available to us. In other words, if global trade declines, the world economy will stop growing… and different industries will be affected in different ways.
Unwinding globalization will lead to increased volatility and unstable markets worldwide.
Be careful in this environment. Select your stocks carefully. Get rid of multinational companies that do most of their business in other countries. Consider buying gold to hedge against the chaos ahead.
You might be asking, “If trade makes everyone better off, why do so many people want protectionist measures?”
More on that tomorrow…
Nick Rokke, CFA
Analyst, The Palm Beach Daily
Editor’s Note: Global trade is all about specialization. What do you think the United States should specialize in? Share your thoughts with the Palm Beach community right here.
Some industries rely more on imports than others. Protectionist measures will hurt industries with a global supply chain much more than local manufacturers.
In the chart below, you can see which industries get most of their inputs from other countries.
The two industries most reliant on imports are clothing & footwear and motor vehicles. Over 30% of the final value of these products comes from imported goods.
If the government passes a tariff or border adjustment tax, the prices of these goods will rise significantly. This will mean lower profits for the companies in those industries… and less money in consumers’ pockets.
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