(ChatGPT - Morton)
Unnerving tariff comments are creating economic distress. The stated focus being illegal immigration and the shipment of illegal drugs. Important issues, but likely not the actual reason for hitting your Mexican and Canadian trading partners with a 25% tax on their exports.
Perhaps the real issue is a misalignment of currencies.
The Canadian dollar relative to USD has dropped steadily over the past 10 years.
A Canadian corporation selling into the U.S. market receives USD and converts back to CAD at roughly 1.4. What a terrific advantage! Sell Canadian energy, rare metals, precious metals, lumber and manufactured goods to our American neighbors and pocket the currency premium. From a U.S. perspective, why not apply a 25% tariff and partially level the playing field?
Europe has a similar issue:
Not quite the currency export advantage that Canada has, but still significant.
What might cause currencies to become significantly undervalued and is there a way to correct this distortion?
Government Intervention. China and Japan actively influence their currency level relative to their trading partners. If the U.S. places further tariffs on their exports, expect to see their currencies drop (to at least partially offset this competitive export hurdle).
Productivity. Canadian and European productivity growth is dismal. Adjusted for immigration, Canada has recently experienced a net decrease in productivity. One can argue that the dream of creating wealth and working hard has been lost in these former robust geographies. If "This is It", shouldn't higher expectations be set?
(Morton -photo-2024)
Growth. Along with a lack of productivity comes a lack of growth in the economy. Foreign investment disappears, eliminating that source of currency strength. U.S. economic growth has steadily outperformed both Canada and Europe over the last decade and continues to outperform (U.S. GDP grew 2.80% in the third quarter of 2024, Germany 0.1%, Canada 0.3%).
Inflation. Expectation of future inflation partially drives interest rates. Levels of inflation have fallen dramatically in Europe and North America. I would argue that the outlook for inflation over the next five years is similar between major trading partners and that there should not be a need to raise / lower relative interest rate levels to compensate.
Interest Rates
Interest rates in Europe and Canada are lower than the U.S., putting pressure on their respective currencies. It pays well to hold U.S. dollars.
So what can be done to balance the misalignment of currencies? There is no easy answer. The U.S. attracts a vast amount of global capital. Foreign entities buy U.S. dollars and sell their domestic currency, maintaining the superiority of the U.S. dollar. Additionally, the U.S. is a massive seller of energy (in U.S. dollars) bringing further strength to the U.S. currency.
One solution would be to somehow make Europe and Canada more attractive destinations for capital. Now that is one tough endeavor! Capital would have to be treated in a much more positive way with reduced tax, complexity, competitive restrictions.
An alternative is to make the U.S. less attractive. A partial solution would be to lower interest rates (rates as of December 3, 2024).
(Current 10 year Government Bond Yields)
Trump has spoken repeatedly about lowering interest rates. He just might be the man to do it. Over time, appoint a new Federal Reserve Chairman to lower short term rates and attempt to influence (down) longer term rates. The offset to this action is the possible consequence of much higher inflation. I am skeptical that Federal politicians stay awake at night thinking about the damage inflation does to our savings.
My vote would be that lowering U.S. interest rates will be the course of action.
regards, Tim
Tim Morton, CFA is a retired portfolio manager with 45 years of experience working with private clients. For the past two years, the editor of mortonir.com and a contributor to Barron's. My comments are not to be taken as investment recommendations. They are purely for discussion purposes. Please see your advisor for investment advice.
What's to stop the US from annexing Canada?