Trump, Drones, and Trade Deal Negotiations

The reaction of Donald Trump to the seizure of the drone by China reveals a glimpse of what we should expect from him when dealing with relatively aggressive counterparties.

More than that, this also brings into question the recent euphoria in the stock market because his reactions to not only incidents like this, which admittedly are unusual, but also what we would expect his reactions to be to other economic or trade related issues, which might be treated with the same offensive nature, could result in more questions than answers.  Wall Street usually doesn't like that.

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However, Wall Street has rallied aggressively on the heels of the election, fueled by the hope for lower taxes and fiscal stimulus, but I have already argued the problems with this in that tightening monetary policy poses an immediate headwind to economic growth and simulative fiscal policy takes a long time to work its way through the system, so there is a big gap when handing off the baton.

Read more about the macroeconomics of this handoff.

After China agreed to return the drone and issued a statement with the word regret in it, and I am saying it that way purposefully because that was probably the closest thing we will ever see to an apology from China, Donald Trump reacted offensively, not politically, and suggested that we let China keep the drone, but implied that they shouldn't think about doing something like that again.

Sort of like in a schoolyard, Donald Trump just told China not to push him again, but this is not the schoolyard and the consequences of offensive tactics like this create uncertainty.  I'm not suggesting that tactics like this will not be effective, they may very well lead him down the path to achieve the changes he is looking to make, but changes are not clean, they don't come without uncertainties, but the stock market is not respecting that either.

Not only is the stock market not recognizing the difference between monetary tightening and fiscal stimulus, but they don't seem to be respecting the uncertainties associated with the Trump policy changes being proposed, especially when his tactics, which have almost surely a focus on achieving the upper hand in negotiations, bring with them potential political conflict.

This is extremely important, especially when trade deals are considered, when the risks of a trade war exist, but more importantly when his tactics for negotiation are realized.  He plays hardball, he looks to get the upper hand in his negotiations, and the only way to do that is to come at them from the position of strength.  That means whoever is on the other side of the negotiation must believe that he will do what he is threatening to do, and if that means tariffs on some or all products produced in China that could cause serious questions to arise that currently are not being considered.

Admittedly, Donald Trump is probably not looking to impose widespread tariffs on imports from China, but if he's not perceived as being prepared to do that China will have no reason to come to the table and negotiate a better trade deal, a more free flowing currency, cracking down on stolen intellectual property, or whatever it is that Donald Trump may seek to achieve.

Using China as an example, if he wants China to come to the table he's going to have to stir the pot, create uncertainties, impose a degree of fear, and refuse to be pushed around, and it starts by asking for more than he actually wants, but China will need to believe he's capable of following through as well.

When Donald Trump told China to keep the drone this past weekend he essentially told them that he will not be pushed around.  When it comes time for negotiation that will add value, but again uncertainties will exist that the market does not seem to be respecting right now, and those uncertainties will come at a time when monetary tightening and fiscal stimulus are not actually offsetting each other.

The iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) has been the digest beneficiary from Trump, the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) and SPDR S&P 500 ETF Trust (NYSEARCA:SPY) are not far behind, but the PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ) has been the laggard.  Still, QQQ is not down, and all markets have appreciated.  So far he market is not concerned with any of the issues mentioned herein, but it will be soon.