Could the Western yearning for protectionism subvert the existing world order?


    By Samy Chaar, Chief Economist, Lombard Odier

    Sometimes electoral promises tend to remain just that: promises. It appears Donald Trump is keen to keep his word. His first weeks at the helm of the US have certainly demonstrated an intent to turn campaign messages into political reality.  

    With trade a signature issue, odds are high that protectionist measures be enacted, beyond the already announced withdrawal from the Trans-Pacific Partnership. How tough a stance the new US administration takes on trade will shape not only growth during the next few years – global recession being a definite risk – but also the longer-term world order. The time may have come to reappraise trade relations with markets long considered closed.

    Since Adam Smith first extolled the virtues of free trade back in 1776, few economists have questioned its benefits. The great John Maynard Keynes himself, albeit having argued for tariffs in 1931 to help Britain recover from the Great Depression, was steadfast in the view that free trade is the best policy for economic growth in the long run. American scholar Richard Epstein wrote last year in a paper (published –  somewhat ironically as will transpire below –  by the Hoover Institution): “the simple but powerful truth [is] that overall levels of profitability and wealth increase under free trade. The short-term relief that targeted groups get from protectionist measures mask the larger inefficiencies that slow down the rate of growth”.

    Why then such wrath against globalization across Western countries? To begin with, free trade is one concept, fair trade quite another. 

    Even in the heyday of global commerce, covert protectionism never really ceased.

    More importantly though, the populist backlash on both sides of the Atlantic stems not from globalisation per se, but from the uneven distribution of its benefits. Middle-classes did not share the wealth created during the post-Cold War period. In fact, they saw their living standards drop and job insecurity increase.

    Mass deportation of Mexican Americans, higher import duties to protect domestic jobs and farmers…does this sound familiar? Funnily enough, these measures actually date back to 1929-1933. In June 1930, President Hoover signed into law the Smoot-Hawley Tariff Act, despite veto urges by economists and executives (J.P. Morgan partner Lamont is said to have nearly dropped to his knees), threats of retaliatory actions by many trading partners and his own misgivings about undermining international cooperation. Retaliation, led by Canada, did occur. US imports and exports dropped by over 60% between 1929 and 1932 – only serving to worsen the effects of the Great Depression on US workers and farmers. By 1933, two thirds of global trade had evaporated.

    Coming back to the present day, what do we know about Trump and trade? We know that the new President and his entourage consider free trade agreements as job-killers. We know that China, with whom the US runs by far its largest bilateral trade deficit (at near USD 350 billion in 2015), has been explicitly targeted – with Mexico next in line. And we know that trade is an issue on which existing legislation gives the US President substantial room for action.

    Should a full-on trade war be engaged, with China and Mexico responding tit for tat to US-imposed tariffs, the direct impact on the US economy would be large enough to cause a recession. 

    And that is even before accounting for supply chain disruptions.

    Real world manufacturing is a far cry from textbook theory. And the relationship between importers and exporters is not a simple one.

    Components often cross borders multiple times before a final product reaches the consumer. Consider just the journey that a modern US car seatbelt undertakes: manufactured in Mexico, woven and dyed in Canada, cut and sewn back in Mexico and finally installed in the US. Another case in point is the Boeing 787. An emblem of US manufacturing prowess? Certainly, but its components happen to be sourced from all over the world.

    Outside of the US, the economic impact also stands to be huge.

    Were US protectionist measures to “succeed” in closing the long-time trade deficit, the dollar would undoubtedly appreciate, tightening financial conditions across the globe.

    For emerging markets the immediate whammy would be double: higher servicing costs on their massive dollar-denominated debt at a time of shrinking exports to the US. Worse, the dollar’s very role as the world reserve currency could be called into question.

    It is precisely because an Obama-led US was intent on bolstering its own leadership in Asia that China found itself excluded from the multiyear Trans-Pacific Trade negotiations. After President Trump reneged on this pact, Chinese leaders were not long in reactivating talks on the Asian regional trade deals that they support. The recent World Economic Forum also offered President Xi Jinping a great stage to criticise (Western) protectionist tendencies, likening them to “locking oneself in a dark room”.


    China meanwhile is opening up – and faster than most care to acknowledge. Last October, its currency officially joined the US dollar, euro, yen and British pound in the IMF’s special drawing rights basket. The yuan may not yet be freely usable, nor widely traded on financial markets, but it is on its way to gaining reserve currency status.

    Trump’s surprise win and promise of trade barriers has sent some investors running for the hills in emerging markets but, at Lombard Odier, we are staying put. Our conviction that China’s developments will significantly impact the emerging bloc at large keeps us structurally overweight. With its industrial demand benefitting the likes of Brazil and Russia, as well as trade across the Pacific Rim, China is arguably the link that ties together all emerging economies. Alongside Beijing’s multi-billion investment to resurrect the ancient Silk Road to the Middle East and Europe (now termed “One Belt, One Road”), this could indeed massively alter the world order as we know it.


    This is a marketing communication issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter "Lombard Odier"). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This marketing communication is provided for information purposes only. It does not constitute an offer or a recommendation to subscribe, to purchase, sell or hold any security or financial instrument. It contains the opinions of Lombard Odier, as at the date of issue. These opinions and the information herein contained do not take into account an individual’s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes a personal recommendation to any investor. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Lombard Odier does not provide tax advice. Therefore you must verify the above and all other information provided in the marketing communication or otherwise review it with your external tax advisors.
    Some investment products and services, including custody may be subject to legal restrictions or may not be available worldwide on an unrestricted basis.
    Investments are subject to a variety of risks. Before entering into any transaction, an investor should consult his/her investment advisor and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. The information and analysis contained herein are based on sources considered to be reliable. However, Lombard Odier does not guarantee the timeliness, accuracy, or completeness of the information contained in this document, nor does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices, market valuations and calculations indicated herein may change without notice.
    Past performance is no guarantee of current or future returns, and the investor may receive back less than he invested. The value of any investment in a currency other than the base currency of a portfolio is subject to foreign exchange rate risk. These rates may fluctuate and adversely affect the value of the investment when it is realized and converted back into the investor’s base currency. The liquidity of an investment is subject to supply and demand. Some products may not have a well-established secondary market or in extreme market conditions may be difficult to value, resulting in price volatility and making it difficult to obtain a price to dispose of the asset.
    European Union Members: This marketing communication has been approved for issue by Lombard Odier (Europe) S.A., a credit institution authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg and by each of its branches operating in the following territories: France: Lombard Odier (Europe) S.A.• Succursale en France, a credit institution and regulated in France by the Autorité de contrôle prudentiel et de résolution (ACPR) and by the Autorité des marchés financiers (AMF) in respect of its investment services activities. United Kingdom: Lombard Odier (Europe) S.A. • UK Branch, a credit institution regulated in the UK by the Prudential Regulation Authority (PRA) and subject to limited regulation by the Financial Conduct Authority (‘FCA’) and the Prudential Regulation Authority (‘PRA’). Details of the extent of our authorisation and regulation by the PRA and regulation by the FCA are available from us on request. UK regulation for the protection of retail clients in the UK and the compensation available under the UK Financial Services Compensation Scheme does not apply in respect of any investment or services provided by an overseas person.
    Switzerland: This marketing communication has been approved for issue by Bank Lombard Odier & Co Ltd, a bank and securities dealer authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).
    United States: Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
    This marketing communication may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Lombard Odier.
    © 2016 Bank Lombard Odier & Co Ltd – all rights reserved

    let's talk.