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Beginning or the end of protectionism?

19 March 2018

Miton’s Anthony Rayner looks at two recent events and the growth of political risk in the markets

The Italian election and the announcement of US tariffs on steel and aluminium, have been much talked about, but rarely linked. Yet they are linked in a fundamental way.

The Italian election saw over 50% of the vote go to populist parties, with traditional parties losing ground, while the US tariff announcement looks at odds with the philosophy of free-trade globalisation that has dominated the last few decades. Both underline important changes to the status quo and both are driven by similar forces.

A growing dissatisfaction with the status quo has been much documented, with Brexit and the election of Donald Trump high profile examples, which caught many commentators and investors off-guard. These recent events remind us that these dynamics are not fly-by-night and lead us to re-examine exactly what is driving this change.

A headline measure of the health of the labour market, like the unemployment rate, which is at or close to record lows in many countries (UK, Germany and the US, but not Italy) provides little insight. But dig a little deeper and unequal income and wealth distribution (particularly housing), as well as job insecurity, go much further in explaining why many want to hit the reset button, particularly when looking at the younger demographic.

Indeed, the Italian election is just one of many votes for populist parties in recent times. The graph below, put together by Deutsche Bank, shows how support for populist parties is at a multi-decade high, and is in fact just below the level of the 1940s (the criteria is fairly subjective but has been consistent over time).

Source: Deutsche Bank, 1900 – 2018

It’s tempting to think of the Italian vote as anti-EU, though it’s perhaps more accurate to say anti-establishment and Euro-sceptic. More specifically, it was a comment on the dire state of the Italian economy and rising levels of immigration, a combination rarely ignored for long in history.

Turning to the US tariff announcement, history shows that if this evolves into a trade war then, yes, those that depend most on exports (like China and the Eurozone) might suffer most, but countries like the US will suffer too (the S&P 500 Index derives around 30% of its revenue outside the US). The worst-case scenario is one where a trade war adds to the inflationary environment and curbs growth, in essence leading to stagflationary pressures.

Whether these moves are a threat to the world order or not is best answered by another question: is this the beginning or the end of protectionist measures? For example, is this the beginning of a preference for multi-lateral regional deals and the beginning of using ‘national security’ as justification for tariffs? Are we starting to see protectionism in terms of foreign takeovers blocked too?

It’s early days, in terms of the detail and degree of retaliation, but the subsequent resignation of Gary Cohn, the US administration’s top economic advisor and free-trade enthusiast, leaves a predominance of advisers with a preference for protectionism such as Peter Navarro, one of the key architects of resurgent US economic nationalism.

Our view is that the base case of strong growth and rising inflation remains the primary driver of financial markets but that political risk is not to be ignored, whether it’s populism or protectionism.

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