Tariffs

What they are and what they mean to us

If you follow current politics, you will know tariffs are a favorite talking point for incoming US president Donald Trump.  In case the threat becomes reality, let’s understand this a bit better and see how they may affect us.

What is a tariff?

Let’s assume the US imposes a 10% tariff on Canada.  That means:

·         The US government immediately receives an income of 10% for everything Canada sells to the US.  An alternative to raising taxes

·         The US citizen pays up to 10% more for Canadian goods, immediately or within a few months.  This is inflation via oil, cars, car parts, potash, aluminum, some foods, etc. (1)

·         The US economy will shift more purchases to other countries, over time measured in months or years

·         US companies may begin to produce goods that were previously imported, increasing US employment over years

·         Canadian companies lose sales and react by lowering profits and/or selling more to other countries and/or laying off Canadian employees over an indeterminate time

Typically, a US tariff will be responded to by a Canadian counter-tariff:

·         The Canadian government immediately receives an income

·         The Canadian citizen pays more for US goods, immediately or within a few months.
This is inflation via cars, car parts, oil, tractors, machines for industry, some foods, etc. (1)

·          The Canadian economy will shift more purchases to other countries, over time measured in months or years

·         Canadian companies may begin to produce goods that were previously imported, increasing US employment over years

·         US companies lose sales and react by lowering profits and/or selling more to other countries and/or laying off US employees over an indeterminate time

The governments are initially better off, but at the expense of their citizens and companies.  In time, the government also becomes worse off as inflation, unemployment and lower incomes reduce their tax receipts in an economic recession.  A stock market downturn could also be expected.

Types of Tariffs and Their History

There are two main types of tariffs.  Targeted tariffs are applied to a few specific items and are much more common.  Blanket tariffs are applied to a broad range of commodities and goods and are uncommon. 

Targeted tariffs from recent history include the ongoing US softwood lumber tariffs and Trump’s tariffs on steel and aluminum during his first presidency.  Even more recent are the new US, Canadian and EU tariffs on Chinese electric vehicles.

What about blanket tariffs?  Is there a historical reference relevant for this type of strategy?  Yes, according to a recent Paul Wells podcast (2).

In 1930, the US President Hoover imposed the Smoot-Hawley Tariff Act, despite widespread opposition from economists.  Existing tariffs increased by about 20%.  Then new US tariffs were applied like a blanket to 25 countries including Canada.  The trade war was on.  WLM King and the Canadian government responded with counter-tariffs on US products.  By the following year, RB Bennett replaced King as Prime Minister and Canada pushed through further tariff items and increases to counteract the growing US tariff blanket.

Sanity began to prevail when FD Roosevelt defeated Hoover in 1932, as he began working to reduce tariffs and succeeded with a new Trade Agreements Act in 1934.  Canada followed suit and the four-year trade war with the US ended.

There is consensus among economists that the 1930s tariff war made the Great Depression worse than it needed to be in Canada and in the US.  How much worse has never been determined. (3)(4)

Is this History Rhyming?

It looks that way.  The last blanket tariff and trade war between the US and Canada occurred in the same era as the last Fourth Turning and Debt Cycle bottom.

What does this mean for us?

Any form of trade war - such as tariffs - makes the risks of this cycle bottom more certain and more imminent.  Review and adjust your debt, savings and investment positions to Be Prepared.

PS. What if the tariff threat is just a bargaining tactic?  Maybe Canada avoids tariffs by securing our shared border and/or increasing defense spending for NATO.  The increased Canadian government deficits and debt to accomplish this – in the $10’s of billions per year – could be just as financially painful as a trade war.

PPS.  This is an unusually long blog.  I just couldn’t squeeze it down anymore.

1.      https://oec.world/en/profile/bilateral-country/can/partner/usa

2.      North America faces the Trump tariff, Paul Wells, Substack, November 27, 2024

3.      https://www.fraserinstitute.org/commentary/history-clear-high-tariffs-and-trade-wars-devastate-countries

4.      https://macleans.ca/facebook-instant-articles/what-we-can-learn-from-a-disastrous-1930-u-s-tariff-on-canadian-goods/

Inequality

Causes and Considerations

Danielle Park, a Canadian investment advisor, author and blogger, reported recently (1) that the Canadian average house price was 4x income in 1994 (ie. $200,000 house and $50,000 income).  In 2024, even after dropping up to 20% from their peak, our average house price is 8x income (ie. $400,000 house at the same $50,000 income).

During the same Thoughtful Money interview, titled “Stocks Are The Most Overpriced in 100 Years”, she reports the current US S&P stock market at its current overpriced level can expect 40% mean reversion (correction) based on historical results.  Note the Canadian TSX is also at all-time highs and follows a similar, albeit less volatile, route up and down as the US S&P.

These are two stark examples of conditions where Canadian financial inequality is obvious:

·         If you’ve owned a home for 20-30 years, its equity is wealth you have that the younger generation struggles to even start to create

·         If you’ve been in the stock market for 10 plus years, market prices today give you a “paper” wealth far more than the long-term mean

As a result of these beyond normal gains in home and market wealth, a new inequality has emerged.  Dr. Eliza Filby recently published a book in the UK called Inheritocracy: It’s Time to Talk About the Bank of Mum and Dad.  Filby talks about how children born from the 1990’s forward are becoming class separated (or not) by their parents’ wealth.  Parents (who can) are now supporting education, housing, childcare and more.   Their children are advancing in society because of inheritance rather than earning capability.  Inequality grows.

So what?  Well, we have learned from history that inequality is a cycle with highs and lows.  Howe’s Fourth Turning work suggests we are likely at or near a high before a return towards the low in the next 5-10 years.

To Be Prepared for an inequality correction, we, our families and our advisors should consider:

·         Home prices flatlining or dropping while incomes increase until we return to 4x

·         The stock market correcting 30-50% with a multi-year recovery

·         Governments stepping in to directly tax your net worth in addition to your income

·         Quite possibly some combination of these scenarios

How does each affect you?  Your child?  Your parent?

A final thought.  A return towards financial equality likely benefits those of us under 40 or 45 years of age and harms us beyond 45.  To prepare, you and yours can consider some of the strategies presented in previous and future blogs.

1.      Danielle Park on Thoughtful Money, YouTube, November 10, 2024

2.      Inheritocracy book, Dr. Eliza Filby, and YouTube interview by PoliticsJOE, October 3, 2024

Good News

The Fourth and First Turnings

A core purpose of this blog is to encourage its readers to realize history tends to rhyme with itself over time.  Rhyming history is not something we are likely to be considering through the day to day and week to week of life.  Rather, looking back in history to see the future is a very big picture perspective we don’t make time for.  Or maybe we don’t even want to think about it.

Human recency bias causes our instincts to think about the future as being the same as the recent past.  For periods of a decade or two that can be true.  But in other periods – like this one – that is far from the truth. American demographer Neil Howe researched and co-authored The Fourth Turning in the 1990’s and followed up with The Fourth Turning is Here in 2023.  In both books, the purpose is to evaluate 500 years of American history.

Howe has identified a repetitive cycle occurring every four generations with a total cycle time of 80 to 100 years.  The stages (generations) of the cycle can be considered in terms of spring, summer, fall, and winter.  Based on his work, he has determined we are currently in the fourth/winter/crisis stage of the cycle, with a transition into the first/spring/high stage in more or less ten years.

So, what’s the Good News?

The spring high will certainly follow winter crisis.  Spring will be a period of greater financial and social equality across the population.  Spring will bring a greater feeling of community and willingness to work together on big national purposes.  Family life and children are always celebrated in first turnings.   More generally, optimism will prevail over pessimism.

I have read both Fourth Turning books and recommend them if you have any interest (beyond this blog) in having a big picture view of the near future.  If a whole book seems too much, you can find dozens of YouTube interviews – lasting an hour typically - where Howe describes the generational cycle and/or thoughts on how to prepare for it.  I encourage you to do some research of your own rather than take my word for it.  Be Prepared by investing in your knowledge.

PS. The ongoing blog subject area is focused on Being Prepared for historical cycles like the Fourth Turning, so the blogs tend to be a discussion of depressing, negative financial outcomes.  I don’t want readers to think I’m negative.  Rather, my approach is to “prepare for the worst, and hope for the best”.  The intent of this specific Good News blog is to remind readers about the positive side of historical rhymes.  Spring is coming!  I hope you take it to heart.

Fiat

A reset is coming

This blog sets a primary purpose at its outset to learn from history and Be Prepared for history to rhyme in the future.  A key part of financial history is the evolution of the currency system.

So no, this blog is not about Italian cars, it’s about fiat currency.

What is fiat currency?  It means the currency (or money) we use to live our lives is not backed by any real or tangible value like gold.  The fiat nature of Canadian and US dollars means their value relies solely on our individual and communal trust that federal governments won’t renege on their backing of our currency.

History teaches us that for thousands of years, at least back to early Egypt, people relied on real, tangible commodities – most often gold and silver – to improve trading.  Eventually governments took over control of these commodities and began devaluing them from time to time by clipping or diluting coinage.  After the printing press arrived, governments evolved to paper instead of coinage, but still backed by a real commodity.  Finally, governments began to suspend the real commodity backing when they needed more currency than their commodity reserves would allow.  The result is fiat currency.

Every fiat currency in the history of the world has eventually failed and been replaced.  Literally all of them, 100%, no exceptions. There are dozens of books and videos that provide a more detailed description of this history.  I can recommend a couple if you’d like.

Did you know that the Canadian dollar has been an un-backed fiat currency since 1933  (1), that its value is floating relative to the US dollar, and that the US dollar has been an un-backed fiat currency since 1971?

Given we know our fiat currency will fail, likely via failure & reset of the US fiat currency, here are a couple of good questions we should ask:

When?  Smart money experts such as Keith Dicker on the Loonie Hour (2) suggest the failure and reset should have occurred in 2010 after the great financial crisis.  Instead of allowing failure, the governments and central banks suspended reality by embarking on an unprecedented period of low interest rates and high levels of currency printing.  Debts have skyrocketed, none more so than the US government.  How long can this suspended reality continue?  The time before a reset could be a month or a decade according to Dicker.

What will replace fiat?  History suggests every time governments have abandoned backing, they then return to backing.  Historically this has meant a return to gold, but today other options exist such as another commodity or group of commodities, possibly even Bitcoin or other real, tangible assets.  The return may or not also include central bank digital currency (CBDC).  Small countries are tinkering with many of these solutions already.  No one knows the answer.

What does this mean for us?

The indeterminate timeline and unknown outcome make it difficult – but not impossible - to prepare.  Knowing that the reset will probably include one or more of gold, other commodities, or maybe even Bitcoin, gives us the opportunity to own one or more of these assets as a hedge against the future.

The other more important work we can do is be aware of this coming change and listen for clues that could help us Be Prepared.

1.      History of the Canadian Dollar, James Powell, 2006

2.      Loonie Hour #156, October 2024

Debt Cycles Explained

Plain language financial education

How the Economic Machine Works is a 30-minute video by Ray Dalio which provides the layman with an animated, plain language description of how our economy functions.  If you want to make a financial investment in yourself, it is a great way to learn a lot in a short time.  I have viewed it several times over the years to learn and Be Prepared.

The following is a quick review which I hope will encourage you to invest 30 minutes in yourself.

Dalio opens by identifying the three main forces in the economy:

·         Productivity Growth

·         Short Term Debt Cycles

·         Long Term Debt Cycles

Woven into those three main forces and their timelines are Transactions.  The total of all transactions between people, businesses, banks, and governments adds up to make the economy.  Every dollar you spend someone else earns.  He explains transactions can be completed with money or credit.  You can buy groceries from a business with cash or a credit card.  A bank can give you credit to buy a car from a business.  You pay tax to the government and get your road repaired.  Etc., etc.

Of money or credit, credit is the most complex and most important part of the economy.  Why?  Because it is human nature to want something now that you can’t afford until later.  As a result, the total amount of credit is many times the total amount of money in the economy.  Thus, it is our human nature that is driving the short- and long-term debt cycles.

·         Short term debt cycles occur every 5-8 years

·         Long term debt cycles occur every 75-100 years

Over time, these cycles peak and valley around long-term growth in productivity.  Productivity matters most in the long run.  Debt (created from credit) and its cycles matter most in the short run.  Like any cycle, what goes up must go back down and repeat again.  Dalio identifies the 1920’s and 30’s as the last bottom of a long-term debt cycle.  Here we are about a hundred years later in what appears to be another long-term debt cycle bottom.

Long term debt cycles are resolved through a process called deleveraging or debt reduction.  This applies to individuals, businesses, banks and government.  There are four typical stages of deleveraging:

·         1st is austerity – spending less

·         2nd is debt restructuring – loans are called or refinanced at worse terms than before

·         3rd is taxing the ‘haves’ – to reduce inequality with ‘have nots’ and reduce government debt

·         4th is money printing – to stimulate the economy and create inflation to reduce debts

The government and central banks must very carefully balance the first three deflationary actions with the fourth inflationary action.  Too much deflation leads to a depression and too much inflation leads to hyperinflation.  Neither depression nor hyperinflation is good.  Having to rely on government to get it right is equally concerning.

Dalio concludes with three rules of thumb, which can be applied to people as they can to business, banks and government:

·         Don’t have debt rise faster than income

·         Don’t have income rise faster than productivity (you become uncompetitive)

·         Do all you can to raise your productivity – this is what matters most

This blog is a quick review of a fundamentally important piece of financial literacy.  I strongly recommend you take the time to watch the video.  Invest in yourself.  Be Prepared.

Inflation

Understanding it and Preparing your Investments

The first Be Prepared blog on July 8, 2024, looked at multi-generation historical cycles by opening and closing with a look at inflation and timeline-correlated stock market results.  This blog looks at current generation inflation to ponder whether we may be in another 10-year period of high inflation.

Understanding:

Inflation is more technically measured as the Consumer Price Index or CPI.  Canada’s CPI reports that we have experienced 17.6% increase from June 2020 to June 2024.  That’s 4.1% per year!  With this last year having been ‘only’ a 2.7% increase.   Always remember - it didn’t drop to 2.7%, it’s just up less than last year.  1991 was the last year prior to 2021 that Canada was over 3% for a full year and 20 of those 30 years were under 2%. (1)

Thus, Canada’s generational ‘normal’ is around or under 2%.  Yet the Bank of Canada cutting rates twice this summer should mean they believe the current 2.7% indicates they have inflation under control.   Has anyone buying groceries, or a car recently felt inflation is under control?  Me either.  This premature rate cutting combined with other factors probably tends to higher inflation for longer.  Maybe we Canadians live with 3-4% inflation on average for another five plus years?

I’m not alone in this thought.  Many of the smart money persons I follow, like the Outlook 2030 panel (2) and Lyn Alden in her April 2024 newsletter (3), believe we are in for an extended time with higher than ‘normal’ 2% inflation.  Potentially through the remainer of the 2020’s.

Jeff Rubin evaluates changes in the global economy thus far in the 2020’s in his recent book (4) and states “inflation is here to stay”.  His premise is that the continuing sanctions and conflict between competing nations will continue to drive the reversal in globalization of the economy we witnessed for the 3 decades since 1991.  Friendshoring product manufacturing will drive higher price inflation.  AI will have a counter-effect on wage inflation in the white-collar space but our fundamental needs like food, shelter, power, and all their feedstocks will still be made by real people doing real work for increasing real wages.

If we accept this probability of higher inflation for several years, what can we do about it?   We know higher inflation reduces the amount of funds we have left to live day to day, less to pay off debts, and, if we are fortunate, less to save and invest in our futures.

Preparing:

Our day-to-day personal finances tend to suffer from high inflation.  As costs go up faster than incomes our ability to spend, pay down debt, save or invest goes down.  For the balance of this blog, we’ll look at how to prepare your investments for inflation.

We have learned the best investments for high inflation are real assets.  Real assets are physical or tangible goods that can’t be created easily.  Real estate, farmland, commodities, infrastructure, utilities, and the producers of these assets like miners and some manufacturers.  While tech, financials and other growth stocks are still driving the stock markets today, they are not hedges against inflation.  The 60/40 stock/bond portfolio and its iterations are also less likely to reward investment through higher inflation periods.

We have prepared.  We personally have our entire investment portfolio in a diversified range of primarily real assets, some fixed assets and cash.  Given our age, the majority is tilted toward risk management with a minority focused on high return.  Only 20% of it’s in the stock market and none in the bond market.

What can you do?

·         Prioritize paying down debt before increasing your investments

·         Ask your financial advisor where you are positioned relative to inflation and real assets.  Remember, they work for you

·         Check your pension plan to see where they invest on your behalf

·         If you DIY invest, think about reviewing the references yourself

I’m happy to be a sounding board for any of you when you dig into where you are relative to being prepared for inflation.

1.      Worlddata.info/America/Canada/inflation rates

2.      Vancouver Resource Investment Conference – Outlook 2030 panel, February 2024, YouTube

3.      Balanced Portfolio Construction - Lyn Alden.com, April 2024 newsletter

4.      A Map of the New Normal – Jeff Rubin, 2024

History Rhymes

A storm is coming for our personal finances

Mark Twain is believed to be responsible for first saying “History Doesn’t Repeat Itself, but It Often Rhymes.”  What does that have to do with personal finances?

Whether you are a Millennial, a Gen X-er or an early 1960’s Boomer, our adult life experience until now with finance in Canada has been:

·         Inflation - dropped after its 1981 peak at 12.5%, then remained below 3% for 30 years 1

·         The Stock Market - always goes up, more than 10X since 1984 and only once spent five years below its previous high 2

The same life experience is true for all financial planner/advisors still in the workforce supporting your requirements.  Therefore, us as individuals and our planners are biased toward our life experience continuing.

But hold on a moment.  Something seems different in the last few years.  We’re experiencing higher interest rates and higher inflation.  Yet debt is still too easily accessed, and the stock market is still going up.  Is this just a blip or are we now living something outside our life experience?

To manage the risk for our financial plan, I went looking for information outside my life experience.  Could history tell us about what seems different?  What I found included:

·         Principles for Dealing with the Changing World Order, Ray Dalio, 2021

·         The Fourth Turning Is Here, Neil Howe, 2023

·         Broken Money, Lyn Alden, 2024

Changing World Order considers 500 years of rising and declining empires in world history.  A recurring cycle of good and bad finances is identified as one of the three most important determinants to the rise and decline of empires.  He argues that we are in the final years of an ±80-year debt cycle.

The Fourth Turning is Here re-evaluates 500 years of American demographic history and digs into our current position in the a generational cycle recurring every 80-100 years.  He argues we are in the last decade of that cycle, which is a social and economic winter before the arrival of spring.

Broken Money considers the origin and development of money through a technology lens.  It draws out how money has evolved through thousands of years from a tool that allowed society to grow and evolve in the last 100 years to a fiat currency whose quantity is no longer controlled by nature, and how that financial system is failing us.  Her thesis is today’s economic conditions are best related to the 1940’s and 50’s, not the 70’s or anything more recent.

Each of these information sources deserves their own Be Prepared blog someday.  I have reviewed many additional information sources that indicate a similar direction that something has changed. For now, suffice to say I believe we are living in a new paradigm, outside our life experience.

These sources all indicate our upcoming financial experience will most likely rhyme with some combination of Canada’s history from the 1920’s through the 1950’s. 

·         Inflation – experienced deflation for 12 years starting 1921.  Later high and volatile inflation peaking at 14.6% in the late 1940’s 1

·         The Stock Market - spent a full 20 years below its 1930 high, much of it 50% lower 3

That is very different compared to our bias from the start of this blog.  We have personally acted with our finances and investments for this new paradigm, as history rhymes over the next 5-10 years.

Future Be Prepared blogs will dig into actions you can consider.

Footnotes:

1.      InflationCalculator.ca/historical rates Canada website

2.      Yahoo.com/chart GSPTSE

3.      Financial Post, Stocks Through the Ages article, 2021