In this bonus episode, Ted and T3 tackle tariffs. Specifically, they discuss how the exchange of tariffs between the U.S. and China could impact the American dairy industry.
Ted cites lessons learned during the Great Depression to dispel the notion that policymakers in Washington, D.C. will let the situation get bad enough to spur a similar economic crash.
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Episode transcript
Anna: Welcome to “The Milk Check,” a podcast from T.C. Jacoby & Co., where we share market insights and analysis with dairy farmers in mind. We’re back with Part 2 of this month’s discussion. In Part 1, we discussed domestic markets and whether dairy farmers would sell out or stay in the business given the current pricing situation and given where we think prices will go between now and the end of the year. Meanwhile, pretty much any discussion of the world economy is overshadowed by the U.S. and China taking turns slapping tariffs on each other’s exports. T3, get us started. How did this start, and what will it mean for the dairy industry?
T3: Trump announces $50 billion in tariffs on China, which is I think 10% of what China exports to the U.S. China responds with $50 billion in tariffs on U.S. products which, because we export to China so much less than they export to us, amounts to about 50% of our exports to China, and so The Donald deciding that’s not good enough, announces another $100 billion dollars in tariffs on Chinese goods. But the part that nobody is talking about is none of that is supposed to take place for another six months. I believe it’s another 180 days away.
Ted: One hundred eighty days is right.
T3: So what’s gonna happen in the next six months? Well what’s gonna happen is that everybody’s gonna export as much as possible and get it across that border before the tariffs hit. So one of my concerns about what’s going on in terms of international pricing right now, is what they’re trying to do is they’re trying to beat the tariffs to the finish line, and so we’re gonna see really good exports for the next six months. Ironically, even if the tariffs don’t come to pass and there’s some kind of a settlement, what’s gonna happen is everybody’s hurrying up now to make sure they’ve got good inventories before the tariffs hit and then whether they pass or not, six months from now we’re probably gonna have a period of about six months where exports are pretty darn poor because of all this rhetoric that’s going on today.
Ted: Let’s look at it this way. Forget China a minute and let’s talk about Mexico, which is our biggest trading partner. Let’s suppose that the Mexicans dig in their heels and they say, “We’re not gonna buy anything from the United States,” okay? First place, I wanna say they’re not gonna do that because if there’s a quarter of a cent difference, they’re gonna buy from wherever it’s a quarter of a cent is saved. It doesn’t make any difference where it is. Mexicans buy on price and price alone, okay? But anyway, let’s just say that the Mexican trade is shut off and it’s over. So does that mean all of the sudden, that we’re gonna eat all that to business? No. If the Mexicans go out and they choose to buy cheese from Europe, well, Europe’s obviously abandoning some of their markets to sell to Mexico and we’re gonna wind up selling our cheese somewhere else. Now is it pain-free? No it’s not. There may be a few cents a pound cheese difference as all this shuffling occurs and you lose the efficiencies of just going to the neighbor, but it doesn’t mean that all of the sudden exports disappear. What it means is, is that you have to reshuffle who’s selling who. A good example of that is the Russians. We got into a tiff with the Russians and we embargoed them, and they said, “That’s terrific, we’ll use it to develop our own dairy industry,” which is what they’re actually doing over there. Then the Europeans weren’t selling them anything, and then we wound up selling certain customers. The Russians wound up buying it from Belarus and so on, and so you had this reshuffle as to where they’re buying what. So as far as dairy is concerned, there may be some minor price issues that arise, but they’ll be minor, they will not be major.
Now, I want to point out that dairy is one thing and auto parts are another. You don’t have that same synergy in auto parts. If you’re making widgets to put into Chryslers, you’re not gonna be able to get those same widgets in Australia that you were getting in Chihuahua. So, it’s a different phenomena there. If you’re buying airplanes and you decide you’re gonna have a fight with Boeing, you’re probably gonna go to Airbus and I don’t know whether any other alternatives are out there, so it’s a different syndrome in that industry. But as far as dairy is concerned, just because we have a big fight on trade doesn’t mean that the dairy industry is gonna be affected in any sort of fatal way. Given the problems that we’ve had with Canada and Mexico, it doesn’t bother me that we’re gonna get in there and try to hammer out some agreements to keep ’em from cheating. Now if they wanna throw out the babies with the bathwater, you know, maybe something like that could happen, but I sorta doubt it. I think that negotiation is likely fruitful and I think it’s a good thing to have it than not have it. And if we wanna say that, you know, with regard to China that part of the discussion is intellectual property rights, good discussion to have. And if we can put it to bed fine, if we can’t put it to bed, it’s still a good fight to have. So, that’s the way I’m looking at that.
T3: Let’s step back and look at it from a 30,000 foot level. The economy, right now it seems to be going pretty well, but how long is that gonna last? I’m very concerned that it’s gonna have trouble lasting beyond the middle of next year.
Ted: 2019.
T3: 2019. We already see a stock market that’s hesitating a little bit for lack of a better word, but the reason I’m very concerned about a pullback going into 2019 is we already have an unemployment rate at 4% and we seem to be acting like we need to increase employment in this country when our unemployment is 4%. So what’s gonna happen? You’re not going to see a change in unemployment at 4%. What you’re gonna see is an increase in wages. Increases in wages have domino effects that are never as good as people want to believe they are. Prices go up across the board, it causes inflation to go up, it causes interest rates to go up. The next thing you know, you’ve got an inflation rate that’s increasing faster than compensation and salary rates. We’re already seeing that kind of a problem in freight alone, which is having probably a much bigger effect than most people realize. My concern is that our economy as a whole is gonna start overheating right about the time that we’re starting to come to grips with the fact that we really do have too much milk in the U.S., in Europe, and in Oceania next year, and then things could get really ugly. They could be okay the second half of the year. We could have $16.50, maybe. Maybe we have $17.50. I don’t think we’re going to $20 a hundred weight in 2018, and then we get into 2019 and we already gotta look to the downside rather than to the upside because we start losing that demand we’re so hopeful about. That is my biggest concern right now. I think the next three to nine months could be pretty good. Not great, pretty good. But I’m worried that we’re gonna top out at a number that doesn’t put equity back into the farmers’ pockets, and then we’re gonna go lower again and then things could get really ugly.
Ted: I think you’re much too bearish in that regard. First of all, I don’t think the timing is right. I agree with you that inflation is an issue going forward, but it’s gonna be measured in decades and not months, and I think that the debt that we’ve accumulated is gonna be paid by inflation, you know, by depreciated dollars if you wanna look at it that way, but that cycle already started with the increase in the hauling rates which began a couple of years ago. You know, we now have our hauling rates more than 50% higher than they were say in 2014 or 2015, somewhere in that area. Of course, that comes out of the dairyman’s pocket. You know, the cycle that generates the kind of inflation you’re talking about would be four or five years before it gets to the point where it gets to a destructive inflation in terms of wage rates and milk pricing. I feel that the economy will heat up and continue to heat up, you know, and I’ve read some of the reports, which I think you’ve read, that 2019 we’re gonna have a crash. Not gonna buy into that at this point. Gonna take a heck of a lot of things, it’s gonna have to be Smoot-Hawley all over again to cause a collapse and I don’t see that coming. The Smoot-Hawley Tariff Act is what caused the 1929 market crash. In a fit of righteous protectionism, they virtually eliminated international trade to try to protect our own markets and so now that’s why everybody’s worried about exports is because they figure it’s gonna be Smoot-Hawley-Trump and I’m arguing that ain’t gonna happen. Everybody who’s been educated in the history of The Depression is aware of the risks involved in suddenly cutting off trade, and I’m very sure that all our politicians are sitting there biting their nails over that very issue.
T3: Yeah, the Great Depression basically occurred for two reasons, because of increase in protectionism which increased the cost of goods, combined with a desire to reign in the dollar rather than let it go, and so it caused prices to go up and compensation to go down at the same time. It was government economics at its very worst.
Ted: Yep.
T3: And that’s a lesson that I do think we learned pretty well.
Ted: Everybody learned that lesson pretty well, but they’ll figure out a different way to screw it up.
Anna: If no one has anything else to add, let’s close up here and we’ll be back next month. We welcome your participation in The Milk Check. If you have comments to share or questions you want answered, send an email to podcast@jacoby.com. Our theme music is composed and performed by Phil Keaggy. The Milk Check is a production of T.C. Jacoby & Co.
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