Once upon a time, the world looked simple. As long as economies were undisturbed by the whims of politicians, people thought the pie would grow to everyone’s benefit. Politicians, for their part, used to go along with this. The hands-off approach to managing the economy was known as the Washington Consensus and investors liked this approach. It’s hard enough trying to figure how economies work, no one wants to have to second-guess politicians.

Alan Greenspan, the former Chair of the Federal Reserve (Fed), went as far as to say “it hardly makes any difference who will be the next president” regarding the 2008 campaign. It would be a surprise to hear the Fed chairman say that now.

Voters, in many countries, no longer buy this story. Inequality has risen and they want politicians to intervene. The problem is, politicians tend to be seduced by easy solutions and don’t like to talk about the costs. With the aim of getting elected, they ignore the unintended consequences that their policies can create.

Take the recent US-China trade war. About trade deficits, President Trump will often claim something like “Asian countries have been ripping us off for years” and “China has been killing us”. He implies that trade deficits need to be stopped at all costs. The solution? Make Chinese goods more expensive by slapping tariffs on them. Simple, right?

Not necessarily. In 2009, the Obama administration tried to apply tariffs on tyre imports from China. American chicken farmers were hit when the Chinese targeted them by banning chicken feet imports (a delicacy in China). One study found that, for all this trouble, the tariff preserved only 1,200 jobs. But Americans had to spend an extra US$1.1 billion on tyres – almost US$1 million per job!

The bottom line is that tariffs are not the sure thing that they are being sold as. They may come with benefits – after all, who doesn’t want to preserve jobs? But they also come with costs, mostly hidden – no one thought of the chicken farmers!

Politicians will always like to sweep costs under the carpet. But now the electorates want politicians to ‘do more’. This is a recipe for easy-sounding but costly policies. Going forward, investors will have to think hard about what promises politicians make and prepare for more policy surprises and shocks. The Brexit referendum and its aftermath or US tariffs on China could just be the start.

The result could be higher market uncertainty for the foreseeable future. The story is not all negative but the range of possible outcomes is getting wider. Since the referendum, for example, UK companies exposed to foreign markets continue to make money. But at the same time, companies with the biggest exposures to the UK haven’t done so well – the difference between the two sets of companies is not usually so stark. In this world, it still pays to stay invested and it’s even more important to remain well diversified.

 


This post was created for the DISCUS website by Ahmer Tirmizi at 7IM (Seven Investment Management). You can find out more about their investment services here ›