What’s Next For Markets, Economy (Uncut) 02-06-2025

China Retaliates Against Tariffs: What’s Next For Markets, Economy | Gary Shilling

If you look at total investment flows, dollar transactions, both trade and investment, 88% of them involve the U.S. dollar. 88%. Now, what else is left? I mean, that says you’ve got 12% that’s the euro, that’s the yen, that’s the won, you name it.

But the rest is a dollar-worthy action. How would the trade war affect markets and investors alike? What’s in store for 2025? How do we hedge against volatility? These are the themes of our conversation with our next guest, Gary Shilling, president of A. Gary Shilling & Co. Welcome back to the show.

Gary, good to see you again. Glad to be back. Thank you for being back.

Let’s start by talking about the big news items of the week. Trump’s tariffs put on pause with Canada and Mexico for at least, in the case of Canada, for 30 days, while they’re working out the terms of Canada, upping their border security, having a SAR for fentanyl, and having a joint task force to fight the cartels, among other conditions. But just today, on the 4th of February, China retaliates.

If you look at my screen here, China is retaliating with an additional tariff of up to 15% on select U.S. imports starting February 10th. And so it looks like while Canada and Mexico are coming to the negotiating table, China not yet. The markets took the initial news of implementing tariffs earlier in the week pretty badly, but today there’s been a bit of a bounce, a bit of a recovery.

Do you think the, first of all, do you think the scare and the worry of tariffs is over for now, for market participants? No, I think the uncertainty in terms of the whole trade wars is what has developed, is what is of great concern to investors. Usually, investors, as long as they know what’s going to happen, there’s a certain amount of adaptation to it. But when you don’t know what’s going to happen from one day to the next, I mean, for example, yesterday, it looked like Trump wanted to eliminate the Department of Education.

That’s part of what Musk is doing to try to cut government employment, government, government. Today, you’re not so sure. So I think the uncertainty is a big issue.

And Trump, really, he’s a master of uncertainty. I think he revels in the idea of keeping people off balance and creating a certain amount of uncertainty. And of course, as President of the United States, he has a tremendous authority to do that.

Now, in this period of tremendous volatility, how does one position himself in terms of asset classes? All you can say is that you don’t know when this is going to settle down. I mean, Trump has got trade wars going on with Canada, with Mexico, with China, and possibly the EU. And these things sort of blow hot and they blow cold.

And there doesn’t seem to be a systematic pattern of going after one and then the other and so on and so forth. Now, he did have that blow up with Colombia. But the Colombians very quickly backed down and said they’d take a lot of these illegal immigrants to the US from Colombia back.

And that seems to have solved that one in a hurry. But Colombia is a pretty small player on the international scene. But maybe if you’re a coffee addict, it makes a difference.

But other than that, I’m not sure it does. But in any event, I don’t think that Trump has shown a distinct pattern as to who he’s going to go after and in what order. But I think the point is that when you’re in a situation of where you’ve got excess supplies in the world, we’re in an excess capacity world.

We’re in a period of too much supply. And in those circumstances, it’s the buyer that’s got the upper hand, not the seller. And the US is the buyer and the rest of the world pretty much is the seller.

And I think Trump understands that. And that gives the US, not only because of its size, but also because the US is a buyer, tremendous power. And of course, the way we’re structured in this country, when you go to school, they basically tell you you’ve got three branches of government.

You’ve got the legislature that makes the laws, the administration which enforces them, and the Supreme Court interprets them. Well, that’s not the case. You look at federal government spending as a percentage of GDP, it’s about 25%.

So this gives the federal government tremendous power in terms of the US economy for the world. And that’s what Trump is exercising. Well, do you think the US consumer will continue to have the upper hand this year? In other words, what’s your recession outlook? What’s your outlook for economic growth and strength? And ultimately, whether or not the US consumer will be able to withstand higher prices on select items because of tariffs? Yeah, that’s a good point.

And that remains to be seen. Obviously, we’re still pretty early in the year. We’re here we are in early February.

And you don’t really know how this is going to play out. So far, consumer spending has been fairly strong. Unemployment has been fairly strong.

You haven’t seen any kind of really negative effects that suggest that there is a necessity of the Fed dramatically cutting rates or dramatic fiscal stimulus. So at the moment, it gives administration a lot of power to do what they want because there isn’t much, in a way, of pushback from consumers. Now, it remains to be seen if we start to see a big inflation because of Trump’s actions and retaliation from abroad.

It’s a two-sided coin. And you get another bout of inflation. That could be a real signal to consumers and make them start to express their concerns.

And that could act as a limitation on what the administration does. But we haven’t seen that yet. Do you think that inflation is an actual risk for consumers? I ask that because the last Trump presidency, 2017 to 2021, was not met by significant inflation when he implemented tariffs, except for the period of COVID-19.

But that has really nothing to do with tariffs itself. So what about this time? Well, the thing about inflation, as we’ve seen, is it’s not so much the rate of increase. Now, as an economist, I’m always looking at the rate of increase in prices.

And that’s the same with the Fed and the administration. But the consumers, after you’ve had a huge increase, and you’ve had about a 30% increase in average prices since the pandemic, and they haven’t retreated. And that’s what people remember.

They remember what they paid earlier for a box of washing soap or whatever. They remember what they paid for a dozen eggs. And those prices have not retreated.

So it’s not only the rate of increase, but it’s the jump. And the fact that that hasn’t gone away, which I think is what’s really bothering consumers now. Of course, we haven’t had any big surge of inflation in recent months.

But if we were to have that again, I think it’d be interesting to see whether consumers’ memories for the last couple of years would be now in revived, but intensified. And you really see a lot of pressure to try to do something about inflation. And that obviously would have to do with fiscal and monetary policy.

Yes. What was interesting to me was the incredible volatility of not just stocks, but currencies. The DXY spiked dramatically immediately on the news that there would be tariffs.

And then immediately after the news came out that there were tariffs on POS, it came back down. If you take a look at my screen here, Gary, let me show you what I mean here. This is the dollar index.

And, you know, you typically just don’t see currencies move like this. In the last month, you see this is when tariffs were initially announced on the 2nd of February. And then when it spiked up from 108 to 109.8, almost 110.

And then it came back down. You know, this is… What do traders and investors like do in this situation? Because we don’t know which policy measures will be… Well, we’re along the dollar and have been. But that’s a long-term position.

And a lot of it has to do with the fact that, you know, the U.S. is a leading economy. The dollar is the global currency. And it’s the place that people go in times of difficulty.

And so we have long dollar positions. And that’s a chronic situation with us. But let me just say this in terms of the dollar.

You know, it’s one thing for investors, and particularly anybody with a short-term orientation. I mean, how do you deal with a situation where you get this that we’re seeing in this graph you got on the screen, volatility? And then even more so, suppose you’re a business that’s selling or involved in international markets, and you see this kind of volatility in prices. I mean, you can’t change your selling prices of your exports or deal with import competition fast enough.

So that’s really the tough situation. Investors, even if you get it right, it’s relatively straightforward. But if you’re in business, well, that’s a different story.

Can you just elaborate one more time on why you’re along the U.S. dollar as a strategic position? Yeah, it’s several reasons. One is the U.S. is, the dollar is a global currency. And that’s where people go globally in times of uncertainty.

They go to the dollar. They go to the strongest currency. And also, if you look at the trade situation and the investment situation, there’s no alternative.

If you look at total investment flows, dollar transactions, both trade and investment, 88% of them involve the U.S. dollar. 88%. Now, what else is left? I mean, that says you’ve got 12% that’s the euro, that’s the yen, that’s the won, you name it.

But the rest is trivial. The dollar is where the action is. So you’re also long Treasuries then? Yeah.

Okay. Are you concerned about a risk on appetite this year for 2025, which could prompt a sell-off for Treasuries, assuming that Treasuries and stocks are inversely related for this year? Well, you’ve got to be concerned about that. But again, what’s the alternative? Remember, all these things, there’s always two sides of any transaction.

And if somebody says, I don’t want Treasuries, what does it mean they want instead? They want a whole currency? I don’t think they want a whole lot of other currencies, euro or won or yen or whatever have you. So there are always two sides to any financial transaction. And if people don’t want to hold the dollar, what do they want to hold in place? Now, it can’t get tremendous volatility in the dollar.

And central banks are probably more important than anybody else in determining that. And they do have a habit of trying to keep currencies relatively stable. And we’ve seen that historically, where way back in 1985, the dollar was very strong and the central banks decided that enough was enough.

And so they started dumping the dollars and knocked it down considerably. That’s a long time ago, but you do get those periods occasionally. But I would say it’s the central banks that are the biggest determiner, other than sort of the random noise in terms of the dollar.

The trade war, will that prompt, do you think, will that prompt an escalation or an acceleration of de-dollarization, especially from the BRICS countries, Brazil, Russia, India, China and South Africa? Which is to say, once the trade war kicks into high gear, if it does, other countries will dump the dollar in favor of, I don’t know, another basket of currencies perhaps, or another common currency, a de facto reserve currency of the world. Do you see that on the horizon this year? Oh, I think quite the opposite. I think the trade war, that’s the favor of the dollar.

Again, it’s a safe haven. I mean, can you imagine, if you’re looking at a trade war, and you don’t want to, and you have no idea what’s going to happen, you’re going to rush into the sledge burner? Probably not. It’s just limited possibilities, and I don’t think any of them really are attractive relative to the dollar.

I mean, the strength of the dollar is not, and I don’t mean to sound chauvinistic about this, and it’s not an unmitigated advantage, because it means that who has privilege, that it really, we as a country take advantage of in terms of the dollar. We can run trade deficits, and current account deficits, and nobody else can. And there’s virtually no discipline there from international markets.

So this is not an unmitigated blessing, but it is reality. Sure. And how do you feel about precious metals? Gold today, for example, hit a new all-time high as investors, according to Reuters, flocked to safe haven assets amid tariff war.

Is gold one of the plays? Yes. And the reason is because there’s so many forces that can push gold around and do over time. I mean, your graph there is showing a period of gold increases, but I would remind you that gold had a big jump in the early 70s, and then for 20 years, the price in current terms, not in real terms, was literally flat.

But gold is affected by trade wars. It’s affected by shooting wars. It’s affected by international currency movements.

There’s a lot of forces, and a lot of times, they just seem to cancel each other out. You don’t get clear directions. Occasionally, you do in precious metals, but I’m not smart enough to figure those out.

Right. And how do you feel about energy, oil in particular? Now, oil is used as a bargaining chip amidst the trade war as well. And as you know, Trump’s administration wants to produce more oil.

These forces, what does that mean for your outlook here? Well, oil is pretty important, but it’s not the most important thing. I mean, we put a lot of emphasis on it. I’ll just give you an interesting story.

Many years ago, I was working for what was then Standard Oil New Jersey, now Exxon Mobil. And one of the directors raised the question as to whether energy wasn’t the key to economic development. So given the structure of the company at that point, when a director raised the question, boy, a lot of us really jumped.

And we spent a tremendous number of time concocting a model of a country that was really modeled after Colombia in South America in terms of what was really the driving force of development. And was it energy? What was it? What do you think it was? What do you think it was? Take a wild guess. 30 bucks? Oh, no.

What was the driving force of economic development? It must have been industrial production, probably. Educated workforce. Educated workforce.

You look at two countries, contrast Brazil with infinite natural resources, and a government that sort of functions and sort of doesn’t function. Japan, virtually no natural resources. Now, which one would you bet on? I think that’s pretty clear.

I mean, the educated workforce is a driving force in terms of economic development. And I’m not saying that energy isn’t important. But to suggest that that’s the be all and end all, I think is just completely neglecting reality.

Well, now with the Department of Education potentially being disbanded, you know, let’s tie this back to the U.S. I mean, the future of education in the U.S. Do you think canceling the Department of Education is the right move here for the future of economic growth? You know, this gets into a political issue on your view of the world. I think the reality is that, regardless of how you slice it, that the American education system is just not functioning properly. You look at all the money that’s been pumped into public education.

And of course, the conservatives say, well, it’s gone to all kinds of liberal causes and nothing to do with, can Johnny Reed, can Louise figure out mathematical problems? It’s got to do with indoctrination. The liberals would say, oh, no, you’ve got sociological disadvantages. You’re not spending enough, regardless of what you want to say.

Our education system is just not functioning properly. Now, blaming it on the Department of Education is probably simplistic. But the point is that the U.S., despite the poor education, we do have an entrepreneurial orientation.

You want to call it American exceptionalism, call it whatever you want to, but it has given us advantage that other countries simply have not shown, at least not in recent millennia. And I don’t, I’m not a nativist, I’m not a memorial American, but I’m just saying, if you look at the situation compared to other countries, when you say, where would you rather be? I think you’d rather be in this country. And finally, Federal Reserve, how do you think the Fed is going to respond to heightened uncertainty around policy decisions, around the trade war? Do you think they’ll be more inclined to be dovish, given this uncertainty? Well, you’d like to be a fly on the wall and listen to the deliberations of the Fed, because here you’ve got Trump basically saying he wants to control the Fed.

I think most people would agree that one of the huge advantages of the U.S. is that we do have a truly independent central bank. And that’s the case of a few other banks. Bank of England, I think the ECB, the major central banks I think are fairly independent, but not entirely, not to the degree of the Fed.

So the Fed has this independence, and they guard that very, very jealously and deliberately. And Trump’s comments there, I think, are unhelpful, to put it euphemistically. But the Fed, you know, so it makes the Fed, puts the Fed in a spot, because if they do something that is in line with what the administration would like to do, they say, oh, they’re pandering to the administration.

If they do the opposite, they’re saying, oh, these guys are proving their independence. It really creates a problem. I think the Fed right now is basically on hold.

They don’t have a major problem with inflation. Inflation is not down to the 2% target, but it is increasing. It’s drifting down slowly.

The economy is growing at a fairly good clip relative to potential. The labor markets are fairly stable. I mean, the Fed doesn’t really have a lot of pressure to do anything one way or the other.

And given all the turmoil that’s created by Trump and his approach, I think the Fed would probably disassume, sort of sit back and wait, and keep a lot of dry powder. If you had to, final question, if you had to short one asset in 2025, what could that be? Well, I’m not sure. Commodities.

I think we’re in a surplus world. You look at, now, we are short copper. I would say that we manage money, and the portfolios that we manage, we are short copper.

And I like copper on the short side, because copper is a good indication of global industrial production. Copper goes into almost any manufactured product. That microphone in front of you has got some copper in it.

Almost any manufactured product has copper, so it’s a very good indicator of global industrial production. And when you have, basically, a surplus world, and slow economic growth, and slow and even slowing, I think commodities on the short side are the most interesting to play in. And we particularly like copper on the short side.

Great. I appreciate you coming on the show today, Gary. Hey, well, good to be with you, and hope this interview was useful.

Well, yeah, thank you. I appreciate it. And I appreciate you coming on.

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