Trump trade war Great Depression similarities, Morgan Stanley sees economic slowdown

Thomas
Peter/Reuters

• As President Donald Trump’s trade war ramps up further,
  Morgan Stanley just said the protectionist behavior being shown
  right now reminds them of the conditions surrounding the Great
  Depression of 1929.
• Morgan Stanley is also worried about the negative
  effect the trade war will have on foreign direct investment, a
  slowdown in which could crush global economic growth.

President Donald
Trump‘s latest attempt to strong-arm China appeared to
fail on Thursday, as the nation’s Ministry of Commerce dismissed
the US president’s threats as a “carrot and stick” tactic.

The latest back-and-forth weighed on markets globally, and
renewed concerns that the ongoing struggle will be a huge drag on
economic growth worldwide.

Morgan Stanley, one of many
global financial leaders warning of the potential fallout, went
as far as to evoke the Great Depression of 1929 in a
recent note to clients. The protectionist culture permeating
trade behavior reminds them of the downward spiral that worsened
the massive economic meltdown that rocked the US economy almost a
century ago.

The story goes like this: Following World War I, the US raised
duties on agricultural products in response to a steep decline in
exports. That tariff then spurred what Morgan Stanley calls an
“avalanche of protectionist punches and counter-punches,” which
created a more insular international situation ahead of the Great
Depression in 1929.

Then, in 1930, the US enacted the Smoot-Hawley Act, which raised
tariffs on more than 20,000 imported goods. The extreme measure
“likely deepened” the Great Depression, Morgan Stanley says.

And while Morgan Stanley admits the two situations aren’t quite
yet completely analogous, it argues that trade conflicts are a
slippery slope. They can have drastic and unforeseen consequences
if left unchecked.

Even if the current trade battle doesn’t go quite that far,
Morgan Stanley is still very worried about the effect it will
have on foreign direct investment (FDI). It finds that,
throughout history, FDI — which gauges the willingness of global
corporations to invest across geographies — has closely tracked
the pace of worldwide trade.

Morgan Stanley

“Since 1980, global investment has moved in conjunction with
global trade growth,” Morgan Stanley strategists wrote in a
recent note. “The impact on corporate investment could
meaningfully change the trajectory of the late-cycle economic
recovery. Direct investment, a critical element of global
growth, and large-cap market leaders may be more vulnerable to
trade tensions than investors assume.”

As if the immediate threat to the world’s economy wasn’t bad
enough, Morgan Stanley also warns against possible weakness in
equity markets. The firm notes that the 20% of the S&P 500 most vulnerable to trade
disruptions carry a disproportionately big weighting in the
benchmark.

This heavy reliance could create a potentially disastrous
scenario if margins start to get squeezed by the tit-for-tat of a
trade war.

“Companies most vulnerable to protectionism also have profit
margins that exceed the least vulnerable by more than 4%,” said
Morgan Stanley. “At a time when investors are already worried
about peak margins amid higher labor and commodity costs, this
represents an additional risk to margin leaders.”