News & Resources

Market Analysis

Latest Insights
Press Releases
Latest Insights

Market Insights
When Politics Trump Economics: Bracing for NAFTA’s End

by Don Curren | January 2, 2018

Whatever else happens in 2018, it will definitely be a pivotal year for Canada, Mexico and the United States. In the next 12 months, it should become clear whether the North American Free Trade Agreement collapses or not.

If the US does terminate NAFTA – which seems the likeliest scenario at the moment – it will be a landmark event for the global economy and the world’s financial markets. The dissolution of the largest trade bloc in the world and the fragmentation of what’s essentially an integrated continental economy could trigger a wave of volatility across the foreign exchange markets, potentially sending the Canadian dollar and the Mexican peso sharply lower.

It could also have an impact that far exceeds any market volatility. In terms of lasting significance; the abrogation of NAFTA could constitute a turning point – or perhaps more accurately a “turning back point” – in the evolution of global economic integration. A decision to terminate NAFTA would be a definitive sign that the US tilt toward protectionism is substantive, and not simply rhetorical.

President Donald Trump has already engaged in explicitly protectionist gestures – the decision to walk away from the Trans-Pacific Partnership, for instance. But there’s a big difference between exiting negotiations for a regional trade deal and dismantling an agreement that’s reshaped three economies in its 24-year existence.

NAFTA is different because it’s an established fact – and one that many believe has delivered benefits for all three parties. Abandoning it would mean dissolving the world’s largest trade bloc – one that encompasses 450 million people and total trade flows of more than US$1.2 trillion a year.

NAFTA has transformed North America’s economy: since the pact came into effect in 1994, the United States has more than tripled its trade with Mexico and Canada, outpacing trade growth with the rest of the world. It underpins roughly two and half-million Canadian jobs  (or about one in five); 80% of Mexican exports are shipped to Americans, and about 75% of Canada’s.

The numbers are impressive. They’re also irrelevant, at least if you’re trying to make a case in front of the Trump Administration.

That’s because NAFTA isn’t about economics for Donald Trump. It’s about politics.

Economists and think tanks and business groups which have dutifully trotted out statistics and graphs and analysis that point to the gains accrued by the United States have been missing the point.

Trump’s antipathy toward NAFTA is clear.

It’s true, of course, that his position is highly mutable:  after his first meeting with Canadian Prime Minister Justin Trudeau in February, Trump offered up the opinion that all that NAFTA needed, at least in relation to Canada, was a “tweak.”

But, on balance, Trump’s public pronouncements on NAFTA are thoroughly negative, with criticism far outweighing more positive positioning. So negative that the New York Daily News ran a multi-page article in April entitled: “Here are All the Terrible Things President Trump has said about NAFTA — Before Deciding to Stick with it.” (At that point, after a phone call with Canada’s Trudeau and Mexican President Enrique Peña Nieto, Trump seemed more inclined to keep the trade deal.)

During the 2016 election campaign, Trump’s tone on NAFTA was decidedly negative, and his anti-trade stance seemed to resonate with his supporters. If Trump’s policies are, to a large extent, to be driven by a desire to cater to his base, then cancelling or radically revamping NAFTA would seem to be a slam dunk.

Hostility to trade agreements also is a fundamental component of Trump’s belief system. One of the ways to “Make America Great Again” is to cancel or change the trade agreements Trump sees as having undermined that “greatness.”

Many economists argue that soaring trade deficits reflect the fact that domestic savings rates are too low. Due to a number of structural issues, American consumers prefer to buy imported goods rather than save money. Lenders around the world, with their deep appetite for dollars, are willing to advance them the money they need to do that – effectively financing their trade deficits. Eliminating trade deficits with one country or another will only see them popping up somewhere else, like a global trade version of Whack-a-Mole. Trump and his advisers seem immune to that line of reasoning.

So both practical politics and basic ideology argue for the termination of NAFTA. They trump economics – even the rarely discussed fact that NAFTA has lowered prices for consumers in such key sectors as food, automobiles, clothing and electronics.

The “progress” made in the five rounds of negotiation that have been completed so far seems to have been fairly trivial.  There’s been no indication of headway on US demands, with both Mexico and Canada standing together in opposition against a number of proposals  – among them a regular five-year review of the agreement, and the removal of the bi-national dispute settlement process for challenging Antidumping and Countervailing Duties measures.

Two more rounds of talks are scheduled for next year.The US trade negotiators’ willingness to pursue negotiations for so many months seems to belie suspicions that their ultimate desire is to torpedo the talks.

But….persisting with negotiations although you intend to ultimately sabotage them may be a strategic move – it allows you to blame the intransigence of the other parties involved for the collapse of the talks.

Another factor suggesting the US will elect to abandon NAFTA – Canada and Mexico need the US economically much more than the US needs them.

What will happen if the scenario takes place in the New Year? It won’t be the economic equivalent of the Zombie Apocalypse, but what it will look like is really hard to say.

The dissolution of NAFTA would be virtually without precedent and would be one of the most consequential acts in the history of global trade. The consequences – particularly the unintended ones –could be massive.

Some argue that the framework would revert to the FTA (“Free Trade Agreement”), a bilateral arrangement that governed the relationship between the two countries before the creation of NAFTA. But that’s far from a unanimous view. With the dissolution of NAFTA, North America truly moves into the economic equivalent of “terra incognita.”

This means that trying to extrapolate the impact on tariffs and trade volumes could prove fruitless – and certainly isn’t going to provide hard-and-fast answers about what will happen. Some analysts have pointed to the fact that the increase on tariffs on Canadian exports will amount to about US$4.2 billion, a tiny amount compared to the US$278 billion in goods that Canada shipped to its southern neighbor last year – but this assumes that World Trade Organization rules – not the FTA’s – go into effect after the cancellation of NAFTA.

Changes in consumer and business confidence – combined with abrupt changes in exchange rates after the cancellation – could be far more shocking for the three economies.

An attention-grabbing report from Goldman Sachs earlier this month – which was premised on the assumption the revocation of NAFTA is almost inevitable – said the Mexican peso could fall by about 10%, if uncertainty about the fate of the agreement intensifies.

Goldman says the Canadian dollar is somewhat less vulnerable as cyclical factors and monetary policy have overshadowed NAFTA-related uncertainty – but this could also be construed as a potential negative for the loonie if it reflects an ill-justified level of complacency on trade-related risks.

It may be hard to pin down the details of a post-NAFTA world – or even the details of how we get there -but investors, households and businesses with currency exposure would be well advised to brace themselves for a rise in market turbulence.

Don Curren

To receive our weekly market insights, breaking market wires and research reports direct to your inbox subscribe!  

“Cambridge Global Payments” is a trade name, which in this document refers specifically to one or more of these legal entities: Cambridge Mercantile Corp., Cambridge Mercantile Corp. (U.S.A.), Cambridge Mercantile Corp. (Nevada), Cambridge Mercantile (Australia) Pty. Ltd.

Cambridge Global Payments (“Cambridge”) provides this document as general market information subject to: Cambridge’s copyright, and all contract terms in place, if any, between you and the Cambridge entity you have contracted with. This document is based on sources Cambridge considers reliable, but without independent verification. Cambridge makes no guarantee of its accuracy or completeness. Cambridge is not responsible for any errors in or related to the document, or for damages arising out of any person’s reliance upon this information. All charts or graphs are from publicly available sources or proprietary data. The information in this document is subject to sudden change without notice.

Cambridge may sell to you and/or buy from you foreign exchange instruments (including spot and/or derivative transactions; both kinds are here called “FXI”s) covered by Cambridge on a principal basis.

This document is NOT: 1) Advice of any kind, or 2) Approved or reviewed by any regulatory authority, or 3) An offer to sell or a solicitation of an offer to buy any FXIs, or to participate in any trading strategy.

Before acting on this document, you must consider the appropriateness of the information, based on your objectives, needs and finances. For advice, you must contact someone independent of Cambridge.

Certain FXIs mentioned in this document may be ineligible for sale in some locations, and/or unsuitable for you. Contact your Cambridge representative for further information regarding product availability/suitability before you enter into any FXI contract.

FXIs are volatile and may cause losses. Past performance of a FXI product cannot be relied on to determine future performance.

This document is intended only for persons in Canada, the US, and Australia. This document is not intended for persons in the UK or elsewhere in the EEA. In Australia, this publication has been distributed by Cambridge Mercantile (Australia) Pty. Ltd. (ABN 85 126 642 448, AFSL 351278); for the general information of its customers (as defined in the Corporations Act 2001). This entity makes no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law.

Fees may be earned by Cambridge (and its agents) in respect of any business transacted with Cambridge.

The document is intended to be distributed in its entirety. Unless governing law permits otherwise, you must contact the applicable Cambridge if you wish to use Cambridge services to enter a transaction involving any instrument mentioned in this document.

© Copyright 2018, Cambridge Mercantile Corp., ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of Cambridge Mercantile Corp. See www.cambridgefx.com for contact details.