With one stroke of the pen, President Trump (the “Trumpinator”?) most likely signed the death sentence of the Department of Labor’s (DOL) implementation of the so-called fiduciary rule, which would have required investment salespeople to act in their clients’ best interests with their retirement accounts. We understand if you are surprised that such might not already be the case.
From a regulation standpoint, what separates investment advisers under the Advisers Act of 1940 (like Bristlecone) from brokers (sales-based registered representatives of brokerage firms and insurance agents) is the fiduciary standard—the very same standard that applies to trustees. Practically, and as we note on our website (Why Bristlecone?) – there is a higher level of ethical responsibility for investment advisors than for brokers. As sales-based employees, brokers act as agents and typically need only to find investments that are “suitable,” whereas registered investment advisers are required to be diligent in pursuing the client’s best interests.
This distinction is significant: an investment could be suitable but not necessarily in the client’s best interest. For instance, certain types of annuities, life insurance, and mutual-fund share classes carry inordinately high built-in commissions paid by investors, much of which are used to compensate the broker. They might be in line with an investor’s needs and risk tolerance, yet if appropriate alternatives with lower commissions are available, a fiduciary is required to use these cheaper options. A broker held to the suitability standard is not.
Bristlecone is proud to uphold the higher standard, and it was one of the main reasons for starting our firm almost 13 years ago. Indeed, we agree to it in writing when you hire us. On the other end, Wall Street continues to be hypocritical: a recent report from the Consumer Federation of America noted that brokerage firms market their sales people as trusted “financial advisors” to the public, while claiming in legal filings with the DOL (opposing the fiduciary rule) that “broker-dealer reps and insurance agents are not true advisors because they do not actually provide unbiased advice and are not engaged in relationships of trust and confidence with their clients.”
As much as we believe in the rule, being a fiduciary is not just about regulations or labels. It is about placing your clients’ interests ahead of your own. For investors to better judge whether this is the case, advisors should be totally honest about compensation, and disclose clearly how they are getting paid and how much their services cost. Additionally, since every financial relationship has the potential to create conflicts of interest (for a humorous take on this: “Imagine if everyone in the world had a fiduciary duty (…),” advisors must not only identify and disclose such conflicts, but also have the character to avoid them as much as possible. To quote Seth Klarman, the famed value investor, being a fiduciary is “about the sacred trust of managing clients’ money, not about how we can make more for ourselves.”
Trade Deficits: Do they matter?
One consistent theme from President Trump’s campaign was that the United States is “losing” at trade, and trade deficits are the evidence. “Mexico has taken advantage of the U.S. for long enough. Massive trade deficits & little help on the very weak border must change, NOW!” Trump tweeted. The US President is not the first politician nor the only one to claim that trade deficits are inherently bad, and that they are caused by “bad deals” such as NAFTA. To stop shipping American jobs abroad, presumably the answer is to negotiate better with our trading partners, and raise taxes on imports. These speeches clearly resonated across a large portion of the electorate on both sides.
Never mind that there is plenty of evidence showing that free trade has benefited Americans overall(and foreigners) by creating jobs and raising incomes around the world. Clearly, it has not worked out for every industry and some US workers have suffered. But the reasoning behind the solutions proposed remains misguided. A better framework would replace the focus on trade balances with an understanding of global trends in saving versus spending.
To illustrate, and looking at Germany or Switzerland—countries with large trade surplus, one might wonder how it is possible that despite a strong currency, high wages, and high taxes, they manage to sell more goods to the rest of the world than they buy. The answer is counter intuitive: trade balances have little to do with trade policies. A nation’s trade balance is determined by the flow of investment funds into or out of the country. And those flows are determined by how much the people of a nation save and invest—two variables that are only marginally affected by trade policy.
To understand why, we need to review the basics: The 1st concept to understand is that of the balance of payments between two countries: It measures the value of all transactions between the two (goods, services, investments, cash…), and by definition, it equals zero. The balance of payments is divided in 2: the current account, and the capital account.
The current account measures the flow of goods, services, investment income, as well as some other smaller items. Within the current account, the trade balance measures the flow of goods and services. Using Mexico as an example, the US has a deficit of about $58 billion in goods traded (which President Trump referred to), but has a $9 billion surplus in services traded. Net, the trade balance is $49 billion out of a total of $584 billion (worth noting is that Mexico, like the US, has a trade deficit with the rest of the world despite the surplus with us).
Next, the capital account tracks the buying and selling of investment assets such as real estate, stocks, and bonds. The flows in the capital account tend to be much larger and react much faster to changes in policies, taxes, and other factors. Now, remember: since the balance of payments always equals zero, the surplus in the capital account of one country equals the deficit in its current account, or to simplify:
(Investment – Savings) = (Imports – Exports)
Consequently, countries that buy more goods than they produce (US, Mexico…) will receive more capital from the countries that save more than what they can invest within their borders. On the other end, countries like Switzerland or Germany, with high savings and fewer investment opportunities, have no have other alternatives than investing in US stocks, bonds, or real estate.
The reality is that the German or Swiss surplus is not the result of a deliberate trade policy. Rather, it is the consequence of various factors, such as the propensity to save, a specialization in producing certain type of goods, and an ageing population with little immigration. These result in a tendency of these countries’ companies and individuals to invest abroad, as future economic growth is expected to be more dynamic outside of their borders. To prove this point, following the reunification of West and East Germany, the combined trade surplus shrank for several years as the country invested a lot of money within its borders.
The bottom line is that American trade deficits are largely the result of some of the world’s major trading nations’ unwillingness to spend more within their borders combined with American willingness to sell claims on its future income to foreigners.
This relationship explains why protectionist policies such as import taxes won’t cure the US trade deficit. The tax will indeed make import more expensive, and might reduce them for a short period. But then, fewer imports will mean a smaller supply of US dollars flowing back to currency markets, while the demand from countries with excess savings will remain the same. The effect will be to raise the value of the US dollar relative to our trading partners’ currencies. It will make US exports less attractive and imports cheaper to US consumers and businesses until the trade balance matches the savings and investment balance. Raising import taxes only achieves two things: raise prices of the goods that are taxed, and increase the value of the dollar. It won’t affect the trade deficit.
What should the US government do then? Unfortunately, there are no magic bullets. It requires a diverse and coordinated set of policies which will take time to play out. Domestically, it could do more to encourage savings and business investments, while discouraging consumption and borrowings that finance it. And since government debt is sucking the biggest share of US domestic savings, reducing government debt would help as well: If the US government was closer to balancing its budget, the trade deficit would go down as more American savings would fund more productive private investments at home (On the other end, the administration’s plans to increase infrastructure spending while cutting taxes are very likely to have the opposite effect and increase the trade deficit).
Additionally, instead of pressuring countries with trade surplus to revalue their currencies, and threatening them with import taxes that will have the opposite effect, our political leaders should pressure them to implement policies that would discourage savings and increase their domestic consumption. It should also pressure them to increase government spending, deficits, and debt. These would be more effective in reducing trade imbalances.
But more importantly, our point was that trade deficits are not necessarily bad, and reducing them could make us poorer. Despite record trade surpluses, German workers experienced stagnating real wages for almost a decade from the late nineties until 2008. Trades are made by individuals, not by nations. If you buy a good from someone else, presumably, both parties received something of value, which is why the trade happened. Do you care about your trade deficit with your local grocery store? Do we care about trade deficits between Oregon and California? The idea that trade deficits between the US and Germany, or any other country, are intrinsically bad is a simplistic and nationalistic concept that has no bearing in economic reality. As long as foreign savings finance productive investments, deficits do not matter to the wealth of our country. They reflect greater investment opportunities. However, when they finance excessive consumption, housing bubbles, and wasteful expenditures, trade deficits lead to painful economic re-adjustments.
The only way to increase wealth and incomes around the world is by specializing and increasing productivity. This can only be achieved if we allocate our resources to their most efficient use. This in turn requires businesses and individuals to be free to invest and trade across the world. Government does have an important role in helping those negatively affected by globalization and technology. Preventing everyone else from enjoying the benefits of free trade is counter-productive.