Deputy Chief Economist
Head of U.S. Economies
BMO Capital Markets
Ben D. Jones
Managing Director, Intermediary Distribution
BMO Global Asset Management
Product Strategy Manager
BMO Global Asset Management
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In November of 2018, the United States-Mexico-Canada Agreement, also known as USMCA, was signed as a show of intention to replace NAFTA. What does this potential new trade agreement mean for markets, both domestically and globally? And what impact will it have for your clients?
Our guest this episode is Michael Gregory, Deputy Chief Economist for BMO Capital Markets. We discuss the importance that trade agreements, historically with NAFTA and looking forward to USMCA, have on North American economies, including the sectors that benefit the most from these agreements. Plus, Michael discusses the impact that USMCA may have on investors and advisors.
In this episode:
- A look back at how NAFTA started
- Why did the U.S. want a new agreement?
- What we might expect in the future with USMCA
- How does this new trade deal affect portfolios?
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President Trump – We’re gathered together this afternoon for a very historic occasion, the signing ceremony for a brand new trade deal, the United States Mexico Canada agreement. So important. With our signatures today, we will formally declare the intention of our three countries to replace NAFTA with the USMCA, a truly groundbreaking achievement modern day agreement.
Emily Larsen – That’s C-SPAN audio from a press conference in November 2018 at the G20 Summit in Buenos Aires. Today, we’ll be exploring the story from the beginnings of NAFTA to the USMCA, as well as what it means for advisors and financial markets. That November signing might sound like the end of the story but it’s really just the beginning.
Ben Jones – Welcome to the Better Conversations. Better Outcomes. presented by BMO Global Asset Management. I’m Ben Jones.
Emily Larsen – And I’m Emily Larson. On this show, we explore the world of wealth advising from every angle, providing actionable ideas designed to improve outcomes for advisors and their clients.
Disclosure – The views expressed here are those of the participants and not those of BMO Global Asset Management, its affiliates or subsidiaries.
Michael Gregory – My name is Michael Gregory. I’m the Deputy Chief Economist and Head of U.S. Economics for BMO Capital Markets. Basically, I try and figure out what’s happening in the North American economy, both United States and Canada, and what that means for interest rates, what that means for currencies. Hopefully we can tell our customers where they should be positioned in the face of what potentially may be coming down the road.
Ben Jones – Michael and his team have spent a lot of time examining the cross-border impacts of NAFTA and the USMCA. Today, he’s going to guide us through what you need to know about those agreements. We’ll discuss how NAFTA started, why the U.S. wanted a new agreement, what happened over the course of the last year, and what we might expect in the future. We believe that you can apply what you learn today with your clients and their portfolios as this trade deal will have far-reaching impacts, not just for North American financial markets but also across the world.
Emily Larsen – We caught up with Michael in Toronto, Canada.
Michael Gregory – We’re in First Canadian Place, which is the headquarters for the Bank of Montreal, globally. It’s right smack dab in downtown Toronto. This technically is actually the tallest building in Canada, but it actually has fewer floors than the one across the street because they decided to dig down for that one, so it starts further down ground. We’re a little bit higher but they’ve got more floors.
Ben Jones – Now, tell me about your story, how did you end up getting into economics and ultimately your role here at BMO?
Michael Gregory – I think what really wetted my appetite for economics was — it’s kind of funny. I used to go grocery shopping with my parents, and I would just be amazed that people would go into grocery store; they have a little bit of money to spend, and somehow they’d come out with products in these carts. No one’s telling them what to buy. Producers aren’t being told what to produce, yet somehow magically this all just happens. I was so fascinated by that. Originally, I started to study just business, commerce. I took a few economics courses as every commerce student has to take. I go, I really like this. So, I quickly finished the undergraduate degree in commerce and then went to graduate school for economics.
Ben Jones – I like that. How did you end up at BMO?
Michael Gregory – Well, I started off at some other Canadian banks but eventually moved down to Lehman Brothers in the United States, worked for there for a little while, and realized it was time to move back home to Canada. Put out some resumes, and it turned out that BMO was the one that had the strongest guarantee of a job, not just further interviews. I did have a mortgage to pay and four children to feed, so I needed a real job. Plus my father worked for Bank of Montreal. He did his entire career working — so, there was something also kind of romantic or sentimental about working for BMO.
Ben Jones – Now, I love your story about the grocery store because probably one of my favorite economic theories is that of emergent order. It just always reminds me of that. Today, I was down in the undergrounds of Toronto walking through the tunnel system. Everything just moves and flows perfectly. There’s no stop lights, there’s no signs. Actually, as an outsider, someone who only comes up here four times a year, I’m more confused but I just follow the crowd and it works.
Michael Gregory – Yeah. It never fails, I’m in a mad dash to catch my commuter train heading out to home, and I usually leave it to the very last minute, knowing exactly how long it would take me given the crowds. But invariably there’s someone who stops you because you look like a nice person, and they ask you a question. I really can’t explain it to you well. I just say, follow the crowds.
Ben Jones – I like that. So, we’re here today to talk a little bit about NAFTA and free trade. This has made a lot of news and headlines over the course of the last year. But I was wondering if we could just start in a little bit of a higher level, if you could just share a little bit of the history of how free trade agreements came to be.
Michael Gregory – Right, I mean, generally speaking for the United States, the first major free trade agreement that they entered into was the one with Canada back in 1989. So, that was negotiated back in the late 1980s when Ronald Reagan was president, and Brian Mulroney was the Prime Minister of Canada. This was a big deal.
President Reagan – My fellow Americans, if someone were to ask as a Nation who our best friends are, what would be the answer? It’s difficult to imagine any better friends than our neighbors, the Canadians. Our two peoples have lived side-by-side in peace and with the spirit of good will for the better part of two centuries. Last week, Prime Minster Mulroney and I entered into a free trade agreement which, once approved by the United States Congress and the Canadian Parliament, will establish our two countries as the world’s largest free trade area. The U.S. Canadian Free Trade Agreement is the culmination of 18 months of strenuous negotiations between our governments. Both Prime Minster Mulroney and I placed an active role in the process, keeping the negotiations on track and ensuring that the outcome would be absolutely fair and equitable. Frankly, I think we’ve come up with a winner; a winner for people on both sides of the border.
Michael Gregory – Because the notion of free trade had been flaunted out there before, but never really put into a concrete deal. There were some hard negotiations but they came out with a deal. That was in place for about five years, and then it was decided that maybe Mexico should be included in this deal. So, in 1994, the Canada U.S. Free Trade Agreement became the North American Free Trade Agreement, or NAFTA. That’s been in place since 1994, but clearly, it was time for some change, time for some modification. A lot of things exist out there that didn’t exist back in 1994, like the Internet and things like that.
Ben Jones – Yeah.
Michael Gregory – And e-commerce. We need a modern trade agreement to reflect a modern economy.
Ben Jones – Now, one question that I always find really interesting is that we call these agreements free trade agreements but then they’re negotiated. So, is it really free trade or is it kind of free trade?
Michael Gregory – Well, there’s no such thing as free trade. Maybe free trade within the United States but between countries, these things tend to be managed a little bit. Because when they’re not managed, not everyone trades fairly. If you’re trading partner trades fairly, then it doesn’t really matter about — and they follow similar rules and regulations, product standards, quality, safety, things like that; you don’t need to manage trade. But that doesn’t always happen. So, you do need to manage trade a little bit. The thing about trade agreements is that you may have what we call winners and losers, but the fact of the matter is by specializing in what you do best, you end up with a bigger pie that can be split above everybody. So, people talk about the gains from trade. Everyone is better off by trading.
Ben Jones – Yeah, so it’s not necessarily a zero sum game in that there’s winners and losers necessarily. It’s like the pie grows and so everyone’s piece of the pie grows a little bit as well. In that way, we’re all winners.
Michael Gregory – Yeah. The thing to keep in mind though is while there are gains from trade, the gross benefits tend to be very diffused throughout the economy. Yet the cost of that trade agreement tends to be very concentrated. Let me give you an example. The U.S. Chamber of Commerce says the average vehicle in America is $1,000 cheaper because of NAFTA, because of North American integrated supply chains. Okay, that’s great. We all benefit by $1,000 cheaper vehicles. Yet, if you were a company making parts in Wisconsin or Indiana, and that closed down and shifted that production to Mexico, that community has been devastated. Now, the aggregate benefit of everybody is still greater than that cost, but that cost can’t be ignored. It becomes a social problem, it becomes a political problem. We’ve done a good job in the United States in dealing with the costs from trade. Other countries that trade lots have mechanisms when people lose their jobs because of trade, because they’re not competitive anymore.
Emily Larsen – NAFTA has not been updated since it was first signed in 1994. Ben asked Michael what occurred in North America as a result of the NAFTA agreement.
Michael Gregory – We’re seeing now that, for example, two-way trade between Canada and United States, between Mexico and United States, we’re talking about $1T. That’s a massive amount of two-way trade going back and forth, better efficiencies. And if you want to think of something like Fortress North America, our competition is not Canada and Mexico, our competition is Europe, our competition is Asia, our competition in the not-too-distant future is going to be Africa. So, we need to make sure we’re producing things here in North America, here in the United States as efficiently as we possibly can so that we keep the jobs and keep the production and keep the technology here.
Ben Jones – The components parts, manufacturing, goods and services have the ability to go where there’s a surplus of the desired input cost to make those goods across borders which benefits everyone in either lower cost of goods, higher productivity, and maybe even in higher consumption.
Michael Gregory – Oh, and that’s just the idea. Yes, cheaper car parts, mostly from Mexico within the North American environment, allows vehicles to be assembled in America at higher paying assembly jobs, and that’s a good thing. It means consumers can buy those vehicles at a reduced rate. But as I mentioned before, that’s not a costless endeavor. It’s a net benefit but it’s not zero cost.
Ben Jones – Let’s just talk a little bit about what’s occurred over the course of the last year. NAFTA started coming up about two years ago in the U.S. Presidential race and picked up steam through the course of 2018. What exactly was the kind of impetus for this change? Was it both sides wanting to re-negotiate? Was this really unilateral? What was the impetus?
Michael Gregory – Well, I think both Mexico and Canada were happy with the status quo. Yeah, the deal wasn’t all-encompassing but that’s okay. Obviously the impetus for change came from the U.S. Administration, the U.S. Trade Representative, and it began with NAFTA being called the worst trade deal ever. That was always a misnomer to begin with because when you really look at trade flows between Canada and the United States, yes, the United States has a trade deficit with Mexico, but it’s all covered by automobiles. Mexico has a comparative advantage in making automobiles; not only for America, but for around the world. So, they’re good at it. But if we strip out the auto trade part, which is an important part, you strip that out; America has a nice trade surplus with Mexico across every other good. Turn to Canada, has a small trade deficit with Canada but a really big trade deficit in terms of energy, lots of imported crude oil. Better to get it from Canada than Saudi Arabia, right? Or somewhere else? Great. But if you strip that out, America has a pretty big trade surplus with Canada across every other good. The point I’ve always told our customers and our employees is that if you have a trade surplus with your northern neighbor apart from one sector, which they have a comparative advantage at, and you have a trade surplus with your southern neighbor apart from one sector where they have a comparative advantage at, that’s not the worst trade deal ever. That’s a trade deal that’s actually working, working very well to the advantage of America. Now, it’s not without cost. If you look at trade as its win or lose, well, then clearly, there’s been some losses. So, that became a political issue. So, America wanted to — the United States Government wanted to do a better job of, can they entrap a little bit more out of NAFTA that they didn’t have before?
Ben Jones – I wanted to interject here and clarify something. The words trade deficit and trade surplus get thrown around a lot when discussing trade agreements like NAFTA, but doing so, as Michael pointed out to me, really oversimplifies or dramatizes headlines on this topic. Listen as Michael explains.
Michael Gregory – Trade deficit would mean that you are importing more from a country than you are exporting to them. Some would say, well, if we have a deficit, it means the production that that represents, that we are not doing ourselves, that we’re importing from you and that you are not buying from us, is a net loss to us. Which that could be taken to be the case, but the bottom line it is a sign of countries trading in such a way that one country is dominating a trade agreement. That said, you can say, I have a deficit. Two situations: both are $100B, which is a big deficit. For country A, that represents, I export nothing to that country but I import $100B of goods. I have a $100B deficit. Country B, I export $100B but I import $200B from them. I still have a $100B deficit. Which of those two situations would you have? You’d clearly want the one where I’m also exporting because the quality of that deficit is better. So, you have to look at two-way trade flows. So, when you say, there’s an $80B deficit with Mexico, for example, that’s an $80B deficit that arises from hundreds of billions of dollars of two-way trade flow going back and forth. You do something to reduce the deficit, you do something to affect those trade flows will affect jobs, will affect production. So, again, it matters what the trade flows are, not the net result, what the trade flows are.
Emily Larsen – So now onto the new agreement, the United States Mexico Canada agreement, or USMCA. Michael walked us through what changes will happen under this new agreement.
Ben Jones – How much of this is an actual new agreement and not just a renaming of the old agreement?
Michael Gregory – That’s a great question. A few years ago, Canada, Mexico, and the United States realized that NAFTA had to be modernized. Rather than look at a trilateral deal, Canada, Mexico, and the United States entered into — with other countries — into the Trans-Pacific Partnership, which was designed to update NAFTA in lieu of doing it separately among the three countries. So, a lot of what’s in the USMCA are things that Canada, the United States, and Mexico already agreed to as part of the Trans-Pacific Partnership, which of course the United States pulled out of first week of the Trump administration. A lot of this, what we see here, we’ve seen already. In fact, both Canada and Mexico are still part of an updated Trans-Pacific Partnership. When the U.S. pulled out, they had to re-negotiate some things, and most countries have now signed onto that. So, from that perspective, it’s not new. It’s new from a NAFTA perspective but not new from a trilateral perspective. But there are parts of that that are a bit different. There’s not so much a sunset clause but there’s a finite time under which this thing will be re-looked, which is kind of important. Also there were some major concessions from the status quo that was done specifically with Mexico on the auto side, and then with Canada on the agricultural side.
Ben Jones – So, let’s start there first, and then I want to come back to this idea of kind of a sunset period. So, break apart the new agreement for us; specifically with respect to the Canadian dairy industry, the Mexican auto industry. What really changed as part of this agreement?
Michael Gregory – Well, the big change, really, most benefit for the United States will come from the fact that for a car now to be classified as made in North America, and therefore can be duty-free throughout North America, it has to have a certain amount of production content of higher wage jobs, which is kind of important. That will probably lift the wages of some Mexican workers which is not a bad thing. But also more importantly it would make more competitive or the need of the higher wage jobs in the United States compared to Mexico. So, it’s going to need more production; parts feeding into the auto industry. So, it’s a net win. It’s a win. There’s no question about it. This is good news for the U.S. auto industry. This is good news. It’s going to be more production. Whether it means a lot more jobs, I don’t know, because of the way the industry is going is very heavy into automation, and therefore it’s unclear where that’s going to end up net jobs, but definitely they’ll be more production. So, that is unequivocally a win. Up to this point, parts of the Canadian agricultural sector, particular in dairy, poultry, and eggs had very high tariffs and basically had restrictions and imports because of it. Now, the United States has access to part of that. Interestingly, as part of the Trans-Pacific Partnership, the U.S. already negotiated access to, say, the Canadian dairy industry, and what they’ve done now is did it again. Basically, have essentially with less than a percentage point equivalent of market share access that they were already negotiated.
Ben Jones – We talked a little bit about this, that everyone’s a winner with free trade agreements and there aren’t necessarily — it’s not zero sum. But when you talk about costs — that’s another way of saying losers. So, what are the costs of free trade, and what industries maybe will feel this more than others?
Michael Gregory – For the USMCA. Well, I mean, obviously moving away from the status quo, given that they didn’t feel there’s anything wrong with the existing deal, would necessary mean that it is not as advantage both to Mexico and to Canada which is why it’s a net advantage for the United States. It’s a win for the United States. It’s unequivocally a win. The question is that other state, the USMCA that is still much better than no agreement at all. From that perspective, you’re better off. But there are some industries that are going to feel the adjustment there; obviously agricultural, online retailers, and of course the Mexican auto industry will feel a little bit of that sting in terms of profitability in the industry because they may face some upper pressure on their wages. Or the fact that production growth may not be as robust as it otherwise would have been now that some of that net growth in production will be channeled more to the United States.
Ben Jones – Here’s where the way forward becomes a bit unclear. You may have noticed some intentionally specific language in Trump’s press conference at the beginning of this show.
President Trump – With our signatures today, we will formally declare the intention of our three countries to replace NAFTA.
Ben Jones – The word intention is crucial. Because although the USMCA has been signed, it has not been ratified by each countries’ legislature. And as such, it won’t go into effect until it is.
Michael Gregory – It’s not really an issue both in Mexico and Canada where the party, they will easily pass these things. We have a new Congress in January. And, even if they do support the USMCA politics play an awful big role in getting good legislation passed into law. So it could be a little problematic from that perspective. We go back to the original NAFTA for example — which was negotiated under the Bush administration and we had a change of president, we also had a change of Congress and they decided well we don’t really want to pass this thing. We’re not too pleased with the provisions on Mexico’s labor standards and environmental standards. So the original NAFTA that was agreed to had two side agreements that were subsequently agreed to so Congress would pass it. Having tasted that once before, it’s possible they may seek some other things. And since we now have a new government in Mexico as of December 1st, things could get a little bit dicey or a little bit more uncertain. We’ll see. The fact of the matter is, it does seem like if you look at the political base of the Democratic Party now, it’s a lot more pro-business pro free trade then it would have been back in the early 1990s. From that perspective, I think this thing will eventually get passed.
Emily Larsen – With a new party in power in the House of Representatives, a government shutdown to start the year, and the fact that things don’t normally go smoothly in politics, as of the publishing of this episode there’s no real timeline from when the USMCA might take effect. However, it does look like it will eventually become law — possibly at the start of 2020, and Michael talked about the impact it will have on investors and advisors.
Michael Gregory – Well, I think from day one, Canada has started relaxing some of its quotas on some agricultural products, particularly dairy to help some farmers. But in terms of their broader investment themes, I think if you look at what it means for capital spending in the auto sector, I think that those prospects do brighten a little bit from that perspective. So capital equipment manufacturers, machine and equipment manufacturers, that will be an area where it’s probably going to do a little bit better. But these are also sectors that are heavy users of steel and aluminum which still face import tariffs which are rather painful for those involved in those industries or use those as imports. Which again just emphasizes the fact that – yes, we’re producing more steel in America now. Good. But that’s at the expense of a lot of people now paying a lot more for steel. What’s the net benefit? Historically using tariffs to protect a domestic industry has not been a net win and I doubt it will be a net win this time.
Ben Jones – With respect to this sunset clause, you brought this up earlier, this is one thing that I thought was really interesting and that you and your colleagues have written about. Which is the new USMCA agreement has a six year revisit clause. Or where you can revisit and renegotiate different parts of the treaty and then has another 10 years you can sign on for. But at 16 years this whole things, sunset, has to be renegotiated again. What was the reasoning there and does this add what kind of uncertainty for investors.
Michael Gregory – Originally the ante on the table by the administration was they wanted a five year sunset clause. In other words it automatically ends after five years unless all the parties agree to it. Which, as a business and that you’re investing and thinking about allocating across a North America production platform, five years is not a very long period of time. The fact that we now have this six year relook is not really a source of uncertainty. First of all, after six years, if anybody doesn’t like the idea of what’s going on, we formally enter a 10 year period of negotiations. In that 10 year period, or even sooner, if the parties want to extend it, they can. But if we can’t agree after 10 years of talking about it whether or not we want to continue this, the agreement will die after 16 years. 16 years, I think, given — is long enough for businesses to have some certainty. And besides, a lot can happen in 16 years. And I’ll give you one forecast I know will be absolutely correct. By the time we relook at the USMCA, Donald Trump will not be President of the United States. Obrador will not be President of Mexico. I’m not too sure about Justin Trudeau as the Prime Minister of Canada because there’s no fixed dates in terms of tenure. The parties will change. And I do think that in the course of time there will be a general view, you know what, we are better trading then not trading. We are better cooperating internationally then not cooperating. Despite the fact that there’s a finite date on this agreement, potentially, I think most people who have looked at this, including ourselves, is that that’s not an issue. That’s not a source of uncertainty in any way what so ever.
Ben Jones – Okay, so overall; positive, negative or neutral for Canada?
Michael Gregory – Slightly negative, but barely.
Ben Jones – Okay. And overall; positive, neutral or negative for Mexico?
Michael Gregory – A little bit more negative then Canada, but very manageable.
Ben Jones – And for the US?
Michael Gregory – Unequivocally positive.
Ben Jones – So this is where the USMCA stands now, and we’ll be sure to come back to you with Michael and his team’s thoughts should there be any new developments before the agreement goes into effect. Hopefully you were able to take away some new insights today that you can use to help answer your client’s questions, or provide some objective context for what they might be hearing in the news. In addition, we hope that we’ve added some insights for you into how portfolios might be impacted when this goes into effect. Michael has some final words for investors thinking about how this trade deal will be viewed in the future.
Michael Gregory – Despite all of the rhetoric we saw going into the negotiations, the worst trade deal ever, bad language concerning the parties. The fact is we came out with a deal that is not bad. Probably it’s the best we could have got if we were going to renegotiate things in this environment. And it just proves that, despite all of the rhetoric, people I think understand deep down that trade is important for America. Trade is important for Canada, it’s important for Mexico in terms of a share of the US economy. It’s not as big as some other trading nations, but it’s growing. And it’s trending the most it’s ever been. Whether we like it or not, we are becoming a trading nation. And you have to look at US exports by themselves; if that was a country by itself it would be the 11th largest country in the world. This is a lot of production, a lot of jobs that are tied to exports. And therefore it’s critically important that when we enter into trade negotiations that we realize we’re not talking about losing jobs. We’re talking about making jobs, getting jobs, maintaining jobs.
Ben Jones – I sincerely appreciate you making time to have me in this afternoon and talk about this and share your insights. It’s been super valuable and I think our listeners will find it as valuable as well.
Michael Gregory – Thank you, it’s been fun.
Emily Larsen – We’ll have links to the work of Michael and the economics team on this topic, as well as a link to their website on our show notes page if you’d like to get in touch and ask them questions directly. Thanks for listening this week and thanks to C-SPAN for the audio from Trump’s press conference and to the US National Archives for the audio of President Reagan’s radio address to the nation on January 9th, 1988.
Ben Jones – Thank you for listening to Better Conversations. Better Outcomes. This podcast is presented by BMO Global Asset Management. To access the resources discussed in today’s show, please visit us at www.bmogam.com/betterconversations.
Emily Larsen – We love feedback, and would love to hear what you thought about today’s episode. You can send an e-mail to email@example.com.
Ben Jones – And we really respond.
Emily Larsen – We do.
Ben Jones – If you thought of someone during today’s episode, we would be flattered if you’d take a moment and share this podcast with them. You can listen and subscribe to our show on Apple Podcasts, or whatever your favorite podcast provider is. And, of course, we would very greatly appreciate if you’d take a moment to rate or review us on that app. This show and resources are supported by a very talented team of dedicated professionals at BMO, including Pat Bordak, Gayle Gipson, Matt Perry, Derek Devereaux. The show is edited and produced by Jonah Geil-Neufeld and Annie Fassler of Puddle Creative. And these are the real people that make this show happen, so thank you. Until next time, I’m Ben Jones.
Emily Larsen – And I’m Emily Larson. From all of us at BMO Global Asset Management hoping you have a productive and wonderful week.
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