NAFTA – An Example of Cooperation in Our Hemisphere

The North American Free Trade Agreement (NAFTA) is a trade pact that established deep economic ties between the three largest countries comprising North America.

Officially, the agreement came into place at the start of 1994, but it was a major diplomatic achievement that began with ideas from the Ronald Reagan administration in the 1980s. Globalization was starting to show its teeth and it made sense that neighboring countries, rich in natural resources, should put their minds together and work on improving each other’s comparative advantages. Such a level of specialization, as dictated by the Ricardian theory of trade, would mean that continental progress could be achieved if each country set its vision to produce what it could at its best.

The result was clear. Almost every piece of analysis dissecting the effects of NAFTA have concluded that Gross Domestic Product and employment opportunities for all partners improved since the mid-1990s, with Mexico seeing rapid growth and prosperity. For Canada, the inclusion of intellectual property standards allowed for innovation from up north to be refined and actually exposed. Meanwhile, the U.S. has benefited from a variety of products being manufactured at lower costs while also being able to excel at agricultural production with higher numbers of labor and more demand. America has additionally experienced an increase of about 200K export related jobs created annually since the agreement was signed. Those jobs tend to pay 15.0-20.0% more than the jobs that left. Eliminating trade barriers also improved relations between the U.S. and Mexico, especially after a history of border conflicts and social havoc. Diplomatically and commercially, NAFTA is as good as the European Union because it created a cohesive vision and plan of action, incentivized careful cooperation, and aided in setting standards for other future trade agreements.

Nevertheless, the accord has its flaws. Arguments have been made against U.S. dominance of farm and crop production that set Mexican lower-class folks to fail in their smaller endeavors as they could no longer compete. Additionally, many in the manufacturing realm in the U.S. argued that traditionally good-paying jobs fled south of the border with no plan to replace the economic activity of those areas dependent on making auto-parts, tools, and other typical heavy industrial works. Recently, the U.S. also complained about unfair pricing advantages in lumber and milk production in Canada. Overall, the deal has had mostly pros, but a change of the guard in the U.S. has certainly brought the pact under serious scrutiny with many economists arguing in favor of the administration upgrading the terms to better reflect modern activity.

Unfortunately, there is the belief amongst a few that NAFTA simply is not a good deal anymore and that other arrangements should be considered. The threat of this abandonment certainly put the Mexican peso (MXN) and Canadian dollar (CAD) on alert starting at the end of 2016. The anti-trade sentiment manifested in the U.S. presidential campaign alone led many traders to heavily bet against the peso, which also started the dwindling of the “loonie.” However, the surge of equity markets and other concerns for the U.S. administration caused these fears to fade and the peso to appreciate. In fact, it was one of best performers of 2017, overcoming losses that in 2016 brought it to its weakest level on record, several times. Nevertheless, anytime NAFTA talks make headlines, the Peso immediately suffers.

Currently, President Donald Trump is urging his officials to push for a preliminary agreement in April. Mexican trading negotiators are also asking for something to be accomplished by end of the month since they want a guaranteed agreement prior to elections in July that will bring in a new president and congress. The seventh round of talks came to a close in Mexico at the end of March, with most reports on the private meetings highlighting procurement as the biggest challenge yet. One of the biggest concerns at the moment is a U.S. proposal to feature a “sunset clause,” which means that the country would like to sit every 5-6 years to re-evaluate terms. Canadian officials have stated that this could prove problematic and counter-productive since businesses will not be able to work on long-term plans if they have to account for potential changes in such a comprehensive deal. Mexico is definitely feeling pressure as 81.0% of its exports go to the U.S. and 46.0% of imports hail from America.

Furthermore, this is accompanied by risks of political changes that may emerge from anxiety and bitterness towards the U.S. position on the pact and border control. Anti-establishment mood is growing and fomenting an anti-U.S. stance. Mexico will hold presidential elections on July 1st that could also change the course of trade if a candidate with more leftist populism takes over. His name is Andres Manuel Lopez Obrador, and he has a good chance at victory since he once was mayor of the capital. The free movement of goods could be threatened by tariffs and even physical barriers. There is tension, but also hope.

Senior Foreign Exchange Trader and Strategist at Tempus, Juan Perez believes that since officials have agreed not to have a deadline (originally set for end of March) the talks will improve. Per statements by NAFTA officials, there have been advancements in some areas and friction on others. As far as FX fluctuations are concerned, Perez predicts some tough times for both the CAD and MXN, “since the Federal Reserve is more likely to maintain a course of monetary tightening that improves bets on the U.S. Dollar.” Inflationary growth in Mexico has also led Banxico, the central bank, to hike interest rates, cushioning the peso and avoiding depreciation. Nevertheless, Perez feels NAFTA must remain and that “the governments must work as closely as they did in the past not to bring unnecessary headaches like the ones we are seeing with the U.K.’s Brexit.” Once downside risks related to the pact fade, the CAD and MXN can be expected to stay afloat, but until then they are quite vulnerable and markets are in high volatility over the future of trade globally.

Juan Perez Senior FX Trader and Strategist Tempus

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