RichardAboulafia.com 

:: January 2017 Letter ::

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Dear Fellow Forlorn Trade Fans,

Useful corporate management anecdote: in business, there are A players, B players, and C players. They all see Jiro Dreams of Sushi, a documentary about a brilliant octogenarian Japanese chef. The A players watch the movie, and aspire to be as accomplished as Jiro. The B players spend the next day raving about the movie to friends. The C players order sushi for lunch.

Unfortunately, there are also D players, who see the movie and whine that people like Jiro are stealing American jobs (anecdote sourced from tinyurl.com/jqhoqof). These D players are now running the US, UK, Russia, Turkey, and several other governments. They may run France soon too. Donald Trump’s inauguration speech brilliantly redefined the D player perspective: “We've made other countries rich while the wealth, strength, and confidence of our country has dissipated over the horizon...From this day forward, it's going to be only America first, America first.” (The best take on this: www.newyorker.com/cartoons/a20260).

For the US aerospace industry, an innovation powerhouse with a massive trade surplus, this is toxic. In 2000, US civil operators took 46% of all Boeing jetliner output; in 2016 they took just 19%. Protectionism sounds seductive. For many, it would be great if US companies sourced more from home producers. But the problem with protectionism is that it leads to retaliation. Paradoxically, the world’s D players have everything in common, but they also love fighting with each other. There are six ways protectionism can damage the US aerospace industry:

First, China. As The Economist put it (January 28), “Economic Armageddon became a bit more likely when Donald Trump took office on January 20th, given his threats to impose a 45% tariff on Chinese imports.” His administration has rattled all available sabers, threatening a blockade of China’s South China Sea bases and an end to the US’s One China policy. This could easily lead a trade war. An obvious target would be jetliners, with China’s orders shifted from Boeing to Airbus. This is the greatest risk for Boeing and its suppliers. In 2016, they delivered 126 jets to China, with more going there via lessor; it’s their most important export market.

Second, Open Skies Revisited. The big three US carriers have complained for years about the big three Arab Gulf carriers, with claims of “unfair subsidies.” Delta has been particularly noisy about this. The US has had Open Skies agreements with the UAE since 1999 and with Qatar since 2001. Previous US administrations have been fine with this, but US carriers are likely to regard the Trump Administration as a receptive audience for their whining.

As with China, the easiest way for the Gulf carriers to retaliate against a protectionist air travel move is to switch orders from Boeing to Airbus. The biggest problem with this is Boeing’s 777X. Of the 306 firm orders, 235 are for the three Gulf carriers. Boeing is making a $10 billion investment in this plane; losing 77% of the order book would have a devastating impact on investor perceptions of the company. And Delta’s political base is far more pro-Trump than Boeing’s; Trump and his allies might just decide that Washington State is completely irrelevant to their political and economic concerns. Meanwhile, Boeing’s Iran deal will likely vanish if (or when) the new administration gets around to re-imposing sanctions.

Third, there’s the risk of a border tax. Trump has called for “a very major border tax,” reported to be 35% (and applied “selectively,” an invitation to cronyism). But aerospace is not TVs or children’s toys. A border tax could result in rapid sourcing changes by these industries, but the bulk of aerospace imports comes from of life-of-program contracts and risk-sharing partnerships. For example, Boeing can’t just take the 787 wing contract away from Japanese suppliers and move it to the US. Instead, Boeing will simply find its costs rise markedly. All large civil aerospace primes and Tier One OEMs have created elaborate global supply chain networks, which depend on the relatively frictionless transit of parts between countries.

Fourth, we don’t know how the end of the post-World War II trade order will impact aviation demand. Trump is withdrawing the US from the proposed Trans-Pacific Partnership (TPP). He also promised to re-negotiate or terminate NAFTA. The Trump administration may ignore WTO rulings, jeopardizing that institution too. There’s no way to tell how badly jetliner demand would be impacted by this – our industry depends on hauling business travelers, tourists, and freight, all of which would be hurt by slowing trade. Growing protectionism is already impacting world trade; in September the WTO cut its trade growth forecast for the year to just 1.7%, the slowest rate since the 2008 financial crisis.

Fifth, there’s the risk of an all-out trade war. We could see a series of escalating high-profile trade battles bringing world trade growth to a standstill. Given the mix of isolationism, chaos, and confusion we’ve seen over the past two weeks, you can’t rule it out (or a real war, either). This administration seems to thrive on public opposition, controversy, and political theater. Our industry would be at the epicenter of a cataclysmic trade war. A recent Peterson Institute for International Economics study (https://piie.com/system/files/documents/piieb16-6.pdf) spells out the risks, and says a trade war would most impact companies which “manufacture machinery used to create capital goods in the information technology, aerospace, and engineering sectors.” My friend John Persinos, writing in Investing Daily on the impact of a trade war (tinyurl.com/jmp48nz), thinks Boeing could be the single worst affected stock.

Sixth, consider the opportunities lost when walls go up. This industry benefits enormously from multinational enterprises. The best-selling jet engine of all time, the CFM56 and Leap series, comes from a 50-50 transatlantic JV established in the 1970s. Outgoing CFM CEO Jean Paul Ebanga recently sent me a superb new CFM history (The Power of Flight, by Guy Norris and Felix Torres) with a very timely note: “CFM is the perfect testimony of how rewarding the future can be if you trust the ‘other,’ especially if he is different.” It would be a massive loss if this wisdom was replaced with mindless isolationism.

January Aircraft Binder updates include the World Aircraft Overview, CH-47, Tucano, AH-64, E-737, E-8, and S-92 reports. Please note: we’re still running a bit late with these due to a new publication system; my apologies for that. And all the best for 2017.

Yours, ‘Til The A Players Save Us,
Richard Aboulafia
 

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