A Global Banker’s View of Trade

Show Notes

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Transcript

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Jill O'Donnell: Welcome to Trade Matters, a podcast of the Clayton Yeutter Institute of International Trade and Finance at the University of Nebraska-Lincoln. I'm Jill O'Donnell. Our guest today is Michael Salerno, Vice President of Global Banking at First National Bank of Omaha. Mike, thanks for being here today.

Michael Salerno: Thank you for having me.

Jill O'Donnell: I'd like to start with a question about uncertainty, which is a word we've heard quite a lot over the last year and a half or so with respect to trade policy. Federal Reserve economists just published a paper very recently in which they quantified the impact of trade policy uncertainty on investments. They found that a rise in trade policy uncertainty last year reduced US investment by more than 1% and they cited higher expected tariffs and increased uncertainty about future tariffs as deterrents to investment. Have you seen that from your vantage points in global banking?

Michael Salerno: Yes, I'd say we've seen that over the last two years and with tariffs and just the trade agreements not being done. For example, just with uncertainty with Brexit alone, it's usually a good place where our clients would like to expand into the EU. Being able to go to the UK and have similar banking and legal systems is a great way to kind of take a leap into that and because they are part of the EU at this point, that would have made it easier for them to then use that as a hub to all the other countries that are in the EU. With that uncertainty, we've definitely seen plans put on hold, expansion put on hold and really trying to wait and see if that is going to be the route or if they want to really have one place service all the EU, do they need to pick a place like Ireland or Germany. We've also seen expanding into markets like Japan or China where there aren't the agreements done, investments or strategies put on hold in order to see how things play out, in order to see if they're going to have a competitive advantage or are they going to be at a disadvantage from a price perspective. So, with uncertainty, obviously, companies are trying to build a strategy. It's hard for them to know what their outcomes are going to be if they don't have a direct path forward on some of the outstanding issues that are affected from trade and foreign policy.

Jill O'Donnell: You mentioned Brexit, something I'm sure you're watching closely as are many. The European Union and the United Kingdom have been wrestling with that situation there and that seems to be an indicator that it can be hard to undo economic integration with the UK having been integrated into the EU, not with the currency, but otherwise integrated in other ways. What are current dynamics that you're seeing, like Brexit or elsewhere around the globe, right now telling you about how hard it might be to undo integration? We've also heard a lot about the US and Chinese economies potentially decoupling. What would you say about that?

Michael Salerno: Well, I'd say those are kind of two different situations. When we look at Brexit really being part of the European union, there's a lot more integration than just supply chains. So, if the UK does leave, and depending upon whether it's a deal or no deal, it's going to have impacts. Just moving people back and forth over borders. The potential for having customs and duties and all the other stuff that goes with that, but more importantly, you have a lot of individuals that are working in the UK that aren't citizens because they're a part of the European Union. So, that's really hard to, I would say, to separate because it's just not the supply chain. You're talking about people that are working, that are supporting schools and health care, which is going to cause, I think, a tremendous amount of disruption, let alone not being able to transfer over borders. Today, for them, it's almost like going from state to state and now it's truly going to have hard borders with customs and that's adding more complexity. That is more than just the deals that they're trying to work with exit on, kind of, are they' going to have customs, or are they going to have a hard border with Ireland? How do you import export? So, that's going to be a lot harder to, I would say, tear down that integration that's currently there. When we talk about China and some of the other areas in decoupling with that, there is a ton of integration. There are US companies that are importing from China, creating products, and then exporting back. So, those supply chains are are completely intermixed and in order to separate, we're talking about really looking at a new supply chain. How are you finding new buyers and suppliers? It's tough because our clients that we've seen have spent a lot of time, money, and investment building those relationships in China and for them to go out and find someone to be a new buyer or a supplier is going to take time, money, investment and more importantly trust. You've got to rebuild those relationships, find a partner that you can trust and have a long term relationship and what's at risk here is that as we start to see this trade war continued to go on, we are seeing more interest from our clients in saying, "I am buying this product from China. It's getting more expensive. I don't see anything in end. I have competitors that are not, and my products are more expensive. I can't compete unless I find a new supplier. Help me find a supplier somewhere other than China, whether that's India or Vietnam." If we start moving further down that road and they're building those relationships and tariffs go away, there's no motivation to bring those back, and that's, I think, what's really at risk and that's what the concern is with the uncertainty is spent a lot of time, money, and built this trust and now we're going to end these relationships to go somewhere else and it's never going to come back.

Jill O'Donnell: On that note, and shifting just a little bit into the agriculture sector here, we know that trade tensions between the United States and China have have been high of late. Both countries have imposed new rounds of tariffs on each others' products with the most recent round having taken effect on September 1st. This has certainly impacted agriculture. As you know, China was the number one destination for US soybeans, that fell off dramatically late last year and China has sought soybeans from other markets. You wrote in a blog post in June, and I'd like to just quote from that for a moment, you wrote "The fact that China has shifted to other countries for imports during the US trade negotiations only underscores the fact that opportunities emerge even as existing relationships shutdown." So, I'd like to follow up on that. Where do you see those other opportunities emerging and what does it take to act on them?

Michael Salerno: Sure. With China looking more to South America, Brazil and Argentina for their supply, that's left US companies that are exporting trying to find a place that needs their demand more. We've seen that particular, I would say, growth is in Southeast Asia. So, other areas outside of China, we've seen a dramatic amount of growth with, I would say, our commodities going to Vietnam, going to Thailand, Bangladesh, trying to find customers there I think has been easier. There's definitely the demand. There's a growing middle class, but the problem is it's not as a mature market as China. So, our clients who have built those relationships over decades, most of them know their clients. They've got payment terms in place, whether it is going to be a open account with maybe ensuring the receivables, maybe some still done on letters of credit, but when we're going over to Vietnam, for instance, our clients are finding their demands there, but trying to get the deal done is a little bit more difficult. There's enhanced risk just from the capital structure of the banks that they're dealing with, maybe the end customer can't pay up front or cannot obtain the credit to get a letter of credit issued by the bank, so we're looking at more advanced topics on how do we actually get the deal done. Are we doing a letter of credit and giving them terms, but our client doesn't want to take on that risk. So, they're talking about, "Well, how about we do a confirmation? We don't want to take the risk in Vietnam. It's a new customer, but we know there's a different political environment over there. We'll pay the confirmation fee and we want to give our customers 180 days to pay, but we want to get paid right away. So, can you discount that for us so when we ship, we know that we're looking to a US bank for the risk and we're getting paid right away and we'll just find a way for the Vietnamese customer to pass those fees onto them so that they can get the financing through us, which is probably not available maybe to them in country." So, finding customers I think happens quite quickly and quite often, but a lot of the deals that we are getting involved in aren't getting done as fast and it's really trying to negotiate those payment terms. Who's going to do the financing, how are we going to get paid knowing that they might be a broker, they need time to sell that, they're having trouble getting financing, really evaluating the whole spectrum of payment terms rather than with China, it's, "Yep, they'll send us a letter of credit or we'll get a cash in advance." So, different dynamic.

Jill O'Donnell: How do you weigh or sort those various dynamics? So with China, firms face a tariff disadvantage now with retaliatory tariffs, although because of the long established sort of nature of those relationships, the deals can get done a little faster versus the growing but less mature markets that you mentioned in Southeast Asia where there may not be the tariff disadvantages, but the deals can't get done quite as fast. How do you weigh and sort the cost benefit in that situation?

Michael Salerno: It's really just looking at the risk. So, if they're going to go to Singapore, obviously a great credit rating, there's great banks there. If the customer that's going to buy has a good credit relationship, we can do a letter of credit and everyone feels comfortable. It's just a little bit more cost, either to the buyer, the supplier, or maybe they split it, but when we go to Bangladesh, Thailand or Taiwan, there's a different risk dynamic and that's when we're really looking at, can they get cash advance? If they get a letter of credit, what is the bank look like? Is there a credit risk there that they're unwilling to take? Is there anything going on in the country that they're not willing to take the country risks? We're really evaluating the country, the bank, and the buyer and trying to evaluate the level of risks the customer's willing to take and making sure we're putting in the right products to mitigate that risk or match up with their risk appetite.

Jill O'Donnell: I'd like to get a banking perspective on free trade agreement negotiations from you as well. So, as you know, the US-Mexico-Canada agreement is pending congressional approval, at least of this recording, there are talks between the US and Japan. Potentially there will be talks between the US and the UK when Brexit is complete. Other countries are potentially going to be talking with the US as well about potential free trade negotiations. So, I wonder, what does a banker like you look for in the content of such negotiations as they're ongoing or perhaps as in USMCA already concluded?

Michael Salerno: So with USMCA, what we're really looking for there is what is the differences from NAFTA compared to the new agreement and is there anything material that's going to create an advantage for our clients or a disadvantage? Most of our clients are probably more ag based. So, we look at that and make sure that they're going to be on a level playing field with any of the other countries they're competing with. If we know that it's not, then there's going to be some uncertainty and maybe that's going to direct some effort toward another country, and that's what we're seeing with Japan. So, we know that the trade agreement isn't done with Japan and there is European agreement, there's an Australian agreement and we could potentially be at a pretty sizable disadvantage for beef and pork and those are huge markets for our customers here in Nebraska. So, the focus for us is that we really want that agreement to be completed and put us on a level playing field, so then we can compete and it's really, then, it's our brand and it's our quality, which we think we can compete very easily on, but if we do have a large price disadvantage then not. So, we're really looking at those and trying to evaluate, is that going to create any issues positive or negative for our clients and if it is, evaluate that.

We think USMCA should get done, we hope it does get done. The big thing from there is really IP and some of the other stuff that's been in there, that's been in the news. I think hopefully we'll get fleshed out and we can get that in place. If it doesn't and it continues to go on, that again creates more anxiety and uncertainty and could delay investment or just expansion of our products being exported to those markets. In relation to the EU, we're hoping that those talks continue to go and I think we've made some movement in relation to some of the main concerns and I think most Nebraskans are probably concerned about the agricultural products and making sure that we can be on a level playing field and be able to export more freely into the EU. We're really watching that to make sure there's some moves that will allow us to really open up in that market and then knowing that if there is a no deal Brexit, that the administration can move quickly on a trade agreement there. If there is a deal, we're probably not going to have the ability to have a direct agreement with UK right away, but depending upon what happens day to day, if there is a no deal with the UK, we want to make sure to move fairly quickly and we think that could present some really good opportunities for our exports to the US.

Jill O'Donnell: Let's talk for just a moment about trade in services. I think this is sometimes an undertold story. Service industries account for over 75% of US GDP and the US consistently runs a surplus in trade in services, and in Nebraska alone services exports doubled between 2006 and 2016 from 1.1 billion to 2.2 billion dollars according to the Coalition of Services Industries. So, they're important and they're growing as a component of trade. Tariffs are not applied to services, although non-tariff barriers could be. You said before that 20% of your work deals with services. Is that growing and how might changes in trade policy that have occurred over the last year impact the flow of trade in services?

Michael Salerno: It is growing. We definitely have a base of agriculture and manufacturers and your typical exporters, but we're really starting to see is some of those companies that are providing services, whether it's going to be accounting, or software, consulting or relocation, their customers are global and they're taking them global. So, there are starting to provide those same services here in the US, following their clients globally into Europe, into Asia and we're seeing that they're getting more comfortable with that. So, we're starting to see more companies that were purely domestic on the services side, reach into Canada, reach into Europe, things that are very easy and are really being pulled by their customers. So, we think that's going to be an important part and it's going to continue to grow. When we talk about trade policy, what really comes into mind with those is when we're talking about IP and just some of the other, I would say, aspects that would affect entities or services in there. So, if we talk about how they're taxed, what their corporate structure is, and the different services that they might be able to offer, is very important. Not to mention that if they have to actually have a physical presence to offer their services and do they have to have an entity with bonding and all the other different fees. So, being able to set up an entity to provide services is different from country to country and maybe is not what we would say tariffs, but those non barrier tariffs, some of those restrictions on foreign companies providing services can prevent our customers or Nebraskans going into those countries and being able to be effectively compete.

Jill O'Donnell: I'd like to ask you about a dynamic that's playing out thousands of miles away in Geneva at the World Trade Organization. This can seem perhaps far away and arcane in our day to day lives, but it is a coming dynamic and that has to do with the appellate body at the World Trade Organization, which is essentially the last resort for member countries to take their trade disputes to be to be settled through WTO rules. The US has been blocking the appointment of new judges to the appellate body because of concerns over the way that body operates to the point where due to term limits there will be only one judge left by December of this year, at which point the appellate body can't function. Is this a dynamic that you're watching at all and what might be the implications for trade from a banking perspective if that option for settling trade disputes can no longer function?

Michael Salerno: I don't know that we're watching too closely, but we are very aware. We work with World Trade Organizations throughout the US and some overseas and they've been a great resource for just issues related to trying to find new customers, or trying to find buyers and all the other things that go along with education to help our clients, but I would say with the appellate body, I think there is a lot of concern from the community. As you know, and we've talked about, there's a lot of uncertainty around trade, there's tariffs, there's non barrier tariffs, there's all these things that are going on across the globe and the one place that people or these countries or these companies could go to would be the WTO and try to get some type of resolution. Without this there, it's allowing a lot of these things to go, I would say, continue, and there's no real governing body or mediator to address this, which is causing more of these non barrier tariffs to come up and different issues that are happening at ports and other ways to kind of combat or retaliate against some of the tariffs. If we don't get this in place, it's just there's not going to be a venue for that. We know that EU has been very, very strong on trying to find a creative or alternative solution to put this body back in place, knowing that the US so far has been pretty stringent on not removing their veto or continue to block judges. So, I would say that as we get closer to December, if we do get down to one judge, there will probably be more ideas or more solutions that will be put forth to the membership to try to find an alternative path to kind of have a venue to hear these, and more importantly try to enforce some of the issues that the countries are experiencing.

Jill O'Donnell: What other trends in foreign policy, or trade, or international relations at large are you watching that are important to the work that you do and to your clients?

Michael Salerno: I would say the two most important things that we're focused on today really is the free trade agreements. Just trying to understand the volatility, the uncertainty and everything that's going on because that directly impacts flows for imports and exports. It's going to have economic impact to all the countries, whether it's their GDP growth, it's going to affect their currency. All that creates new risk dynamics which is allowing us to to really kind of stay on our toes and trying to redo our strategies and constant conversations about risk and how do we have plan A, B, C, and sometimes D to mitigate these risks.

The second thing that we're really watching is technology. So, every country is having some type of disruption, whether it's with trade or its payments, and things are moving a lot faster and with that we're also having issues around fraud. It's harder to fight fraud if payments are going faster and having instant payment systems that are all being developed by different countries, it's hard to try to tap into those globally. So, with all the different [inaudible 00:20:46] around Swiss GPI, trying to have faster and more transparent payments, different companies using Blockchain, other, I would say, fintechs or companies trying to come in and create this interoperability between the different faster payment systems really could change the dynamic, I would say, with trade. I think we're going to see in the next five years that payments are going to be more faster, they're going to be less expensive and all your fees and foreign exchange are going to be transparent. We're also hoping on the trade side that with disruption we'll see not as paper focused industry and that we'll be able to move much more fast and take our transactions from days, down to hopefully hours.

Jill O'Donnell: Let's talk for a moment also about foreign direct investment, how has, or have, the changes in trade policy, for example, the US pullout of the Trans-Pacific Partnership impacted FDI flows that you can see?

Michael Salerno: I'd say a great example of that is just Japan. We know that they're a huge importer of beef and pork and they have had some very large companies that know that the US has great products and they enjoy the quality and they have invested heavily into companies here in the United States as a just a way to integrate their supply chains. When we did not join TPP, obviously, the countries that did and then their agreement with the EU, they know that it's going to be cheaper to import pork and your, sorry, pork and beef, from Europe and Australia. We've seen those same countries that have had investment and then were continued to invest in the United States, start making those investments in Australia and Europe and knowing that if they're going to need to continually meet the demand of their population with beef and pork, and it's going to be a significantly cheaper to source that from those countries, they want to be able to make the investment to make sure that the pork and beef that are coming into their country meets their standards and their quality and they're building huge plants and JVs that normally we would have expected it to happen here in the US.

Jill O'Donnell: Thank you. Last question today, it's the same for every guest, and that is, what have you read lately about trade? A book or article that is most striking to you?

Michael Salerno: Well, I would say the two things that I read every day is Trends in Trade on the Bloomberg feed, and then I also like to read the Economist Espresso app. I wouldn't say there's any one thing that's been really striking to me, but I think what is striking is getting those updates, just how vastly everything is changing so quickly. So, there is not just one area of focus or one country, it's every day there's five or six things that are making a dramatic impact in trade or in the global economy, and trying to try to put all those together is becoming more complex. So, we talked about soybeans going into China, but with the flu there they lost a lot of their herds. So, their demand of soybeans has gone down. Talking about how that's intermingled, there might be another update then about, "We didn't grow that many soybeans because of the floods and then we did because they couldn't plant their corn." So, it's just keeping track every morning from different sources and trying to hear their viewpoint or their take on it is pretty intriguing.

Jill O'Donnell: So, what's your strategy to keep up with all this increased pace of change?

Michael Salerno: I just try to find... I think those are probably my two favorite sources just because they're kind of an aggregator of all the different, I would say, publications and articles out there and they can link them back to everywhere else, and what I really like to do is if it's something that affects the US is try to hear their take on it, but then find a similar publication from the country in there and get their take on it. Just to try to sort through what's really happening, what's important, and how we can try to mitigate those risks.

Jill O'Donnell: Michael Salerno, thanks for giving us a banker's perspective on trade today.

Michael Salerno: Yeah, thank you for having me. I appreciate it.

Jill O'Donnell: That's it for this episode of Trade Matters. A big thank you to Bryce Doeschot, Haley Apel, and to Brianne Wolf for helping produce this podcast. Join us next time for a conversation with Chuck Hagel, former US Secretary of Defense and former US Senator from Nebraska.

Please subscribe to Trade Matters on iTunes, Stitcher, or wherever you get your podcasts. If you have ideas or topics you would like to hear about on Trade Matters, we'd love to hear from you. Send us an email at YeutterInstitute@unl.edu or, follow us on Twitter @YeutterUNL [corrected.] Opinions expressed on Trade Matters are solely those of the guests or hosts and not the Yeutter Institute or the University of Nebraska-Lincoln.