Trump's Punishment of China: The Start of a Radical Rejection of Foreign Capital?

This article was first published by me on Talkmarkets: https://talkmarkets.com/content/global-markets/trumps-punishment-of-china-the-start-of-a-radical-rejection-of-foreign-capital?post=182537&uid=4798

Donald Trump really wants to punish China and the world. We can focus on China and see what will happen to our relationship with the world. Tariffs keep escalating. Trump says the trade war is easy to win. Chinese stocks are leveraged as collateral to other deals, and are subject to margin calls. There may be some weakness in China.

The one thing we need to know about Donald Trump is that he has certain principles. They can be dangerous, and against all sound economic reasoning. But that doesn't matter to him. His tariffs are one manifestation. His desire to buy back treasuries on the cheap is another manifestation.

And yet, reading the Chinese is difficult. If the going gets rough, and as the stock markets in China continue to decline, China will likely sell a lot of US Treasuries at some point, because of needed cash and to inflict some pain on the adversary. It will likely be measured. But Donald Trump has said he wants to buy back treasuries at a discount. He originally said he wanted to default but it was changed to buy back at a discount. He has never refuted this position.

So, I would not put it past a radical Trump to attempt to get China into a position that is so weak, that POTUS would tell China, discount or nothing. There are only a few problems with this approach:

1. Central banks could care less about stock markets. This is why stocks are really speculative investments. The PBOC and the Fed simply do not care if markets crash. They do, however, care about their government bonds. As for the Fed, well it would not look kindly on discounting precious treasury bonds.

2. The US government would then issue new bonds to China, at a lesser value on paper but with higher interest rates. This of course would put all US programs in jeopardy. All safety net programs, Social Security, etc, could be affected. It would put at least some collateral in jeopardy. It would unsettle all financial markets. It would bludgeon the new normal as I wrote could happen based on the administration's planning papers.

So, ultimately, getting bond yields to rise would undo world collateral. I think that is a goal of this administration. In the above article Peter Navarro and Wilbur Ross are quoted:

Most recently, the 2012 South Korea trade deal was negotiated by Secretary of State Hillary Clinton – she called it “cutting edge.” It was sold to the American public by President Obama with the promise it would create 70,000 jobs. Instead, it has led to the loss of 95,000 jobs and roughly doubled America’s trade deficit with South Korea. Corporate America does not oppose these deals. They both allow and encourage corporations to put their factories anywhere. However, Mr. and Ms. America are left back home without high-paying jobs. There is nothing inevitable about poorly negotiated trade deals, over-regulation, and an excessive tax burden – this is a politician-made malaise. Therefore, nothing about the “new normal” is permanent. [Emphasis mine]
That is the only mention of the New Normal. It is simply not permanent for the administration. The only way to break it is for interest rates to rise and collateral in markets far and wide to go bad. I believe that this will result in a massive credit crisis in our nation and maybe throughout the world, leading to war and/or overthrow of the Republic.

3. The US could see a stock market crash, but worse than that, the US could see markets that should be opened suddenly close to American businesses. This will be likely a permanent shift, and it could happen if the US is no longer welcome to the Chinese belt and road investment plan for Central Asia. Putting a dollar value on that lost business is simply impossible because no one knows how successful the Chinese will be.

4. As Michael Roberts, economist at the City of London, has said, free trade weakens the weak and strengthens the strong, but a trade war weakens everybody. He acknowledges that free trade is not perfect, but that trade wars are a disaster. In order to punish the world in a trade war, it is necessary for POTUS to punish the United States as well. The only time trade wars possibly will not punish the aggressor nation is if the unemployment is huge, as in Nazi Germany in the 1930's. That plan didn't work out so well.

Rather than make everybody weak, where Jim Cramer could only say, I can't promise to find you a bull market anywhere, why not let the strong be strong. We just would need some dealmaking compromise to tap that strength. Donald Trump may actually consider a deal like that, but only if his confidence about himself wains. If he thinks he can fight a trade war to win, he will indeed do so.

5. The US must run trade deficits because we are the world currency. There are major advantages to having the reserve currency. Trump wants to give that power away. That power insures investment in the USA. It insures people with money coming to bring us jobs. Yes, some of the investment can be tweeked by law, to give more benefits to US citizens looking for work. It is not a perfect system. But it is an advantageous system in the long run.

But Donald Trump wants to eliminate trade deficits. The staff at Financial Sense has given us information about this very issue with a refreshing argument regarding wealth distribution and trade imbalances. This group is an outlier regarding whether trade wars hurt all nations (most economists think they normally do with the occassional exception as we saw in Nazi Germany), but Financial Sense points out that there is another reason why this trade war could hurt the United States.

Trump created tax cuts for the rich in order to transfer wealth from the working people to the big corporations. When Germany did this, as the article notes, Germany began running surpluses. From Financial Sense:

It is not at all a coincidence that Germany began to run surpluses just when households began to retain a smaller share of what they produced. Contrary to Oettinger’s claims, Europe is not running a surplus with the United States because Americans for the first time discovered German cars. It is running a surplus with the United States because between 2003 and 2005, to reduce domestic unemployment, Germany implemented policies that reduced the share of income German workers received and caused business profits to soar.

Trump is not adverse to other efforts to transfer wealth from main street to Wall Street. Tariffs themselves shift income. Financial Sense is saying that surpluses are a function of how income is distributed and about how nations treat their citizens. There is some truth to this view, as we already know that Germany's citizens have a low rate of homeownership and the nations formerly called PIIGS, like Italy, have more wealth (and the downside, more debt) distributed towards the people than does Germany.

As for how tariffs would work regarding the United States and imbalances, Financial Sense makes a very interesting comment:

In the United States, it turns out, tariffs are unlikely to have an effect on the trade deficit because the relationship between domestic savings and domestic investment is determined not by domestic savings preferences but rather by foreign capital inflows. These foreign capital inflows are themselves determined by the need for foreigners to park their excess savings in a safe haven. 
Our safe haven/reserve currency status, then, dooms any effect tariffs may have on the trade deficit!

And this same economic principle is why trickle down economics does not work here:

But in countries where desired investment levels don’t exceed actual investment levels and where the cost of capital is low and there is more than enough savings to satisfy the investment needs of businesses, trickle-down economics cannot work: transferring income from consumers to savers does not result in more investment. In fact, it may result in less investment to the extent that businesses react to lower consumption by investing less in the production of consumer goods.
Perhaps this is the fear companies have, that consumption will be lowered, first by tax cuts for the rich, second by cutting social programs, third by the imposition of tariffs, fourth by globalization and fifth by robotics. So, when consumption does decline, and investment is not present to offset, real problems happen with the economy.

The final point of the article is a simple truth, the US runs a capital surplus as safe haven and that is offset by a trade deficit which cannot be changed without stopping the flow of investment into the USA.

The Goal of Trump

Ultimately, getting bond yields to rise the way POTUS desires, would undo world collateral. I think that is a probable goal of this administration. Real reflation requires higher yields. Banks are afraid to lend when yields are low, unless they can burden the borrower with a fixed rate swap. That doesn't apply to home mortgages. Banks just don't lend.

In the age of derivatives, Greenspan knows these higher yields won't happen. He is for slighly higher yields, but he is the architect of the system of low yields and derivatives we have now!

So, how does punishing China fit in with this administration plan? Well, punishing a nation that buys your debt because you are stable does not reconcile with a madman in the White House doing all he can to appear unstable. And taking the trade war to the very end, the discounting of treasury bonds, would not bode well for the Chinese view of safety.

And if the US government buys back bonds at a discount, it is a red flag to ratings agencies that the government simply does not have enough stability to redeem bonds at full price! Offering new bonds with higher yields instead of paying full price would have to tarnish the credit rating of the United States.

Fitch is crystal clear in this assessment, that Donald Trump, in wanting to punish nations through tariffs, is a risk to the world economy even without buying back bonds at a discount. We can imagine how those agencies would assess his behavior if he carries out all of his threats. But so far, Fitch has seen enough.

Yet in spite of all this, the Republican Party knows that Trump has the unquestioned and irrational allegiance of the party base to POTUS. The party leaders are afraid to touch him, as he has become sort of a third rail for his fanatic followers. And the party has turned fanatical.

The ultimate control of this game, then rests with Donald Trump, at least until Democrats can show majorities, which will not be easy as long as they shun centrist politics. He can compromise and make deals, or he can determine to take major economies down in massive credit crisis scenarios. Treasury bonds underpin our financial system. The ball is in his court and the court of his radical advisors.

Maybe Trump has already contemplated stopping the flow of foreign funds to the United States as a safe haven. That is, whether he has thought that far or not, a probable end result of his thinking, what with the destablilizing of our treasuries and massive permanent tariffs, and a weakening of global alliances. America First must mean we are totally isolationist, closed to foreign investment as a means of destroying the safe haven, and closed for business, except for what we choose to export.

For Further Reading:

Henry Kissinger Schools Mercantilist Trump About Reserve Currency

Things That Smart People Don't Know









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