China: Paper Tiger

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China’s shock currency devaluation last week begs the following questions: Is China a rising giant of the twenty-first century poised to overtake the United States in wealth and military prowess? Or is it a house of cards preparing to implode?

Conventional wisdom espouses the former. Yet, hard evidence suggests the latter.

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Your correspondent in the world famous Long Bar on the Bund in Shanghai, China. The Long Bar (about 50-yards long) was originally built in 1911 during the heyday of foreign imperialism in China just before the formation of the Republic of China (1912-1949). Bar regulars were divided into “tai-pans” (bosses who sat near the window), “Shanghailanders” (who sat in the middle), and “griffins” (newcomers who sat at the far end).

I made my first visits to Hong Kong and Taiwan in 1981 and my first visit to Communist China in 1991. I have made many visits to the mainland over the past twenty years and have been careful to move beyond Beijing (the political capital) and Shanghai (the financial capital) on these trips. My visits have included Chongqing, Wuhan, Xian, Nanjing, new construction sites to visit “ghost cities,” and trips to the agrarian countryside.

I spent five days cruising on the Yangtze River before the Three Gorges Dam was finished so I could appreciate the majesty and history of the gorges before the water level was lifted by the dam. I have visited numerous museums and tombs both excavated and unexcavated.

My trips included meetings with government and Communist Party officials and numerous conversations with everyday Chinese people, some of who just wanted to practice their English language skills on a foreign visitor.

In short, my experience with China goes well beyond media outlets and talking heads. In my extensive trips around the world, I have consistently found that first-hand visits and conversations provide insights that no amount of expert analysis can supply.

These trips have been supplemented by reading an extensive number of books on the history, culture and politics of China from 3,000 BC to the present. This background gives me a much broader perspective on current developments in China and a more acute analytical frame for interpretation.

An objective analysis of China must begin with its enormous strengths. China has the largest population in the world, about 1.4 billion people (although soon to be overtaken by India). China has the third largest territory in the world, 3.7 million square miles, that’s just slightly larger than the United States (3.6 million square miles), and only slightly behind Canada (3.8 million square miles).

China also has the fifth largest nuclear arsenal in the world with 280 nuclear warheads, about the same as the UK and France, but well behind Russia (6,490) and the U.S. (6,450). China is the largest gold producer in the world at about 500 metric tonnes per year.

China has the second largest economy in the world at $15.5 trillion in GDP, behind the U.S. with $21.4 trillion, and well ahead of number three Japan with $5.4 trillion. China’s foreign exchange reserves (including gold) are the largest in the world at $3.2 trillion (Hong Kong separately has $425 billion in additional reserves).

By way of contrast, the number two reserve holder, Japan, has only $1.3 trillion in reserves. By these diverse measures of population, territory, military strength and economic output, China is clearly a global super-power and the dominant presence in East Asia.

Yet, these blockbuster statistics hide as much as they reveal. China’s per capita income is only $11,000 per person compared to per capita income of $65,000 in the United States. Put differently, the U.S. is only 38% richer than China on a gross basis, but it is 500% richer than China on a per capita basis.

China’s military is growing stronger and more sophisticated, but it still bears no comparison to the U.S. military when it comes to aircraft carriers, nuclear warheads, submarines, fighter aircraft and strategic bombers.

Most importantly, at $11,000 per capita GDP, China is stuck squarely in the “middle income trap” as defined by development economists. The path from low income (about $5,000 per capita) to middle-income (about $10,000 per capita) is fairly straightforward and mostly involves reduced corruption, direct foreign investment and migration from the countryside to cities to purse assembly-style jobs.

The path from middle-income to high-income (about $20,000 per capita) is much more difficult and involves creation and deployment of high-technology and manufacture of high-value-added goods.

Among developing economies (excluding oil producers), only Taiwan, Hong Kong, Singapore and South Korea have successfully made this transition since World War II. All other developing economies in Latin America, Africa, South Asia and the Middle East including giants such as Brazil and Turkey remain stuck in the middle-income ranks.

China remains reliant on assembly-style jobs and has shown no promise of breaking into the high-income ranks.

In short, and despite enormous annual growth in the past twenty years, China remains fundamentally a poor country with limited ability to improve the well-being of its citizens much beyond what has already been achieved.

With this background and a flood of daily reporting on new developments, what do we see for China in the months and years ahead?

Right now, China is confronting social, economic and geopolitical pressures that are testing the legitimacy of the Communist Party leadership and may lead to an economic crisis of the first order in the not distant future.

In contrast to the positives on China listed above, consider the following negative factors:

Trade wars with the U.S. are escalating, not diminishing as I warned from the start in early 2018.

Trump’s recent imposition of 10% tariffs on the remaining $300 billion of Chinese imports not currently tariffed (in addition to existing tariffs on $200 billion of Chinese imports) will slow the Chinese economy even further.

China retaliated with a shock devaluation of the yuan below 7.00 to one dollar, a level that had previously been defended by the People’s Bank of China. Resorting to a currency war weapon to fight a trade war shows just how badly China is losing the trade war.

But, this currency war counterattack will not be successful because it will incite more capital outflows from China. The Chinese lost $1 trillion of hard currency reserves during the last round of capital flight (2014-2016) and will lose more now, despite tighter capital controls. The spike of bitcoin to $11,000 following the China devaluation is a symptom of Chinese people using bitcoin to avoid capital controls and get their money out of China.

The unrest in Hong Kong is another symptom of the weakening grip of the Chinese Communist Party on civil society. The unrest has spread from street demonstrations to a general strike and shutdown of the transportation system, including the cancellations of hundreds of flights.

This social unrest will grow until China is forced to invade Hong Kong with 30,000 Peoples’ Liberation Army troops now massed on the border. This will be the last nail in the coffin of the academic view of China as a good global citizen. That view was always false, but now even the academics are starting to understand what’s really going on.

International business is moving quickly to move supply chains from China to Vietnam and elsewhere in South Asia. Once those supply chains move, they will not come back to China for at least ten years if ever. These are permanent losses for the Chinese economy.

Of course, lurking behind all of this is the coming debt crisis in China. About 25% of China’s reported growth the past ten years has come from wasted infrastructure investment (think “ghost cities”) funded with unpayable debt. China’s economy is a Ponzi scheme like the Madoff Plan and that debt pyramid is set to collapse.

This cascade of negative news is taking its toll on Chinese stocks. This weakness began in late June 2019 when the summit meeting between U.S. President Trump and President Xi of China at the G20 Leaders meeting in Osaka, Japan failed to produce substantive progress on trade disputes.

Since then, the trade wars have gone from bad to worse and China’s economy has suffered accordingly. My expectation is that a trade war resolution in nowhere in sight and the trade war issues have been subsumed into a larger list of issues involving military and national security policy.

The new “Cold War” is here. Get used to it.

Regards,

Jim Rickards
for The Daily Reckoning

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Why China’s a Paper Tiger

This post Why China’s a Paper Tiger appeared first on Daily Reckoning.

Markets are still digesting last week’s Chinese devaluation that sent the Dow crashing over 700 points last Monday.

And as everyone knows by now, the Trump administration labelled China a currency manipulator.

The ironic part of it is that China has been manipulating its currency to strengthen it against the dollar.

Here’s the dynamic you need to understand…

The Chinese yuan is softly pegged to the dollar. To maintain the soft peg, the People’s Bank of China (PBoC) sells dollars and buys yuan.

That props up the yuan. It’s basic supply and demand economics.

One of the primary reasons China tries to strengthen the yuan is to prevent capital flight out of the country. If the yuan depreciates too rapidly, massive amounts of Chinese money would look to flee abroad where it can get much higher returns.

After all, would you want to hold a rapidly deteriorating asset that constantly loses value? Or if you were a Chinese investor, would you try to convert your money into a currency that holds its value?

That’s the question Chinese investors have been facing.

A capital drain could devastate the Chinese economy, which badly needs the capital to remain in China to support its massive Ponzi schemes, ghost cities and overinvestment.

That’s why the PBoC has been trying to support the yuan, even though a cheaper yuan helps Chinese exports.

That’s the conundrum China faces. It wants a cheap yuan — but not too cheap.

I wouldn’t call last Monday’s devaluation  the sort of “max devaluation” I’ve warned my readers about before. That would have been a devaluation of 5% or more in a single day, and that’s not what happened last week. I would classify it as a “red line” devaluation.

The yuan temporarily broke through the 7.00:1 “red line” dollar peg. It has since returned to normalized levels.

It’s actually ironic that China is being labelled a currency manipulator, if manipulating your currency means cheapening it.

That’s because China was manipulating its currency to strengthen it against the dollar. And when the yuan/dollar exchange rate crossed the 7.00:1 “red line,” that meant China temporarily stopped manipulating its currency higher.

If China didn’t manipulate the yuan higher, it would depreciate even more against the dollar. And the exchange rate stabilized last week when China resumed the manipulation. In other words, when China strengthened the yuan.

Welcome to the currency wars! They take on a logic all their own. In many ways it’s a race to the bottom.

I explained it all years ago in my 2011 book Currency Wars.

As soon as one country devalues, its trading partners devalue in retaliation and nothing is gained. China’s case is complicated by its desires for both a strengthened and weakened yuan.

But the ultimate reality is that currency wars produce no winners, just continual devaluation until they are followed by trade wars. That’s exactly what has happened in the global economy over the past 10 years.

Currency wars and trade wars go hand in hand. Often they lead to actual shooting wars, as I have repeatedly pointed out.

Let’s hope the currency wars and trade wars don’t turn into shooting wars as they have in the past.

But below, I show you why China is more of a paper tiger than an actual one. Why do I say that? Read on.

Regards,

Jim Rickards
for The Daily Reckoning

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EU: No strategy yet if China halts critical exports in US trade war

The European Union on Thursday said it had no clear strategy on how to ensure continued supplies of critical raw materials if China, the world's leading supplier of rare earth minerals, used such exports as leverage in the escalating US-China trade war. EU Trade Commissioner Cecilia Malmstrom said the EU's executive commission was beginning to look carefully at the issue, but had not developed a clear strategy.

Wall Street and the New Cold War

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The stock market seems to rise or fall almost daily based on the latest news from the front lines of the trade wars.

When Trump threatens new tariffs and China threatens to retaliate in kind, stocks fall. When Trump delays the tariffs and China agrees to resume negotiations, stocks rise. And so it goes. It has been this way since January 2018 when the trade war began.

The latest dust-up came late last week when Trump threatened tariffs against Mexico if it doesn’t do more to curb illegal immigration to the U.S. Markets sold off on Friday as a result, bringing a terrible May to an end. Largely due to the trade war, the stock market had its worst May in seven years.

From the start, Wall Street underestimated the impact of the trade war. First they said Trump was bluffing. Then the analysts said that Trump and Xi would put their differences aside and make an historic deal.

All of these analyses were wrong. The trade war was problematic from the start and is growing worse today.

China will lose the trade war. The reasons are obvious. Foreign trade is a much larger percentage of Chinese GDP than it is for the U.S., so a trade war was always bound to have more impact on China than the U.S.

And if China tries to match the U.S. in tariffs dollar for dollar, they run out of headroom at $150 billion while the U.S. can keep going up to $500 billion and inflict far more pain on China.

Other forms of Chinese retaliation are mostly nonstarters. They cannot dump U.S. Treasuries without hurting their own reserve position and risking an account freeze by the U.S. China cannot turn up the pressure by stealing intellectual property because they’re already doing that to the greatest extent possible.

China’s latest threat is to ban exports of “rare earths” to the U.S. and its allies. Rare earths are essential for the production of plasma screens, fiber optics, lasers and other high-tech applications. Electric vehicles, mobile phones and telecommunications systems would be impossible to build without them. China is responsible for 90% of global production, which makes them a potent weapon in the U.S.-China trade wars.

“Rare” earths aren’t actually that rare. They are plentiful in quantity. The problem is that they are found in extremely low concentrations. This means a huge amount of ore and expensive mining processes are needed to extract even a small amount of these vital substances.

So rare earths are one weapon China possesses.

But over time, Western powers can replace rare earths purchased from China. There could be major manufacturing disruption in the meantime, it’s true. But it would not be the end of the world.

The U.S. will win the trade war and either China will open its markets and buy more U.S. goods or the Chinese economy will slow significantly.

But while the trade war is important, it’s not the main event.

The trade war is part of a much larger struggle between China and the U.S. for hegemony in Asia and the Western Pacific.

They are locked in a new cold war being fought on many fronts. These include trade; technology; rights of passage in the Taiwan Strait and the South China Sea; and alliances in South Asia, where China’s Belt and Road Initiative is promising billions of dollars for infrastructure development.

The U.S. is responding with arms deals and bilateral trade deals to counter Chinese influence. Even if a modest trade deal is worked out with China this summer, it will not put an end to the larger struggle now underway.

What are the implications?

If the Chinese view the trade war as just one step in a protracted cold war, which I believe they do, then we’re in for a long period of contracting growth that will not be confined to China but will affect the entire world.

That seems the most likely outcome for now. Get set for slower growth and perhaps stagflation. It could be like the late 1970s all over again.

Slowly, Wall Street is taking the trade wars seriously. But it is still missing its larger implications of a new cold war.

This new cold war could last for decades and it will affect the entire global economy. Let’s just hope it doesn’t turn into a shooting war.

Below, I show you why it could. Read on.

Regards,

Jim Rickards
for The Daily Reckoning

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Rare Earths Sector ETF $REMX Booming Again On Trade War With China

Summary

1)Rare earth critical mineral crisis heating up as China Retaliates against Trump Tariffs.

2)Rare Earth Shortage could cripple tech giants such as Apple and Tesla.

3)Rare Earth ETF $REMX was over $100 during last rare earth crisis in 2011 now its under $15.

4)If Chinese cut off rare earths, prices could skyrocket in parabolic rise.

5)China Controls Rare Earth Sector which was invented in USA.

Over eight years ago I wrote about a crisis that could unfold in the United States related to rare earth imports from China.  Remember the Chinese control the rare earth market.  These rare earths are used in your phones, Ipads, and hybrid/electric vehicles.  Just think of rare earths in all your advanced technologies which involve magnets like hard drives and speakers.  Some think the rare earth boom has been and gone...but I think its coming back and it could be very soon.

 

In this article published back in September of 2011, I warned about a potential   rare earth critical minerals crisis which could cripple the United States economy especially technology companies that use rare earths (REMX) such as Tesla (TSLA) and Apple (AAPL) when tensions with China flare up again.

China usurped the rare earth industry away from America back in the 1980's when GM sold its magnet technology to the Chinese.  No one cared back then as the metals were kind of obscure and the American Public cared more about Michael Jackson.  But the Chinese knew that these metals would be the guts of the new mobile technology and defense systems.

I tried to get Obama to make an emergency executive act back during the Credit Crisis to boost jobs and develop a secure USA rare earth supply chain.  All I heard was crickets.

Back then they ignored the fact that these metals are behind our top defense systems, guided missile programs and technologies the public is still unaware as its being kept top secret.  For years I warned that America was becoming a client state of China as the elites sold our most advanced industries for pennies.  As I said back then, "We are now on the verge of reaping the whirlwind resulting from our short sightedness on rare earths."

The new administration under Trump has listened to a large segment of the population who know their businesses have been shutdown by the Chinese shrewd game of catering to the corporate elites.  Those who have allowed our uranium and rare earth secrets to be sold over the past 30 years should be tried for possibly treason.  Such a tragedy as we are now in such a weak position with the Chinese.

Our technology depends on rare earths and Trump should consider what I requested Obama to do almost 10 years ago to make an emergency executive order to fast track American rare earth and battery metal development.

China is shrewdly gaming us into positions of weakness and dependency. To ignore the global chess game being developed by China is close to an act of treason or at least malfeasance by our elected representatives.  It is survival time on a national level.

Recently Lynas (LYSCF) one of the only publicly trade rare earth producers may be signaling to the market that America may be the place for rare earths as they are planning to build the first rare earth separation plant with an American Chemical company.  I wrote years ago that Lynas should do that rather than build an expensive facility in Malaysia which has shown to be an unfriendly jurisdiction from an operating perspective.  They have had a lot of local opposition in Malaysia. Glad they are finally listening to investors like me that said to invest in USA.

It is noteworthy that there was a huge presence of short sellers in rare earth and uranium stocks.  Almost eight years ago we were almost ready to start rare earth production in the USA before the Chinese cut the prices dramatically.  All development stopped and Molycorp went bankrupt as well as many of the junior developers.  China with a single click destroyed the sector which was trying to get started and all the investors who had the foresight.

 

Remember China has a bullet on how to respond to Trump's tariffs right now.  All they have to do is restrict rare earth exports crippling the US Economy as they did 10 years ago.

Unfortunately, It may take 10-15 years now to restart industry.  A lot of the American expertise from the 1950's were around 10 years ago but now are way past retirement.

There is speculation that the Chinese are prepared to shut down rare earth exports in response to Trump.  Share of the rare earth etf (REMX) were up yesterday on record volume as Bloomberg reported the President of China visited a rare earth facility to send clear message to Trump.

Investors should be prepared for Chinese retaliation with rare earths which could send prices soaring like it did in the past.  The Chinese have warned the US that they have tools at their disposal to retaliate against Trump.  That weapon of choice may be rare earths.

Remember the Rare earth ETF (REMX) hit a high above $100 back during the last crisis in 2011...now its trading under $15.  No one remembers what happened 10 years ago but we do.  The market has totally ignored rare earths until this week when we saw this record volume as sources are saying the Chinese may retaliate with rare earths.  If they do get ready for the next bubble in rare earths which may even surpass the 2010 run.

 

Disclosure: I am/we are long REMX.

Debt “Death Spiral” Approaching

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Today our spirits wallow. And our brow is creased with worry…

For we are informed the United States is racing into a “death spiral” of debt.

That is, when every public dollar it borrows must service its debt… crowding out all other demands.

That debt presently exceeds $22 trillion.

It expands by day, by hour, by minute, by second.

But when does America finally go corkscrewing into the fatal abyss?

Eight years, 10 years — perhaps a dozen?

The all-important answer shortly.

But first a brief canvas of Wall Street… and the stock market.

The Trade War Strikes Again

The opening whistle blew this morning and the Dow Jones instantly sank triple digits.

Once again we must look to trade.

Chinese state media indicated early today that China is in no special hurry to resume peace talks.

This is because the United States once again crossed Chinese interests…

It has put Chinese telecommunications behemoth Huawei under the ban — the firm can no longer purchase components from American firms.

But stocks absorbed the initial blow… and gradually clawed their way back.

But not enough to break even. The Dow Jones ended the day 99 points lower.

The S&P lost 17 points; the Nasdaq 82.

And so the merry-go-round spins.

But when will the United States enter the “death spiral” of debt?

To begin we sit down with the facts…

Interest on the Debt: The Fastest-Growing Budget Item

Four items alone constitute 78% of the federal budget — Medicare, Medicaid, Social Security and interest on the national debt.

All other programs scratch along on the remaining 22%.

These include “defense,” education, scientific research, all bread, all circuses — all remaining programs.

But the fastest-expanding sinkhole in the budget… is interest on the national debt.

Interest on the debt is the great villain of our tale, the horseman of our apocalypse.

The United States government ladled out $221 billion in interest on the national debt through the first four months of fiscal year 2019.

That is nearly 10% greater than last year’s payments over the same space.

And this we have on official authority of the United States Department of Treasury:

Interest on United States public debt will stretch to some $591 billion this fiscal year — a record.

$2,000 out of Your Pocket

Could you put an extra $2,000 to good use this year?

Perhaps you could heave an extra $2,000 into savings, investment, leisure, charitable causes, etc.

But if you are the average American, the national debt denies you that option.

That is because over $2,000 of your tax bill is being siphoned to service this debt.

All of which transpires while the gross domestic product continues to expand.

In a growing economy, the old-time Keynesians preached a gospel of fiscal restraint.

It is the time to store in reserves, to save against the rainy day — the inevitable rainy day.

Come the recession, the government can then proceed against it with a brimming war chest.

“Countercyclical” policy, academic men style it.

But the old Keynesians currently preach before an empty church. The flock has gone winging off for the heretic faith of perpetual deficit.

And the United States is passing rapidly beyond all hope of heaven…

The Tragic Math

When unemployment last sunk to today’s 3.6% — in 1969 and 2000 — the United States government boasted surpluses.

In lean seasons these surpluses it could sacrifice upon the altar of “countercyclical” fiscal policy… and push back against recession.

But the Congressional Budget Office (CBO) projects this year’s deficit will verge upon $900 billion.

And CBO estimates GDP will limp along at an average 1.9% per annum the next decade.

But again, debt is piling on at 6% per year.

Trillion-dollar annual deficits are therefore in prospect for the next decade — at least.

Annual interest costs on the debt will scale $724 billion by 2025, estimates CBO.

And $928 billion by 2029… or nearly 25% of the entire budget.

When inevitable recession descends the war chest will not only be empty. It will have a gaping hole in its bottom.

But let us add another strand to the hangman’s noose…

CBO Numbers Don’t Account for Recession

CBO’s figures do not admit the possibility of recession for the following 10 years.

A handsome assumption, that is, given the present expansion will rank history’s longest come July.

How can it peg along another decade without recession?

Even the Federal Reserve is giving out visible and audible signals of the coming rough-house.

It is publicly airing mentions of negative interest rates, “standing repo facilities” (a variant of QE) — and more.

Would it ransack its toolkit for policy options if not expecting to use them?

Does a man ransack his closet for an umbrella… if not expecting rain?

$2–3 Trillion Annual Deficits

If the economy does sink into recession — depend on it — the government will plunge even deeper into debt to “stimulate” the economic machinery.

“We get a recession,” affirms analyst Sven Henrich, “and you are looking at $2–3 trillion [annual] deficits.”

Interest on the debt will swamp the budget — especially if interest rates rise.

CBO’s current 2029 forecast of $928 billion then appear quaint.

As stands, CBO estimates the average interest rate on the debt will rise from 2.3% last year… to 3.5% in 2029.

The Lord help us all if interest rates run much higher.

But when — again — will the United States go spinning into the death spiral of debt?

The “Primary Deficit”

The United States Treasury Department’s Office has issued its Fiscal Year 2019 Q1 Report.

In in, Treasury’s Office of Debt Management projects total U.S. government borrowing from the public.

Among the metrics it tracks is the “primary deficit.”

The primary deficit is:

The amount by which total spending exceeds total revenue — excluding interest payments on debt.

For the next number of years interest on the debt approximates other elements of the budget deficit.

But beginning in 2024, Treasury projects the primary deficit will fall to zero… and then turn negative.

Explains Zero Hedge:

While in 2019 and 2020 surging U.S. interest expense is roughly matched by the other deficit components in the U.S. budget, these gradually taper off by 2024… The real red flag is that starting in 2024, when the primary deficit drops to zero according to the latest projections, all U.S. debt issuance will be used to fund the U.S. net interest expense, which depending on the prevailing interest rate between now and then will be anywhere between $700 billion and $1.2 trillion or more.

And that is when the “death spiral” begins — 2024 — five years from today.

That is, when every new dollar Uncle Samuel borrows from the public goes to service interest on the debt.

The “Ponzi Finance” phase

Continues Zero Hedge:

In short… the U.S. will enter the penultimate Ponzi finance phase — the one in which all the new debt issuance is used to fund only interest on the debt — sometime around 2024.

Setting the business in concrete is Craig Eyermann, research fellow at the Independent Institute:

When the national debt reaches the point where all newly borrowed dollars must be used to pay this mandatory expenditure, the U.S. government will have passed the event horizon that marks the boundary of the national debt death spiral.

Of course, the United States may enter the fatal orbit later than 2024.

But also earlier.

Either case, it is dead on course…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Prepare for Trench Warfare

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What if China isn’t half so desperate for a deal as the president believes?

Are we in for an extended siege of economic trench warfare?

Today we explore possibilities… and their implications.

We first direct our gaze to Wall Street.

Investors came crouching from their shelters this morning… as if expecting an aftershock to the quake that drove them underground yesterday.

With Monday’s 617-point battering — piling atop last week’s losses — three months of stock market gains have vanished into the ether.

The S&P 500 endured its 15th-largest decline in history yesterday. It has shed $1.1 trillion since May 5 alone.

Markets Bounce Back

But the Earth held today. And investors cleared away some of yesterday’s wreckage.

The Dow Jones rebounded 207 points.

The S&P reclaimed 23 of the 70 points it lost yesterday. The Nasdaq gained 87.

Markets were encouraged by President Trump’s comments that he will strike a deal with China “when the time is right.”

He will have an opportunity at the G20 summit in late June. There he will meet China’s Xi Jinping, for whom his “respect and friendship is unlimited.”

But is China sweating dreadfully for a trade deal as Trump assumes?

China Braces for Escalation

China does — after all — ship some $500 billion of products to these shores each year.

It cannot afford to sit on them like a broody hen.

But you might have another guess, says the director of monetary policy at the People’s Bank of China:

As for the change in the domestic and external economic environment, China has sufficient leeway and a deep monetary policy toolkit, and so has full ability to deal with [economic] uncertainties.

But here we cite a government mouthpiece, a marionette in human form. You no more trust his word than you would trust a dog with your dinner.

Just so.

But affirms Brad Setser, senior fellow for international economics at the Council on Foreign Relations:

Trump’s escalation comes at an awkward time, but if push comes to shove, they’re quite capable of supporting growth through more investment and credit.

There may be justice here.

Twice as Much Stimulus as During the Financial Crisis

If you believe the Federal Reserve is a gargantuan spigot of credit, the People’s Bank of China brings it to shame.

ING estimates China has pledged 8 trillion yuan in economic support — twice as much “stimulus” as it offered during the global financial crisis.

And the Organization for Economic Cooperation and Development (OECD) estimates China’s fiscal stimulus this year equals 4.25% of GDP… up from 2.94% last year.

Meantime, Chinese domestic consumption has been on the increase.

Growth through increased consumption — say the economics wiseacres in practice among us — reduces dependence on exports.

Is most of this stimulus woefully wasteful? Does it finance vastly unproductive economic activity?

Yes and yes.

Is the way to wealth through consumption — rather than production?

No, it is not.

But if Chinese authorities believe they can offset lost exports by bellowing credit and vomiting money… they may choose to dig in for the long haul.

“A nation is never as happy as when it’s at war”

A trade war may even rally the people to the colors…

A nation is never as happy as when it’s at war — even trade war.

War gives the people enemies to hate… and leaders to love.

What better way to distract a people from their own government’s eternal swinishness, its infinite rascality?

Despite all contrary appearance, the United States government does not run a corner on either.

In fact, China’s state media took to the warpath Monday.

It shouted for a “people’s war” against Mr. Trump’s “greed and arrogance.”

And why not? It could argue…

‘China is a proud, accomplished and ancient nation, with roots sunk deep into history.

It is the “Middle Kingdom,” the center to which all the world’s divergent rays bend.

Who are these upstart Americans to shove us around?’

Economic “Trench Warfare”

We would remind the president — respectfully — that wars are far easier to start than finish.

The boys will be home by Christmas, they gloated in August 1914.

Four years later they were still in the trenches — or in boxes.

Could the United States and China soon be locked in the extended stalemate of economic “trench warfare”?

The strategists at Deutsche Bank’s chief investment office fear so:

Unless a deal can be struck quickly in the coming weeks, markets will need to prepare themselves for an extended period of economic trench warfare. And large listed U.S. companies in particular could well find themselves in the line of fire.

China has previously chosen to “wait, strategically inflict pain, delay and hope U.S. pressure eventually goes away.”

But China has heaved aside that option, argues Deutsche Bank.

Now it is reaching for its shovel… and preparing to hunker in.

In conclusion:

The nature of trade wars (like actual wars) is that they foster nationalist sentiment and jingoism. The first shots are fired in the hope of quick victories. And before you know it, both sides are stuck in the trenches, with no obvious and politically feasible way out.

The coming weeks may well yield the answer.

But how will markets hold up if diplomacy collapses?

All Pressure May Fall on Trump

A failed trade deal was sufficient to send stocks careening this past week.

President Trump has all his cargo loaded on two wagons — the stock market and economy.

If either cracks an axle, if either collapses under the strain, his reelection prospects collapse in turn.

Therefore, argues analyst Sven Henrich of Northman Trader, all pressure rests upon the presidential shoulders of Donald J. Trump:

Because for Trump there’s an election to worry about. The Chinese don’t have an election to worry about and that puts the time pressure on Trump, not the Chinese. The Chinese will continue to intervene and yesterday they showed backbone and followed through on retaliation. But because the U.S. election cycle clock is ticking Donald Trump cannot afford a trade war extending into the end of the year, especially if the consequences of such a protracted trade war would spill into the larger economy.

Will the Great Negotiator be the one to blink first?

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Retaliation!

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“The next few weeks could be rocky.”

Bank of America’s fortune cookie writers may have undersold their case…

The trade war famously reopened Friday. The United States imposed 25% tariffs on $200 billion of Chinese products.

Come this morning, China announced retaliatory tariffs on $60 billion of United States products.

They enter effect June 1 — unless a negotiated truce first washes them out.

CNBC lists the butcher’s bill:

Beijing will increase tariffs on more than 5,000 products to as high as 25%. Duties on some other goods will increase to 20%. Those rates will rise from either 10% or 5% previously. 

American agricultural products were not excepted. Soybean and cotton prices went plummeting today… in consequence.

Additional retaliation, suggest some Chinese sources, may await.

Trade war, like any other war, is harder to stop than to start.

China Maximizes the Market Impact

Was it coincidence that this morning’s blast arrived in time for opening whistle on Wall Street?

Samantha Azzarello, global market strategist at JPMorgan:

China retaliating as fast as they did was a clear signal they’re not going to be pushed around… It was interesting it wasn’t done on the weekend. It was done just in time Monday morning for markets to open.

On cue the floodgates swung open at 9:30… and a red deluge came washing down the canyons.

The Dow Jones was instantly 400 points under… then 500… 600… and 700 by early afternoon.

By midafternoon the worst of the hemorrhaging was plugged.

The Dow Jones ended the day down 617 points.

But for the first occasion since February, it has slipped beneath its 200-day moving average — which has the chart watchers shaken and rattled.

The S&P lost another 70 points today.

But percentage wise, the trade-sensitive Nasdaq withstood the worst slating of the three — down 270 points on the day — or 3.41%.

“Very bad for China, very good for USA!”

President Trump laughed off all concerns this morning… and insisted China is brunting the true impact.

Their [sic…] is no reason for the U.S. Consumer to pay the Tariffs, which take effect on China today… Also, the Tariffs can be completely avoided if you by from a non-Tariffed Country, or you buy the product inside the USA (the best idea). That’s Zero Tariffs. 

Here he digs his thumbs into China’s eyes, and gives them a good hard twist:

Many Tariffed companies will be leaving China for Vietnam and other such countries in Asia. That’s why China wants to make a deal so badly! There will be nobody left in China to do business with. Very bad for China, very good for USA!

The American Consumer: Hidden Casualty

But the president’s top economics man — Larry Kudlow — conceded this weekend that American consumers will in fact pay much of the freight.

Companies that accept imports actually pay the tariffs at water’s edge.

These costs they pass along to the consumer further down the line.

Thus tariffs represent a tax increase upon Joseph and Jane Average American… who must stretch deeper into their pockets to purchase the same goods.

And now that China has responded in kind, Chinese demand for American products will slacken.

Oxford Economics has issued a new report. It reveals…

That a 25% tariff on $200 billion of Chinese goods imports would cost the United States economy $62 billion once all scales are balanced, once all accounting is settled.

That figure amounts to $490 per household… incidentally.

What if the president levies additional tariffs on all Chinese wares, as he has threatened?

Oxford estimates total economic losses would cost the United States some $100 billion by next year — or $800 per household.

The Seen vs. the Unseen

The president must have misplaced his copy of Economics in One Lesson by legendary economics journalist Henry Hazlitt.

From which:

This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups…

The bad economist sees only what immediately strikes the eye; the good economist also looks beyond… The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.

Hazlitt’s is a faint and feeble voice coming from the tomb.

There is the seen, he reminds us… as he struggles to rise above the din of the living.

But there is also the unseen.

You must consider the unseen effects of any given policy.

But it requires a special effort of the imagination. And few can conjure the image…

The Unseen

They cannot observe the lost jobs, the money unspent on other goods, the cost of retaliatory tariffs.

Here is what the president does not appreciate…

The businesses that will not open or will not expand because the inputs of industry are costlier…

The money Americans will not spend on other goods and services because they are expending more for these goods…

The American products that will go unsold abroad because of the tariffs China throws up in retaliation.

Or as another president, Woodrow Wilson, once said in reference to the sugar tariff:

“Very few of us taste the tariff in our sugar.”

Few ask the right questions… connect the proper dots… draw the right conclusions.

Heave 100 bricks off a rooftop in any American city.

One — perhaps two — will find a man who tastes the tariff in his sugar.

That is precisely how the political men prefer it.

But the costs are nonetheless real.

In the Unseen… We Will See the Light

Yes, it is true… tariffs may open one door for one American.

But they slam one door shut on the nose of another.

For every extra dollar that jingles in the one fellow’s pocket… one less dollar jingles in the other fellow’s pocket.

This fellow will see his pay envelope shrink — in effect, his taxes raised.

In conclusion, tariffs benefit few. And damage many.

Let us instead direct our focus to the unseen, as a wise voice whispers from beyond the grave.

It is here — in the unseen — that we will see the light…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Retaliation! appeared first on Daily Reckoning.

Trump Attacks!

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The trade war is back on. The trade deadline came and went at midnight last night without a deal. So 25% tariffs on $200 billion worth of Chinese goods took effect at 12:01. The tariffs had previously been set at 10%.

Based on Trump’s comments, 25% tariffs may possibly be applied to an additional $300 billion of Chinese goods.

China said it would respond with unspecified but “necessary countermeasures,” although negotiations continued today in Washington.

Some analysts say China can dump its large holdings of U.S. Treasuries on world markets. That would drive up U.S. interest rates as well as mortgage rates, damaging the U.S. housing market and possibly driving the U.S. economy into a recession. Analysts call this China’s “nuclear option.”

There’s only one problem.

The nuclear option is a dud. If China did sell some of their Treasuries, they would hurt themselves because any increase in interest rates would reduce the market value of what they have left.

Also, there are plenty of buyers around if China became a seller. Those Treasuries would be bought up by U.S. banks or even the Fed itself. If China pursued an extreme version of this Treasury dumping, the U.S. president could stop it with a single phone call to the Treasury.

That’s because the U.S. controls the digital ledger that records ownership of all Treasury securities. We could simply freeze the Chinese bond accounts in place and that would be the end of that.

So don’t worry when you hear about China dumping U.S. Treasuries. China is stuck with them. It has no nuclear option in the Treasury market.

How did we get here?

Trump’s trade representatives have complained that China had backtracked on previous agreements and that China was trying to renegotiate key points at the last minute. The Chinese are not accustomed to such resistance from U.S. officials. But Trump and his team are unlike previous administrations.

China assumed it was “business as usual” as it had been during the Clinton, Bush 43 and Obama administrations. China assumed it could pay lip service to trading relations and continue down its path of unfair trade practices and theft of intellectual property. Trump has proven them wrong.

Trump was never bluffing. He means business, which China is finally learning.

There’s still time to reach a deal, however, before the tariffs actually have any practical impact. The tariffs only apply to Chinese goods that leave port after last night’s deadline. That means goods already en route to the U.S. will not be affected.

So it will be at least two weeks until Chinese goods are actually subject to the extra tariffs. So that leaves the window open for a deal.

Trump announced on Twitter early this morning that “there is absolutely no need to rush” to get a deal done, which removed any urgency from negotiations for the moment. You can expect the cat and mouse to continue for the next couple of weeks, with volatile swings in the stock market depending on the news of the day.

But Trump holds the superior hand as far as trade goes. China exports far more to the U.S. than the U.S. exports to China, so China has far more to lose in the trade war. Since the trade war began, the U.S. has suffered only minor impacts, while the impact on China has been overwhelming. The new tariffs will have even more serious effects on the Chinese economy.

A 25% tariff on $200 billion of goods could take 0.3–0.4% off Chinese growth. And if Trump carries through with 25% tariffs on an additional $300 billion of Chinese goods, it could subtract an additional 0.5% from Chinese growth.

That would cost China 0.8–1% of lost GDP at a time when the Chinese economy is struggling and can least afford it.

To go along with slowing growth, the Chinese financial sector is totally insolvent. Consumers’ savings have been used to finance ghost cities, white elephants, capital flight, Ponzi schemes, bribes and kickbacks.

There are some real assets to show (their trains are the best in the world) and some growth, but not nearly enough to cover liabilities.

With a debt-to-GDP ratio of about 250%, China is already well into the danger zone. How much more debt-financed stimulus can it take?

Research by economists Kenneth Rogoff and Carmen Reinhart indicates that debt-to-GDP becomes a drag on the economy at 90%.

China’s leadership can only hope the damage can be limited before the people begin to question its legitimacy.

Could China’s leadership lose “The Mandate of Heaven?”

Regards,

Jim Rickards
for The Daily Reckoning

The post Trump Attacks! appeared first on Daily Reckoning.

The Trade War Is Back

This post The Trade War Is Back appeared first on Daily Reckoning.

President Trump shocked markets yesterday when he announced that a new, heavy round of tariffs on Chinese goods will take effect this Friday. Complacent markets had assumed that a trade deal would get done, that it was just a matter of sorting out the details. Now that is far from certain. Failing a last minute deal, which is certainly possible, the trade war is back. And it could get worse.

What most surprised me about the new trade war was not that it started, but that the mainstream financial media denied it was happening for so long. The media have consistently denied the impact of this trade war. Early headlines said that Trump was bluffing and would not follow through on the tariffs. He did. Later headlines said that China was just trying to save face and would not retaliate. They did.

Today the story line has been that the trade war will not have a large impact on macroeconomic growth. It will. The mainstream media have been wrong in their analysis at every stage of this trade war. And it did not see this latest salvo coming.

The bottom line is that the trade war is here, it’s highly impactful and it could get worse. The sooner investors and policymakers internalize that reality, the better off they’ll be.

For years I’ve been warning my readers that a global trade war was likely in the wake of the currency wars. This forecast seemed like a stretch to many. But it wasn’t.

I said it would simply be a replay of the sequence that prevailed from 1921–39 as the original currency war started by Weimar Germany morphed into trade wars started by the United States and finally shooting wars started by Japan in Asia and Germany in Europe.

The existing currency war started in 2010 with Obama’s National Export Initiative, which led directly to the cheapest dollar in history by August 2011. The currency war evolved into a trade war by January 2018, when Trump announced tariffs on solar panels and appliances mostly from China. Unfortunately, a shooting war cannot be ruled out given rising geopolitical tensions.

The reasons the currency war and trade war today are repeating the 1921–39 sequence are not hard to discern. Countries resort to currency wars when they face a global situation of too much debt and not enough growth.

Currency wars are a way to steal growth from trading partners by reducing the cost of exports. The problem is that this tactic does not work because trade partners retaliate by reducing the value of their own currencies. This competitive devaluation goes back and forth for years.

Everyone is worse off and no one wins.

Once leaders realize the currency wars are not working, they pivot to trade wars. The dynamic is the same. One country imposes tariffs on imports from another country. The idea is to reduce imports and the trade deficit, which improves growth. But the end result is the same as a currency war. Trade partners retaliate and everyone is worse off as global trade shrinks.

The currency wars and trade wars can exist side by side as they do today. Eventually, both financial tactics fail and the original problem of debt and growth persists. At that point, shooting wars emerge. Shooting wars do solve the problem because the winning side increases production and the losing side has infrastructure destroyed that needs to be rebuilt after the war.

Yet the human cost is high. The potential for shooting wars exists in North Korea, the South China Sea, Taiwan, Israel, Iran, Venezuela and elsewhere. Let’s hope things don’t get that far this time.

But the easiest way to understand the trade war dynamics is to take Trump at his word. Trump was not posturing or bluffing. He will agree to trade deals, but only on terms that improve the outlook for jobs and growth in the U.S. Trump is not a globalist; he’s a nationalist. That may not be popular among the elites, but that’s how he sets policy. Keeping that in mind will help with trade war analysis and predictions.

Trump is entirely focused on the U.S. trade deficit. He does not care about global supply chains or least-cost production. He cares about U.S. growth, and one way to increase growth is to reduce the trade deficit. That makes Trump’s trade policy a simple numbers game rather than a complicated multilateral puzzle palace.

If the U.S. can gain jobs at the expense of Korea or Vietnam, then Trump will do it; too bad for Korea and Vietnam. From there, the next step is to consider what’s causing the U.S. trade deficit. This chart tells the story. It shows the composite U.S. trade deficit broken down by specific trading partners:

The Gap https://s3.amazonaws.com/paradigmpress-uploads/wp-content/uploads/2019/05/chart_the-gap-in-trade.pnin Trade - Chart

The problem quickly becomes obvious. The U.S. trade deficit is due almost entirely to four trading partners: China, Mexico, Japan and Germany. Of those, China is 64% of the total.

President Trump has concluded a trade deal with Mexico that benefits both countries and will lead to a reduced trade deficit as Mexico buys more U.S. soybeans.

The U.S. has good relations with Japan and much U.S.-Japanese trade is already governed by agreements acceptable to both sides. This means the U.S. trade deficit problem is confined to China and Germany (often referred to euphemistically as “Europe” or the “EU”).  The atmosphere between the U.S. and the EU when it comes to trade is still uneasy, but not critical.

But the global trade war is not global at all but really a slugfest between the U.S. and China, the world’s two largest economies. In the realm of global trade, the United States is an extremely desirable customer. In fact, for most, we are their best customer.

Think the still export-based Chinese economy can afford to sell significantly less manufactured goods across borders? Think that same Chinese economy can allow for a significant devaluation of U.S. sovereign debt? That’s their book, gang.

But China has finally come to the realization that the trade war is real and here to stay. Senior Chinese policymakers have referred to the trade war as part of a larger strategy of containment of Chinese ambitions that may lead to a new Cold War. They’re right.

Trump seems to relish the idea of bullying the Chinese in public. That’s certainly his style, but it’s also a risky strategy. To quote Sun Tzu: “Do not press a desperate foe too hard.”

China doesn’t like to be chastised publicly any more than anyone else, but culturally, saving-face may be more important to the Chinese. The Chinese are all about saving face and gaining face. That means they can walk away from a trade deal even if it damages them economically. Saving face is too important. But Trump is playing for keeps and will not back down either.

Unlike in other policy arenas, Trump has enjoyed bipartisan support in Congress. The Republicans have backed Trump from a national security perspective and the Democrats have backed him from a pro-labor perspective. China sees the handwriting on the wall.

This trade war will not end soon, because it’s part of something bigger and much more difficult to resolve. This is a struggle for hegemony in the 21st century. The trade war will be good for U.S. jobs but bad for global output. The stock market is going to wake up to this reality. The currency wars and trade wars are set to get worse.

Investors should prepare.

Regards,

Jim Rickards
for The Daily Reckoning

The post The Trade War Is Back appeared first on Daily Reckoning.