Trump Declares War

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Trump has had it!

He is apparently declaring a currency war on the rest of the world. Trump resents China and Europe cheapening the yuan and the euro against the dollar in order to help their exports and hurt ours.

He says it’s time for the U.S. to cheapen the dollar also. Trump has a point. If you put a 25% tariff on many Chinese exports to the U.S. (as Trump has done) or a 25% tariff on German cars exported to the U.S. (as Trump has threatened to do), it can be a powerful way to reduce the U.S. trade deficit and generate revenue for the U.S. Treasury.

But a trading partner can undo the effect of the tariff just by cheapening its currency.

Let’s say a Chinese-made cellphone costs $500 in the U.S. If you slap a 25% tariff on the imported phone, the immediate effect is to raise the price by $125.

A simple solution to tariffs is to devalue your currency by 20% against the dollar. Local currency costs do not change, but the cellphone now costs $400 when the local currency price is converted to U.S. dollars.

A 25% tariff on $400 results in a total cost of $500 — exactly the same as before the tariffs were imposed. Tariff costs have been converted into lower production costs through currency manipulation.

There’s only one problem with Trump’s currency war plan. There’s nothing new about it. The currency wars started in 2010 as described in my 2011 book, Currency Wars. 

As soon as one country devalues, its trading partners devalue in retaliation and nothing is gained. It’s been described as a “race to the bottom.” 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. But the final step in the sequence is often shooting wars. That’s what happened leading up to WWII. Let’s hope the currency wars and trade wars don’t turn into shooting wars as they did in the 1930s.

Meanwhile, the Fed is a critical player in the currency war because it has a major influence on the dollar.

The world is waiting to see what it does at its policy meeting on July 31. There is almost no chance the Fed will raise rates. The choices are to cut rates or keep rates unchanged. The market is betting heavily on a rate cut, for what it’s worth.

If the Fed cuts rates, we’ll have to see how other central banks react. But the Fed has many factors to consider when it meets later this month…

For the past 10 years, Fed policy changes have been relatively straightforward to forecast, based on a simple model. The model said the Fed would raise rates consistently in 0.25% increments until rates are normalized around 4% (the amount needed to cut in case of recession).

The exceptions (where the Fed would “pause” on rate hikes) would occur when job creation is low or negative, markets are disorderly or strong disinflation threatens to turn to deflation. Markets certainly became disordered late last year, when the U.S. stock market nearly entered a bear market. And so the Fed paused.

None of those conditions apply today. Job creation is strong, markets are at all-time highs and disinflation is mild. But a new factor has entered the model, which is the fear of causing a recession.

Estimated growth for the second quarter of 2019 is 1.3% annualized, compared with 3.1% in the first quarter. Using the Fed’s own models (which are different from mine), the Fed is concerned that if they don’t cut rates, a market correction and recession may occur.

But if they do cut rates, inflation may result due to tight labor markets and higher costs due to tariffs.

This Fed decision will likely come down to the wire. Second-quarter GDP will be reported on July 26, and personal income and outlays will be reported on July 30. Both data points (and underlying inflation data) will be available right before the July 31 decision date.

Markets will cheer a rate cut and probably sell off if the Fed does not cut rates. But both the markets and the Fed itself will have to wait until the last possible minute before this conundrum is resolved.

And the world will be watching very closely.

Below, I show you how Fed policy is one of three factors driving a new multiyear rally in gold. What are the other two? Read on.

Regards,

Jim Rickards
for The Daily Reckoning

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The Cult of the Trump Tax Refund

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Last week, I told you how I got a surprise correction from the IRS – one relating to Trump’s new tax laws and my Solo 401(k) retirement plan.

What I didn’t mention is the monetary impact of that note – essentially, I ended up owing a couple thousand more in taxes than I had previously figured.

Before you shed a tear, on balance, the new tax laws were a net positive for my specific situation last year.

Even though my Solo 401(k) contributions were slightly less valuable, the qualified business income deduction was a big win …

While the SALT cap is painful for someone like me living in California – with high state income taxes and high property taxes – at least my oversized mortgage is still fully deductible because I purchased my home before the new lower limits kicked in …

And with a young child in the home, the doubling of the child tax credit (plus higher phaseout thresholds), was an additional positive.

I could keep going.

The point is that many things changed and how the sum total affected you depends on the very specific details of your life.

How did Americans Fare Under Trump’s Tax Changes?

The IRS just released its first batch of official numbers, using tax returns filed by May 23rd.

Roughly 10% of filers are still using the benefit of extensions and haven’t turned in their returns yet. Moreover, that group of people tend to be higher-income filers – with more complicated returns – and they represent 20% of all the income reported to the IRS.

Still, we can get a good idea of where things stand.

Here are some general takeaways:

#1. Households making somewhere between $100,000 and $250,000 received fewer refunds and were more likely to owe money.

That comes from a Wall Street Journal analysis of the IRS’ data. But we’ll talk more about this idea in just a second. It isn’t really what it seems.

#2. Average refunds for households making $250,000 to $500,000 rose 11%.

I suspect this has a lot to do with the aforementioned QBI and other benefits for businesses and their owners.

If you’re starting to feel like only the wealthy made out …

#3. From a high-level view, about the same number of Americans got refunds this year (79% vs. 80%) and for roughly the same amount ($2,879 vs $2,908) as the 2017 tax year.

So if you’re now feeling like the ultra-wealthy made out and everyone else got shafted, you’re not alone.

Barron’s recently cited a Gallup poll conducted in April, which found only 14% of Americans thinking their taxes went down.

However, the reality is far different …

#4. The Tax Policy Center says roughly two-thirds of American households paid less in taxes overall year-over-year while 6% paid more.

How is this possible?

How can half of the population not realize their taxes actually went down under the new laws?

Beyond the fact that many people outsource their tax preparation and thus have no real connection to what’s happening in that part of their life, many Americans only look at their refunds.

If they get money back after they file, they’re happy.

If they get more than last year, they’re really happy.

Of course, none of that makes rational sense.

This year, for example, IRS withholding amounts were adjusted earlier in the year.

That means many workers had less money getting taken out of their regular paychecks. So what they ended up owing or getting back is not a good indication of how they fared overall.

So What’s with the Overreaction?

The entire “cult of the tax refund” is completely misguided and always has been.

Getting a large refund from Uncle Sam simply means you loaned him a good chunk of money at zero-percent interest over the course of the year.

That’s hardly something to celebrate!

Instead, your goal should be paying exactly what you owe and not a penny more.

Or, even better, paying less than you owe without incurring underpayment penalties and then writing a check for the difference come filing time.

And bonus points if you have the difference invested and earning some type of return during the interim … which is the polar opposite of what almost everyone else does.

To a richer life,

Nilus Mattive

— Nilus Mattive
Editor, The Rich Life Roadmap

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About Today’s Jobs Report…

This post About Today’s Jobs Report… appeared first on Daily Reckoning.

The May unemployment report came rolling from the United States Department of Labor this morning.

In the highly technical vernacular of the trade… it was a “miss.”

And not by a nose, not by a hair, not by a whisker.

Economists as a group divined 175,000 May jobs.

What was the actual number?

Seventy-five thousand — fully 100,000 beneath consensus — and the lousiest figure since February.

Each one of 77 Wall Street analysts — each one — heaved up a greater estimate.

But unlike February, they cannot foist blame upon winter weather or a government shutdown.

Thus our faith in experts staggers yet again… and fast approaches our faith in weathermen, crystal gazers, salesmen of pre-owned automobiles and congressmen of the United States.

But our faith in the lunacy of the existing financial system is infinitely confirmed…

Wall Street vs. Main Street

In a healthful and functioning order, the stock market is a plausible approximation of prevailing economic conditions.

A poor unemployment report should send panicked shudders through the stock market.

It indicates a wobbled economy. Rough business is likely ahead. And companies can expect a reduced profit.

Stocks should — in consequence — fall tumbling on the news.

But ours is not a healthful and functioning order. It is rather an Alice in Wonderland order.

Up is down. Down is up. Good news is bad news.

And bad news is good news…

Bad news for Main Street is good news for Wall Street, that is.

Wall Street thrives on Main Street’s bad news as doctors thrive on fractured legs… as dentists thrive on toothaches… as embalmers thrive on murders.

And this morning’s jobs report constitutes good news for Wall Street.

It merely forms additional evidence the Federal Reserve will be slashing interest rates soon.

And low interest rates are the helium that lifted stocks to such gaudy and obscene heights lo these many years.

Stocks Soar on Today’s Weak Jobs Report

The Dow Jones was so heavily floored by this morning’s jobs report it went up 300 points by 11 a.m.

The other major indexes were similarly flabbergasted.

The S&P was up 35 points and the Nasdaq up 130 by the same 11 a.m.

All three indexes composed themselves somewhat by day’s end.

The Dow Jones ended the day 263 points in green territory. The S&P gained 30 points, while the Nasdaq added 126.

Yet as we documented Wednesday, the economy is going backward… and recessionary warnings flash in all directions.

Meantime, all reasonable estimates place second-quarter GDP growth under 2%.

But because the Federal Reserve promises yet additional levitating gases, the stock market has record heights once again in view.

“The Disconnect Between the Economy and Stocks is at Record Highs”

Thus the gentlemen of Zero Hedge declare, “The disconnect between the economy and stocks is at record highs.”

JJ Kinahan — chief market strategist at TD Ameritrade — here affirms the “bad news is good news” theory:

The market’s got a conundrum here. That’s a bad report. Just on the report itself, I think people would want to sell the market. However, the fact that it really makes the case for a rate cut, I think is why you’re seeing the market hang in there.

Affirms Mike Loewengart — vice president of investment strategy at E-Trade:

This is the type of [jobs report] the doves will really take to as it supports the argument for cutting rates beyond politics or trade issues…

Luke Tilley, chief economist at Wilmington Trust, adds:

I think that this is a true slowdown in hiring right now… The market signals are obviously screaming for the Fed to reduce rates.

Wall Street has Jerome Powell by the ear.

When Wall Street screams for lower interest rates, lower interest rates it will have.

Odds of Rate Cuts Approach 100%

The market presently gives 84% odds that the Federal Reserve will cut rates at least 25 basis points by July. By September those odds increase to 95%.

By January, they rise to 99%… with the heaviest betting on two rate cuts.

Investors further expect at least three rate cuts by next June.

But as we have detailed at length… you can expect recession within three months of the inevitable rate cut — whenever it may fall.

Yes, the next destination is recession.

The route may twist, the route may meander, the route may even temporarily turn back on itself.

But it terminates in recession nonetheless.

The “New Normal”

The No. 2 man at the Federal Reserve would nonetheless have us put away all talk of recession.

Mr. John Williams insists diminished growth is merely the “new normal”:

I know this talk of slowing growth is causing uncertainty, some hand-wringing and even fear of recession. But slower growth shouldn’t necessarily come as a surprise. Instead, it’s the “new normal” we should expect.

But with the highest respect to Mr. Williams… why shouldn’t we expect more?

The United States government borrowed in excess of $10 trillion over the prior decade.

$10 trillion is plenty handsome. Yet that $10 trillion of debt yielded only $3 trillion of real GDP.

Or to switch the figures some, the nation’s debt increases roughly $100 billion per month.

But GDP only increases some $40 billion per month.

We have gotten plenty of buck, that is. But not half so much bang to go with it.

The nation’s debt-to-GDP ratio already exceeds 100% — its highest since WWII.

The standard formula says deficits should decline during economic expansions. Come the inevitable recession, the government then has a full war chest to throw at it.

But a decade into the current expansion… the Treasury is depleted.

Trillion-dollar deficits extend to the horizon.

And the debt-to-GDP ratio is projected at 115% within three years.

Meantime, the Federal Reserve expects long-term GDP growth of 1.9%.

It is a bleak calculus — growing debt twinned with sagging growth.

The Mills of the Gods 

As we have argued previously, time equalizes as nothing else.

Scales balance, that which goes up comes down, that which goes down comes up…

The mighty fall, mountains crumble, the meek inherit the Earth.

We suspect strongly that stock market and economy will meet again on fair ground.

We further suspect it is stock market that will fall to the level of economy. Not the other way.

The mills of the gods may grind slowly, as Greek philosopher Sextus Empiricus noted.

But as he warned…

They grind exceedingly fine…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Wall Street and the New Cold War

This post Wall Street and the New Cold War appeared first on Daily Reckoning.

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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Has Recession Already Started?

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“Sit down before fact like a little child,” Thomas Huxley instructed, and “follow humbly wherever and to whatever abyss Nature leads…”

Today we sit down before facts, childlike… and follow humbly wherever and to whatever abyss they lead.

But what if the facts lead straight to the abyss of recession?

Facts 1: April orders for core nondefense capital goods slipped 0.9%.

Facts 2: April orders for durable goods — items expected to endure three years or more — sank 2.1%. Durable goods shipments overall dropped 1.6%… the most since December 2015.

Facts 3: April orders for transportation equipment plunged 5.9%.

Facts 4: April retail sales slipped 0.2%.

Facts 5: The “yield curve” has inverted good and hard — a nearly perfect omen of recession.

Has Recession Already Arrived?

Stack facts 1–5 one atop the other. What can we conclude?

“U.S. recession probably started in the current quarter.”

This is the considered judgment of A. Gary Shilling. Mr. Shilling is a noted economist and financial analyst.

And he gazes into a crystal ball less murky than most.

Wikipedia:

In the spring of 1969, he was one of only a few analysts who correctly envisioned the recession at year’s end and was almost a lone voice in 1973… the first significant recession since the Great Depression.

But is not the economy still expanding?

Q1 GDP rang in at a hale and hearty 3.2% — after all.

But peer behind the numbers…

Much Less than Meets the Eye

Much of the jauntiness was owing to transitory factors such as inventory accumulation.

Firms squirreled away acorns to jump out ahead of looming tariffs, giving Q1 GDP a good jolt.

But that jolt has come. And that jolt has gone.

Meantime, Q2 GDP figures will come rising from the bureaucratic depths tomorrow morning.

What can you expect from them?

A severe letting down, it appears…

Q2 GDP Estimates Revised Downward

Morgan Stanley has lowered its Q2 GDP forecast from 1.0%… to a sickly 0.6%.

J.P. Morgan has lowered its own sights from 2.25% to 1%.

Meantime, the professional optimists of the Federal Reserve’s Atlanta command ring in at a slender 1.4%.

Miles and miles — all of them — from the first quarter’s 3.2%.

Might these experts botch the actual figure?

They may at that… and it would not be the first instance.

But the weight of evidence here assembled loads the scales in the other direction.

Besides, recessions first appear in the rearview mirror. They are only identified several months to one year post factum… if not longer.

Perhaps the economy has already started going backward, as Mr. A. Gary Shilling suggests.

Or perhaps he has spotted a phantom menace, a shadow, a false bugaboo.

What does the “yield curve” have to say?

The Message of the Yield Curve

The yield curve is simply the difference between short- and long-term interest rates.

Long-term rates normally run higher than short-term rates. This happy condition reflects the structure of time in a healthy market.

The 10-year yield, for example, should run substantially higher than the 3-month yield.

The reason is close by…

The 10-year Treasury yield rises when markets anticipate higher growth — and higher inflation.

Inflation eats away at money tied up in bonds… as a moth eats away at a cardigan.

Bond investors therefore demand greater compensation to hold a 10-year Treasury over a 3-month Treasury.

And the further out in the future, the greater the uncertainty. Thus the greater compensation investors demand for taking the long view.

Compensated, that is, for laying off the sparrow at hand… in exchange for the promise of two in the distant bush.

Time Itself Inverts

But when the 3-month yield and the 10-year yield begin to converge, the yield curve flattens… and time compresses.

When the 10-year yield falls beneath the 3-month yield, the yield curve is said to invert. And in this sense time itself inverts.

The signs that point to the future lead to the past. And vice versa.

In the careening confusion, future and past run right past one another… and end up switching places.

Thus, an inverted yield curve wrecks the market structure of time.

It rewards pursuit of the bird at hand greater than two in the future.

That is, the short-term bondholder is compensated more than the long-term bondholder.

That is, the short-term bondholder is paid more to sacrifice less… and the long-term bondholder paid less to sacrifice more.

That is, something is dreadfully off.

“A Nearly Perfect Omen of Lean Days Ahead”

An inverted yield curve is a nearly perfect omen of lean days ahead. It suggests an economic winter is coming… when investors expect little growth.

Explains Campbell Harvey, partner and senior adviser at Research Affiliates:

When the yield curve inverts, it’s not the time to borrow money to take a vacation to Orlando. It is the time to save, to build a cushion.

An inverted yield curve has accurately forecast all nine U.S. recessions since 1955.

Only once did it yell wolf — in the mid-1960s.

It has also foretold every major stock market calamity for the past 40 years.

The yield curve last inverted in 2007. Prior to 2007, the yield curve last inverted in 1998.

Violent shakings followed each inversion.

History reveals the woeful effects of an inverted yield curve do not manifest for an average 18 months.

And now, in 2019… the doomy portent drifts once again into view.

The Bond Market’s Strongest Signal Since the Financial Crisis

The 3-month and 10-year yield curve inverted in March. It has since straddled the zero line, leaning with the daily headlines.

But this week the inversion has gone steeply negative.

We are informed — reliably — that the yield curve has presently inverted to its deepest point since the financial crisis.

Why is the 3-month versus the 10-year yield curve so all-fired important?

Because that is the section of the yield curve the Federal Reserve tracks closest. It believes this portion gives the truest reading of economic health.

Others give the 10-year versus the 2-year curve a heavier weighting.

But it is the Federal Reserve that sets policy… not others.

Federal fund futures presently offer 86% odds that Mr. Powell will lower interest rates by December… and 60% odds by September.

If recession is not currently underway, we are confident the Federal Reserve’s next rate cut will start the countdown watch.

Specifically:

Come the next rate cut, recession will be three months off — or less.

Why do we crawl so far out upon this tree limb?

President Trump Should Demand Jerome Powell Not Raise Interest Rates

The next rate cut will be the first after a hiking cycle (which commenced in December 2015).

And the past three recessions each followed within 90 days of the first rate cut that ended a hike cycle.

Assume for now the pattern holds.

Assume further the Federal Reserve lowers interest rates later this year.

Add 90 days.

Thus the economy may drop into recession by early next year.

Allow several months for the bean counters at Washington to formally identify and announce it.

You may have just lobbed recession onto the unwanting lap of President Donald John Trump… in time for the furious 2020 election season.

Could the timing be worse for the presidential incumbent?

Mr. Trump has previously attempted to blackjack Jerome Powell into lowering rates.

But if our analysis holds together…

The president should fall upon both knees… and beg Mr. Powell to keep rates right where they are…

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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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

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What Trump’s Really Thinking

This post What Trump’s Really Thinking appeared first on Daily Reckoning.

Last week the president thundered for a 100-basis-point rate cut… and a resumption of quantitative easing.

But why has President Trump raged anew for rate cuts?

After all…

Latest GDP officially hums at a tuneful 3.2% — and official unemployment scarcely has existence.

Is it simply because the president is a “low interest rate guy”?

Is he merely setting his cap for 2020? Or is his concern far more immediate?

Today we don our detective hat, open our sleuth kit… and piece things out.

But first, another day of long faces on Wall Street — the fourth consecutive losing session.

The Dow Jones shed another 139 points. The S&P lost nine; the Nasdaq 33.

The tariffs go up tonight at 12:01 Eastern should final hour diplomacy fail.

And the hourglass runs low.

But why again the president’s latest shouts for rate cuts?

“Given the Economic Situation, the Federal Funds Rate Should Be Closer to 5% than the Current 2%”

Scratching his head is Michael Carino, CEO of Greenwich Endeavors:

President Trump tweeted that the Federal Reserve should lower the federal funds rate by 100 bps and reengage their bond buying program known as quantitative easing to accelerate the current and longest-ever expansion in the U.S.

What could possibly convince President Trump that such aggressive monetary policy is required. After all, GDP is running well above average at 3.2%, unemployment is at historic lows of 3.6% and… given the economic situation, the federal funds rate should be closer to 5% than the current 2%. Talking about unconventional monetary policy that should only be used in times of extreme crisis is, to be polite, premature.

Then why?

Carino began sniffing for clues…

Instantly he plucked one from the presidential tweet above mentioned:

“China is adding great stimulus to its economy while at the same time keeping interest rates low.”

China?

Now he had the president’s scent. Down dark and bending roads he pursued it:

Trump’s Real Motivation?

… The trade war with China is about to get expensive with tariffs increasing from 10% to 25%.

With China trade at $500 billion, a 25% tariff would be the equivalent of taxing the U.S. $125 billion. This tax is enough to bring the change in GDP in any quarter from a healthy 2–3% to zero or negative. 

Zero or negative GDP growth would pry from Trump his principle selling point — the economy.

At last, this Carino ran down his quarry, seized him by the collar… and hauled him in:

Though a simplistic thought process, it’s obvious President Trump wants to use the Federal Reserve to offset costs of upcoming government action…

Putting it bluntly, China’s central bank is funding state policies and subsidizing the costs of those policies and President Trump wants to do the same. 

Have we solved a puzzle?

Perhaps it explains the president’s most recent wailing for drastic rate cuts and quantitative easing.

But even if inclined, it is far from certain the Federal Reserve can equal the task.

A Decade of Futility

Ten years running the central bank has nailed interest rates to the floor — or just above it.

Rates still remain at levels historically low.

Yet the present economic expansion remains the most punchless on record.

And growth today pegs along at roughly the same rate as under Mr. Barack Obama.

Even he had his scintillating and bedazzling quarters of growth. Yet each proved a false start, a false dawn — a false hope.

Have conditions materially changed under No. 45?

Alas… they have not.

Prior to 2019’s first-quarter 3.2%, growth has trended wrong since 2018’s second quarter.

And Q1’s 3.2% likely owes to transient and passing factors — business inventories to name one.

Second-quarter GDP Will Likely Disappoint

The perpetual bright-siders at the Federal Reserve’s Atlanta wing project Q2 growth of 1.6%.

How about the wizards at Morgan Stanley?

1.1%

And what figure does Goldman Sachs hazard for Q2 GDP?

Only marginally greater — 2.2%.

But these are mere crystal gazings, you say. These seers badly botched the first quarter’s reading.

Maybe they’ll blunder again.

Perhaps they will.

But let us glance again beneath the first quarter’s shimmering 3.2% GDP…

Subtract from the mix inventories and the “addition” of government spending.

We are left with GDP expansion not of 3.2%… but 1.3%.

More:

Consumer durable goods spending sank 5.3% — the steepest plunge in 10 years.

Private-sector consumption and investment trickled to a semicomatose 1.3%.

Consumer spending overall increased a mere 1.2%… off from 2.5% the quarter previous.

And from the previous quarter’s 5.4%, Q1 business investment halved — to 2.7%.

Can the Federal Reserve work a reversal of existing trends?

Not in our telling — its ammunition is largely blank.

The Federal Reserve Is “Largely Irrelevant”

Here, here and here we have presented this argument: The central bank is a false fee-fi-fo-fum.

It pulls false levers, yanks false pulleys.

It is not, in fact, central.

The Daily Reckoning, one week ago today:

The Fed is, largely outside of temporary sentiment, irrelevant. The central bank is not central… The thing people have the most trouble with is the idea that central banks are not central. It flies in the face of everything you have been taught and told your whole life… 

There is absolutely no legitimate reason why anyone should [notice federal funds.] The federal funds market is a nonentity… pocket change… It is the sparest of spare liquidity… Today, federal funds are nothing, an extraneous anachronism.

The true kingpin of the banking system — we maintained — is an invisible “shadow” banking system.

This shadow system consists of the major banks and their offshore subsidiaries.

This shadow banking system has never recovered from the Great Financial Crisis.

Until it does, the economy will likely wallow along at existing speeds — or perhaps slower.

But if the Federal Reserve is a helpless homunculus and the banking system crippled… what might “fund state policies and subsidize the costs of those policies?”

MMT Is “Inevitable”

Modern Monetary Theory (MMT)… or “QE for the people.”

The Treasury will seize the role of the Federal Reserve. It will hose money directly onto Main Street. It will also fund extravagant government programs.

We suspect MMT will gain a vastly wider hearing come the next downturn.

And why wouldn’t President Trump line up behind it if he is in office at the time?

He has demonstrated little opposition to spending money. Quite the contrary… in fact.

There is even a “conservative” version of MMT he could pull from his hat as a “responsible” alternative.

Tycoon Ray Dalio spots the handwriting scribbled upon the wall.

“Inevitable” is how he describes MMT:

To me the most important engineering puzzle policy makers around the world have to solve for the years ahead is how to get the economic machine to produce economic well-being for most people when monetary policy does not work…

It is inevitable that this shift will happen because it is inevitable that central bankers will want to ease when interest rates are pinned at 0% and when quantitative easing will be ineffective in achieving the goal.

We fear Mr. Dalio may be correct.

Unfortunately, this cure will likely prove worse than the disease…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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To the Brink

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The cannons are readied, bayonets are fixed… the bugle is ready to blow.

Diplomacy has failed.

The trade war will resume this Friday — should 11th-hour negotiations fail.

The 10% tariff on $200 billion worth of Chinese wares becomes 25%.

And President Trump threatens to order 25% imposts on an additional $325 billion “soon.”

Existing tariffs are “partially responsible for our great economic results,” he justifies.

Meantime, Chinese negotiators have dallied, dithered and dawdled.

The president, Sunday:

For 10 months, China has been paying Tariffs to the USA of 25% on 50 Billion Dollars of High Tech, and 10% on 200 Billion Dollars of other goods. These payments are partially responsible for our great economic results. The 10% will go up to 25% on Friday. 325 Billions Dollars… of additional goods sent to us by China remain untaxed, but will be shortly, at a rate of 25%. The Tariffs paid to the USA have had little impact on product cost, mostly borne by China. The Trade Deal with China continues, but too slowly, as they attempt to renegotiate. No!

So Mr. Trump drops the carrot… and seizes the stick.

He undoubtedly hopes to pummel China into last-minute concessions.

Then he can thump his chest about a “wonderful” trade deal… wrested only in the nick of time.

Export-driven China needs the United States more than the United States needs China, he believes.

Following Sunday broadside, China threatened to back away from scheduled talks this week.

But it has since come around… and discussions will evidently proceed on the timetable agreed.

Goldman Sachs believes the feuding parties will come to terms before Friday. Sixty percent odds, they give, for a peaceful resolution.

But a dangerous game is underweigh…

China takes its honor very heavily. Will it be publicly shoved around?

Trump’s country hardball, explains Rabobank analyst Michael Every:

Puts [China’s]chief negotiator Liu He in a very awkward position. While it may be Trump’s style to be impulsive in the final stages of a deal, the Chinese government will lose face if they cave in to his demands following a public threat on Twitter. It could be perceived as a breach of trust and the Chinese may conclude that the U.S. has been negotiating in bad faith after all. 

What if China walks away from the negotiating table? Does Trump go chasing after it, sobbing for peace?

Or does he let them slip away — knowing retaliation ensues?

But only when they decide to walk away and announce their retaliation will we truly know Trump’s intentions. Is he really willing to cancel trade talks and to put the recent rally of his beloved stock market at risk? And this with just 18 months left before the U.S. elections? Or will he somehow regain control over his emotional intelligence and still find a way around this strong May 10 deadline?

These are the questions that rise before us. For the moment, no answers are issuing.

But Jasper Lawler — who heads research at London Capital Group — fears the Great Negotiator may be overplaying the cards in his hand:

“We know from experience that this could be one of Trump’s infamous negotiating tactics, but there is a good chance that this time it will backfire.”

We shall see… soon.

But what about the all-important stock market? How did markets take yesterday’s news?

Dow futures plunged 500 points Sunday evening. And the major indexes opened the day deeply in red.

But by mysterious coincidence, eager buyers soon fell upon Wall Street in throngs.

Stocks clawed their way back… and the Dow Jones regained some 300 points by midmorning.

Who came rushing in at the fatal moment?

We have no specific answer at this time.

But the wags at Zero Hedge pointed a jeering finger at the Plunge Protection Team.

By the closing bell the Dow Jones closed to within 66 points of even.

But should diplomacy fail, Friday’s tariffs will represent the largest increase since hostilities commenced last year — some $30 billion.

And the American consumer would bear the blast this time…

Previous tariffs centered largely on capital or intermediate economic goods. But perhaps 25% of Friday’s tariffs target consumer goods.

Can the consumer absorb the blow?

Renegade economist John Williams of ShadowStats believes the economy is already sunk in recession — damn the official statistics.

We have a recession in place. It’s just a matter of playing out in some of these other funny numbers… The economy is tanking, and I’ll contend it already has, although we have not seen it in the GDP reporting. 

And the sting in the tail:

“The underlying weakness is with the consumer.”

That is, the very consumer likely to absorb the worst of the tariffs… should they proceed Friday.

The clock ticks.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Will Trump Nominate Gold Standard Advocate to Fed?

This post Will Trump Nominate Gold Standard Advocate to Fed? appeared first on Daily Reckoning.

Trump has already exerted more influence over one institution than any other president in over 100 years — the Federal Reserve.

That’s because Trump has had more control over Fed personnel than any president since the Fed was founded in 1913. As I’ve written before, Trump now “owns” the Fed.

When Trump was sworn in, he inherited two vacant seats on the seven-person board of governors of the Federal Reserve System. Holders of those two seats are also members of the Federal Open Market Committee (FOMC), the group that sets U.S. interest rates and monetary policies.

President Obama also had the same vacancies, but he did not nominate anyone to fill the seats because he doubted his chances of getting the nominees past the Republican-controlled Senate and he was sure “President Hillary” would do the right thing and appoint pro-Democratic nominees.

In the end, Trump beat Clinton and the vacancies fell to Trump. Then Trump got another windfall. Within 14 months of becoming president, three additional Fed governors resigned (Dan Tarullo, Stan Fischer and Janet Yellen), and Trump suddenly had five vacancies to fill, or 70% of the entire Fed board.

Trump promoted Jay Powell to chair and appointed Richard Clarida as vice chair, Randy Quarles as vice chair for regulation and Michelle Bowman to fill a seat reserved for community bankers.

All of those appointments were well regarded by Wall Street and the media. But that still left Trump with the two original vacancies.

Trump indicated he wanted to appoint Herman Cain and Steve Moore to fill those seats. Cain is a former presidential candidate, chair of the board of the Federal Reserve Bank of Kansas City and CEO of the Godfather’s Pizza chain. Moore is a think tank analyst, founder of the Club for Growth and a former member of the editorial board of The Wall Street Journal.

Cain has now withdrawn his nomination after running into opposition from Senate Republicans based in part on old allegations of sexual misconduct. Moore is also being opposed by those who fault him for not having a Ph.D. in economics.

Whatever the merits, the real reason they have been opposed by monetary elites is that they are “friends of Trump” and will hold Jay Powell’s feet to the fire to cut interest rates and keep the economic expansion going ahead of the 2020 election.

But if Moore withdraws next or if his nomination is defeated, no worries. There’s some indication that Trump’s next nominee will be Judy Shelton.

She does have a Ph.D. and is a well-known advocate of a new gold standard. Just this Sunday she wrote an article in The Wall Street Journal, “The Case for Monetary Regime Change,” that challenged the current system and defended the classical gold standard.

She has also defended Trump’s trade policies, arguing that those who embrace unfettered free trade dogma “disregard the fact that the ‘rules’ are not working for many American workers and companies.”

For those who want Moore to step aside next, the best advice may be “Be careful what you wish for.”

Regardless, the 2020 presidential election is already beginning to take shape.

A few weeks ago, I unveiled my first forecast on the outcome of the 2020 presidential race. My estimate was that Trump had a 60% chance of winning.

I was also careful to explain that my forecasting model includes constant updating and would no doubt change between now and Election Day on Nov. 3, 2020.

That’s normal. Politics is a highly volatile process and it’s foolish to put a stake in the ground this early. My model has quite a few factors, but the leading factor right now is that Trump’s chances are the inverse of the probability of a recession before the third quarter of 2020.

If recession odds by 2020 are 40%, then Trump’s chances are the inverse of that, or 60%. With the passage of time, Trump’s odds go up because the odds of a recession go down.

If a recession does hit, then Trump’s odds go way down. This dynamic can be used to explain and forecast Trump’s economic policies, including calls for interest rate cuts and efforts to place close friends on the Fed Board of Governors.

It’s all connected.

As usual, I found myself out on a limb with my forecast; the mainstream media are sure Trump will lose in 2020, if he’s not impeached sooner. So it was nice to get some company who sees things my way…

A new Goldman Sachs research report also projects that Trump will win in 2020. Goldman shows a narrower margin of victory than my model, but a win is a win.

Of course, their forecast will be updated (like mine) but we’re starting to see more signs from other professional analysts that Trump is a likely winner after all.

Regards,

Jim Rickards
for The Daily Reckoning

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