IN-DEPTH: TRANSCRIPTION - TRADE WARS - WIN THE BATTLE, LOSE THE WAR!
We have talked previously about Trump's focus on US Trade imbalances and the potential for an era of looming global trade wars. We highlighted this most recently in April in a two part series with Charles Hugh Smith entitled: "Were Trade Wars Inevitable?"
- MACRO ANALYTICS - 04-05-18 - Were Trade Wars Inevitable? Part I w/Charles Hugh Smith
- MACRO ANALYTICS - 04-05-18 - Were Trade Wars Inevitable? Part II w/Charles Hugh Smith
Since then President Trump has taken this possibility to a whole new global headline grabbing level.
Let me point out here as a reminder, whatever complaints the Trump administration may have about trade with China it should theoretically settle those disputes through the legal mechanisms of the World Trade Organization. If the US thinks it has a case against unfair Chinese practices then it should trust the multilateral trading authority, otherwise, as history has shown, it’s a recipe for international chaos and a slippery slope to conflict. Frankly, it potentially leaves the US looking like it has contempt for multilateralism with its "bullying" manner of high-handed unilateralism.
Rules, laws, what’s that? Unless of course it is worth it if there is a lot more at stake and going on here than just trade imbalances?
I believe there is.
Trump appears to be playing hardball with China in the belief that its bullying will see Beijing cave to its demands for rectifying trade imbalances.
I showed this schematic in prior videos where trade wars were to be expected since they stem from failed policies and unresolved structural problems (as shown on the right in this diagram).
What the US is trying to do is solve structural, inherent flaws by strong-arming China into making concessions. Because China’s $500 billion annual exports to the US are about four-fold what the US sells to Beijing, Trump is betting that his basically "Mad Max" approach will scare China into submission.
I'm afraid that is just not going to happen! He is 10 years and QE too late!
The US economy has been running a chronic trade deficits with the rest of the world for the past four decades. That’s largely because of a structural change in American capitalism whereby US companies and investors bailed out of the country to set up in cheaper labor territories, such as China - but not solely China!
To accuse China of being the problem is really a deceitful distraction from the way American corporations jettisoned US workers with layoffs and downsizing to improve profits with no policy response from previous US administrations.
It is also a failure for the US to not have adequately responded to the advent of the WTO with resolutions regarding:
- Chinese business practices,
- Chinese State Owned Enterprises (SOE),
- The unregulated theft of Intellectual Property by Chinese Corporations,
- The involvement of the Chinese Communist party in subsidizing corporations and
- Gaining competitive trade advantage through currency manipulation.
A conflict with China because of this was inevitable. However, that doesn't explain Canada & Mexico with the dismantling of NAFTA nor major EU Tariff threats?
Trump’s browbeating manner is no doubt to some degree grandstanding for his voter base in the rust belt states, who might feel a patriotic surge in sticking it to the Chinese. The Mid-term congressional elections in November are also no doubt on Trump’s mind to get the Republican vote out. However, the president’s best laid plans are in danger of veering into a political train wreck.
The expected sequence of the stages of negotiations shown here could quickly get out of control.
Beijing has said it will not back down to intimidation. In an editorial in the Global Times, which reflects government thinking, the tone was combative....
“It is US arrogance to believe that a trade war will exhaust China. But the boot is on the other foot. Trade is mutually beneficial to both the US and China. Scuppering bilateral trade would cause similar suffering to both sides.”
The options at Beijing’s disposal could wreak havoc for the US economy and Trump’s political future. Trump’s inability to see that speaks to his and his advisors’ possible petulance. Maybe I am not giving them sufficient credit or the US economic outlook is that dire?
So far we have seen the US Tariff threats to be as shown here. Note the right column on whether they have only yet been threatened or have been implemented.
This slide highlights the International Retaliation to date. Again note the right column.
The bottom line is that as we go to press very little has actually been enacted to-date. So far it is more about "Sound and Fury". But all that could change on July 6th.
Trump is gambling big time. He is betting that China will be the “first to blink”, as the New York Times reported. That’s because the Trump administration reckons that with China’s huge trade surplus, Beijing has much more to suffer financially if it goes toe-to-toe with the US in a trade showdown.
“China has a lot more to lose than we do,”according to Trump’s trade adviser Peter Navarro, who is an infamous hawk when it comes to dealing with Beijing. Navarro, like Trump, has continually accused China of ripping off the American economy and workers through alleged unfair trade practices and theft of intellectual property from US technology. companies.
The Trump administration is fully cognizant of what this chart illustrates. China will not be able to match US Trade Tariffs in a "Tit" for "Tat" manner. There are simply insufficient US imports into China from America for China to enact tariffs on.
This somewhat dated chart shows US Tariffs on China at a level that is now approximately double this as we talk today.
If the "blustering" continues without resolution and the tariffs are implemented there will be serious ramifications globally. It is not at all out of line to suggest the results will be to bring on a US recession or worse. Once this occurs any resolution and hoped for benefits will be muted by the economic situation that will be underway.
Trumps latest threats now include almost everything coming into the US. Nothing is being left off his list to get tariffs to his apparent goal of ~ $600
Obviously the financial markets are now beginning to sense the hard realities that are likely to occur. Our historic Bull Market may be brought to an abrupt end, not by Monetary Tightening (as it historically has been the case), but rather by a self inflicted profit recession.
We are already seeing businesses react. Daimler warned in its latest earnings conference call. The Philly Fed's just released report showed a historic lift in 6 Month expected prices to be paid by businesses.
There is a strong possibility that the inflation genie is about to be released as expectations for price increases build. Corporations have no way of absorbing these tariffs rates and so they will be forced to pass them on to the consumer in the form of price inflation. Higher retail prices for consumer goods like televisions and footwear imported from China will crimp household budgets, especially among the lower-income population, (who by the way tended to vote for Trump).
The Net result is that the fragile American economy would likely tank from cash-strapped consumers, who are already living on the edge.
If China goes ahead with their threats to impose counter-tariffs on US agricultural products, such as soybeans, corn and meat, the impact on farm states like Iowa, Idaho and Illinois across the mid-west will be severe. Voters from these states were crucial to Trump getting elected to the White House in 2016. By taking the US into a trade war with China, Trump will end up hitting his own political base hardest. The Chinese are counting on that.
The far-reaching injurious effects of a trade war seem on the surface to have escaped the Trump administration’s planning. Many nations now (fairly or unfairly) see the US president as having been carried away with a hubristic notion of American power and an irrational ideological hostility towards China.
Critically important is that the perception of America is being changed around the world. This may have far more far reaching ramifications than currently realized!
China is already feeling the effects in a larger fashion (at least so far) than the US. A thousand Chinese Stocks dropped 10% in a single day after the Trump administration announced their last proposed tariff taxes. All of this forced China apparently to attempt to de-escalate the situation but apparently to no avail.
China inbound investment has already collapsed in the last six months. According to research firm Rhodium Group, Chinese companies completed acquisitions and greenfield investments worth only $1.8 billion, a 92% drop over the past year, and the lowest level in seven years.
But this is much more than simple M&A, it's about capital outflows - which will really upset some of China's wealthiest as they try to find new routes to de-Yuanize their assets.
The rapid decline in Chinese FDI in the U.S. was driven by a “double policy punch” -- Beijing cracking down on rapid outbound investment and the U.S. government increasing scrutiny on Chinese acquisitions through the Committee on Foreign Investment as well as taking a more confrontational stance toward economic engagement with China in general.
Lets step back for a moment and try and make more sense of what actually may be going on here?
How does a Win-Win come out of all this? Or is that even a remote possibility? Who eventually loses and Who wins with various potential outcome scenarios?
Let's first look at the hand China holds.
As we mentioned China can't effectively retaliate through matching tariffs. It will therefore be forced to shift its focus regarding possible punitive actions.
As we first consider what we might expect from China, remember, China is very strategic and long term oriented in its planning so it can be expected that whatever direction it takes it will have other important strategic benefits.
- China could potentially de-escalate tensions by presenting a list of actions it will follow to reduce its significant trade deficits in services with the US,
- This could affect education service institutions, the local tourist industry, and entertainment. However, as the CFR's Brad Setser writes, it increasingly looks like the Administration is putting China in a position where China cannot make concessions without appearing to cave - which most think China won't do. Setser, not alone, has trouble seeing a de-escalation option if Trump goes through with the $200B.
- China could and will likely launch an economic subsidy for its economy in the form of further easing in financial conditions to offset any potential trade-drag,
- Some, such as Deutsche Bank have proposed that in order to offset the negative hit to its consumers, China will loosen policy such as tolerating the property and land market boom in tier 3 cities and cutting the RRR twice over the rest of this year to partly offset the potential drags. This would also involve a modest devaluation of the Yuan.
- China could unleash differential treatment of domestic enterprises, many subsidiaries of US parents,
- As some have suggested, Beijing could simply opt not apply its "market access liberalization" policy recently announced. This could greatly disadvantage US firms. Beijing could also engage in an aggressive crackdown on US firms operating in China (Apple), hinder border passage of US products (automotive), or pursue antitrust and monopoly allegations against US tech names (Micron).
- China could also choose a diplomatic retaliation and order Kim Jong Un to scuttle the recent agreement North Korea signed with the US, humiliating Trump by showing that it was Beijing all along who made the US-N. Korea summit possible and successful ,
- China could pick an aggressive route, and instead of a mild depreciation, it could aggressively pursue a weaker Yuan to boost trade competitiveness,
- Which, ironically, is the catalyst behind much of the Trump administration's animosity toward China. To achieve this, China would relaxing some of the capital control measures that have helped strengthen the renminbi in the past 2 years. That said, such a move would unleash sizable outflow demand, while boosting precious metals and cryptos. The US would also brand China a currency manipulator.
- China, finally, could pick the nuclear option, and gradually or suddenly liquidate its Treasury holdings.
- This is a long-running worry by markets given China’s $1.2 trillion in Treasury holdings. In January, Bloomberg reported this was a possibility which was at the time denied by China State Administration of Foreign Exchange; however the recent liquidation of half of Russia's Treasurys was seen by some as a rehearsal for what would happen if Beijing decides to pursue this approach.
What this suggests is that currently it would suggest is that China will use this opportunity to devalue the Yuan.
They have already shocked the world once with this and as we have discussed in previous UnderTheLens discussions, China's New Capital formation or Foreign Direct Investment is critically important to their economic stability.
So far, President Trump seems to have not noticed the stealth devaluation already underway, but the world's speculators certainly have as the last week saw FX Speculators dramatically shift to a net bullish position (the most bullish since April 2017) with the greatest swing in positioning in history...
.... and as we talk today it is getting worse quickly. While Chinese stocks are up marginally, the Yuan continues to slide as chatter escalates that China is "weaponizing" the Yuan in retaliation to Trump's actions...
The real pain hasn’t even begun!
As we mentioned, China’s ultimate trade weapon is its massive holdings of US Treasury bonds. With nearly $1.2 trillion-worth in holdings of US federal debt, China is by far the world’s largest creditor for Washington. US-based news outlet Bloomberg calls it Beijing’s “nuclear option”.
The media is now picking up on this: -- I quote:
“It can just stop buying US Treasury debt,” warns Bloomberg. “China is the world’s biggest Treasury investor, keeping US borrowing costs low, helping us buy more stuff from China. Ending this symbiotic relationship just when US budget deficits are soaring would devastate the US economy.”
Bloomberg adds that such a “doomsday” option “could blow up” China’s economy too. It compares the abysmal scenario to “Mutually Assured Destruction” (MAD).
Arguably though, such mutually devastating economic consequences for China are moot. It has the alternative sphere of Eurasian economic integration and the new Silk Roads it has busily been building with Russia and others over the past decade.
If Trump pushes Washington’s belligerence too far with Beijing, the economic ramifications will be wide-ranging and dire for the globe.
China may just survive to trade another day with the rest of the world.
But one thing seems sure. With its chronic debts, deficits and dodo-like dollar, America may potentially be ruined beyond salvation. Ruined ironically by a president who touts his “Art of the Deal”.
Coincidentally , China's central bank announced cut the Required Reserve Ratio (RRR) for some banks by 0.5% effective July 5 (the day before tariffs are to go into affect), just over two months after the PBOC did a similar cut on April 17, the first such easing since the start of 2016.
The move will unlock 700 billion yuan ($108 billion) in liquidity amid growing trade war tensions, a sharp slowdown in the Chinese economy, a tumbling stock market, rising forced margin call, and a spike in corporate defaults.
China is spinning the RRR as a move meant to fund mass deleveraging through debt for equity swaps, not as the start of an easing cycle which would send the Yuan sliding and could potentially be perceived as a stealth devaluation by the US, resulting in even more aggressive trade retaliation.
The move will ease liquidity shortages currently seen in the implementation of debt-to-equity programs, and it shows that policy makers still don’t want to send a signal of across-the-board easing, "The central bank may have predicted rising debt risks in the near future, so it decided to set up such an arrangement,"
What is now somewhat frightening is what the US is now moving the escalation towards.
The US Treasury is crafting rules that would block firms with at least 25% Chinese ownership from buying companies involved in ‘industrially significant technology’
The FT reports that according to officials and people briefed on the discussions, the administration has decided to restrict China’s ability to invest in or acquire US companies in the industries identified by Beijing in its so-called Made in China 2025 plan.
The Trump administration appears likely to invoke an act that allows US presidents broad powers in the event of a national economic emergency, which the president is likely to declare.
The International Emergency Economic Powers Act (IEEPA) dates to the 1970's and has in the past been used mostly to impose sanctions on countries such as North Korea and Iran.
Administration officials argue that the restrictions are needed because the US is in an existential innovation war with China over key technologies that will define the future of the world’s two largest economies.
Although the exact scope of the investment measures is unknown, this level of dramatic escalation implies the China hawks have taken the upper hand in The White House, as is clear by Trump trade advisor Peter Navarro's comments - aimed directly at Xi's goal of leading the world in sectors from aerospace to AI...
“China has targeted America’s industries of the future, and President Trump understands better than anyone that if China successfully captures these emerging industries of the future, America will have no economic future, while its national security will be severely compromised.”
The US has more FDI Than Any Other Country in the world.
As TradeVistas wrote in its Essential on foreign direct investment (FDI), the United States is home to the largest stock of FDI of any single country. (On the flip side, the United States is also one of the world’s most important sources of direct investment, with more than $5 trillion worth of assets abroad.)
The attractiveness of the U.S. market for FDI reflects the size and strength of the U.S. economy as well as the long standing U.S. commitment to open markets and the rule of law. The vast majority of FDI occurs on a regular basis in every U.S. state across sectors including manufacturing, financial, and information technologies. But there are cases when foreign investment might carry security implications.
Tariffs are simply about national security: Hayman Capital founder recently proclaimed on CNBC.
There are concerns as to just how this all ends, since as a former Obama administration official noted, the unilateral move by the Trump administration to invoke IEEPA would be unusual.
“That’s a pretty sharp departure from the way things have been done in the past,” adding that
“The Trump administration, kind of across the board, has very much blurred the line and seems to be saying that any significant economic challenge the US faces is also a national security challenge."
We obviously don't know how this will all play out. What is pretty evident is that there is potential for serious fall-out.
The US may will the trade battle but lose much more as a result!
The view of America has shifted and as we outlined in this years thesis paper, "A New World Order" all of this will only accelerate the global shift towards a multi-polar world order.
It will accelerate the global shift towards de-dollarization which would undermine the whole US financial edifice.
Minimally, we will see short term profit deterioration if it is resolved immediately which is highly likely to trigger a US recession.
The IMF is out saying the trade war could push the global economy to the brink of a recession. The Bank writes that whereas the good news is that we are still many steps away from a full blown global trade war.
"the bad news is that the tail risks are rising and our work and the literature suggest a major global trade confrontation would likely push the US and the rest of the world to the brink of a recession" as outlined in the chart here.
We have benefited from Globalization which is responsible for 1000 points in the S&P 500 according to David Rosenberg. It has fostered dramatic increases in PE ratios as a result of net margin expansion.
China initially was seen in America as an opportunity. Then as something that needed to be contained. Today it is seen as a dangerous competitor.
When this happens and economies start to suffer as a result it historically leads to un-resolvable conflicts.
Any shock can quickly move through the global economy and bring on unexpected retaliatory actions. Wars always start that way! I suspect however the next war will by Cyber Wars which attack in stealth fashion the financial and economic infrastructures of the nations involved. They will attempt to disrupt competing economies through shocks to the infrastructure.
In closing let restate what we have laid out in many of our videos. Neither the US Economy nor the Chinese Economy can presently withstand an Economic shock. A trade war with any of its potential shocks is coming at precisely the wrong time!!
As I always remind you – remember the answer in response will be to print more money to somehow alleviate any and all problems.
It is the only answer politicians will ever agree on.
Until No one wants it or Trusts It!