Mad Man Trump Intentionally Provokes China, China Pushes Back Hard

As we now know, when Donald Trump conducted a phone call with the Premier of Taiwan, in contravention of the US-China “one state” policy, he did it intentionally.  He was demonstrating to China that he is willing to take a hard line over trade and the South China Sea.

Never mind that he changed the policy of the current administration -- Trump is serious in taking a more contentious position with China.



Long Live the Victory of the Korean People's Army and the Chinese People's Army!




Trump says that China “takes advantage of us” when it engages in free trade and sells us things at prices so low that we cannot refuse.  He is apparently ready to confront China economically and militarily, no matter the consequences.  This is a dangerous game.

Now China has hit back – hard.

Today, the Chinese renminbi fell by about 10 percent against the dollar, one of the biggest single-day moves since Beijing allowed its money to partially float.  This is a clear, intentional signal on the part of a China that carefully controls the daily changes in its currency exchange rate.

A one-day 10% reduction in the renminbi versus the dollar is huge.

Such a currency move by a major international trading partner and competitor has serious economic consequences.  The US already has enough trouble competing in international trade, and now Trump’s foolishness has resulted in China reducing its prices even more!

Trump’s recklessness will have adverse consequences for all of America.  We have trading partners, you dunce.  You made our competitive position in world markets even worse!

China is not going to back down.  They have all the trump cards.  They can undercut America and will flood our markets until Trump and Congress raise tariff barriers against them.

The Chinese People Cannot Easily Be Humiliated!



What will the American people say a year from now as American exports fall even more, and China grabs an even greater piece of the international trading pie?  What will they say as prices rise and their meager wages are stretched even tighter? 

What will Americans say as Mad Man Trump plunges the US into another recession? 

Trying to change the US-China-Taiwan relationship before he is President is radically disruptive to US policy and harmful to American workers.  He will be sadly surprised by both domestic and international repercussions.

If he escalates this offensive into a military confrontation, it could be catastrophic.

Competitive Devaluation: More Support for the Dollar

Here is more evidence that concerns about immediate dollar devaluation are misplaced.

Mish's Global Economic Trend Analysis has a nice collection of news clips about the economic slowdown in China and the Chinese response to expand their money supply. His post China To Print Money To Combat Deep Slowdown also puts China's monetary policy in the context of the ongoing global game of "beggar thy neighbor", where all parties are pursuing policies of competitive devaluation and trade protection:

. . . the US seems hell bent on destroying the dollar to boost exports and/or to get consumers spending again, and Japan has threatened to get in on the act by selling Yen and buying dollars. Brown is certainly hellbent on destroying the British Pound.

In such a dynamic, our trading partners hardly want to see the dollar crater:

With everyone in on the act, or threatening to get there, the dollar is far more likely to enter a trading range than to crash.

Mish also mentions that this kind of deflationary environment is supportive of an asset that I like at this time, which is gold.

US Default and Dollar Devaluation

The government poured billions of taxpayer dollars into the banks and the GSEs to keep the credit markets working. Not only are credit markets still dysfunctional, but we are on the deflationary expressway to depression.

WPA: unemployed shown at Volunteers of America Soup Kitchen: Washington, D.C. (Circa 1936). Courtesy of the Franklin D. Roosevelt Library Digital Archives, National Archives and Records Administration. http://www.fdrlibrary.marist.edu/images/photodb/27-0637a.gif

The latest idea for greasing the rusty credit system came out of Washington yesterday, as Jon Hilsenrath and Damian Paletta of the Wall Street Journal reported in Fed Weighs Debt Sales of Its Own. The Fed is considering asking Congress for permission to directly issue its own debt, not tied to Treasuries.

The prospect of another source of US debt issuance has naturally raised a lot of eyebrows. For example, Jesse's Cafe Americain was asking Is the Fed Taking the First Steps Toward Selective Default and Devaluation?

What an image. The NY Fed as a GSE, the new and improved Fannie and Freddie. Zimbabwe Ben can simply print a new class of Federal Reserve Notes with no backing from Treasuries. BenBucks. Federal Reserve Thingies.

Perhaps we're missing something, but this looks like a step in anticipation of an eventual partial default or devaluation of US debt and the dollar.

It is prudent to consider this risk. In an earlier posting, Will Quantitative Easing Crater the Dollar?, we have seen Nouriel Roubini's warning that the Fed's quantitative easing

... will eventually leads to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.

But when will this "eventually" occur? There are good reasons to believe that the big risks lie rather far in the future.

So far, money injected by the Fed seems to be falling into a deflationary pit ... that is, it is not effectively offsetting money lost as the private financial system deleverages. And borrowers and lenders are all extremely risk averse right now.

So, the risks of default or dollar devaluation appear to be mainly in the future -- after the financial crisis ameliorates, credit starts flowing, and the economy shows some signs of life again.

Will Quantitative Easing Crater the Dollar?

When the Federal Reserve announced on November 25 that is was spending around $600B on bailing out agency debt and MBS and around $200B on bailing out ABS, many worried that a new program of quantitative easing will sink the dollar and raise interest rates. At RGE Monitor, Nouriel Roubini referred to "desperate actions" and said the the Fed was implementing:

an effective policy of aggressive quantitative easing as the balance sheet of the Fed – already grown from $800 billion to over $2 trillion – will be expanded further as most of the new bailout actions and new programs will be financed via injections of liquidity rather than issuance of public debt. ...

Effectively the Fed Funds rate has been abandoned as a tool of monetary policy
... the Fed is now relying on massive quantitative easing and direct purchases
of private sector short term and long term debts to try to aggressively push
down short term and long term market rates.

Although these moves have reduced ABS and MBS spreads, Roubini believes as others do that there are negative longer-term implications:

... These policies – however partially necessary – will eventually leads to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.

When will this "eventually" occur? In an article titled Ricardian Equivalence, Macro Man commented on the markets' immediate reaction to put the dollar under pressure. To summarize his arguments:

The past few decades, but particularly the past few years, have seem enormous rise in private sector leverage....both through traditional lending and derivatives contracts.

At the end of 2007, Citigroup had more than $2 trillion of assets on their
balance sheet. That number will be a lot lower by the time all is said and done. ...

So in Macro Man's view, any dollars "created" by the Fed to expand its balance sheet (and let's not forget, they have yet to really crack out the printing presses by not sterilizing their asset purchases) will merely partially offset dollars lost through de-leveraging and the implosion of the shadow banking system ...

The impact of these programs will, in Macro Man's view, only submarine the dollar once the crisis is resolved and domestic demand begins growing organically again. That seems likely to be several years away, for there is another kind of Ricardian equivalence at work- the ballooning of the US budget deficit should be offset by a sustained rise in the US private sector savings rate.

This is an important point for investment strategies. If the resolution of the crisis is several years away, perhaps we can expect a relatively stable dollar for some time.

And if the dollar remains stable, and the Fed's actions are offset by private sector deleveraging, perhaps we can expect a deflationary environment to continue for some time.

Sources:

"Ricardian Equivalence"
Macro Man, Nov 26, 2008
http://macro-man.blogspot.com/2008/11/ricardian-equivalence.html

"Desperate Measures by Desperate Policy Makers in Desperate Times: the Fed Moves to Radically Unorthodox Policies as Economy Is in Free Fall and Stag-Deflation Deepens"
Nouriel Roubini's Global EconoMonitor, Nov 26, 2008
http://www.rgemonitor.com/roubini-monitor/254591/desperate_measures_by_desperate_policy_makers_in_desperate_times_the_fed_moves_to_radically_unorthodox_policies_as_economy_is_in_free_fall_and_stag-deflation_deepens

Press Release on MBS
Board of Governors of the Federal Reserve System, Nov 25, 2008
http://www.federalreserve.gov/newsevents/press/monetary/20081125b.htm

Press Release on ABS
Board of Governors of the Federal Reserve System, Nov 25, 2008
http://www.federalreserve.gov/newsevents/press/monetary/20081125a.htm

Interest Rates and the Dollar

There is a good article at Naked Capitalism on interest rates and the dollar. Two of the anomalies noted there:

1. Long dated Treasuries rising (a deflation signal) as stocks stage a dramatic rally

2. Dollar weakening while long dated Treasuries rise (the dollar and bonds usually go together)

The first item is actually consistent with many periods of market history when rates fall and stock prices rise. We have, after all, just been through a long period of falling rates and rising stock prices beginning in the early 1980s and continuing until either the dot-com crash of 2000, or perhaps until the present crisis. When long-term rates fall, the present value of corporate earnings streams rises.

The second item occurs in the context of a great variety of contending and fluctuating forces, making currency and Treasury directions very, very hard to call. But this is not inconsistent with some periods of history. If there is some expectation of a collapse under all this debt, there should well be ambivalence about Treasury debt and the dollar.

Others have already commented that long rates will continue to stay low until added money is not consumed in the deleveraging, perhaps not until there is a real economic expansion, which could be a long time off. Or perhaps continued stimulation will make it occur sooner.

Reference: http://www.nakedcapitalism.com/2008/11/some-anomalies.html

Real Interest Rates and the Dollar?

Nouriel Roubini has been calling for stag-deflation for some time, but worsening economic news, mounting budget deficits, and a swelling Fed balance sheet give his latest warnings even more urgency. The bad news in his latest posting at RGE Monitor includes these snippets:

At this rate of contraction as revealed by the latest data it would not be surprising if fourth quarter GDP were to fall at an annualized rate of
5-6%.

... the balance sheet of the Fed – already grown from $800 billion to over $2 trillion – will be expanded further as most of the new bailout actions and new programs will be financed via injections of liquidity rather than issuance of public debt.

Desperate times and desperate economic news require desperate policy actions ... The Treasury will be issuing in the next two years about $2 trillion of additional debt ...

The amounts of money involved are staggering, so is it no surprise that Roubini concludes (emphasis mine):

These policies – however partially necessary – will eventually lead to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.

When and how severely will these injections of liquidity and swelling debt result in higher real interest rates and weaken the US dollar? Roubini is not alone in thinking that we are about at that point, a good example being these snippets from a recent article in the Financial Times:

The banks have been recapitalised. The government has started buying and guaranteeing distressed debt. Finally, the Federal Reserve has begun in earnest to use its balance sheet (in a sterilised manner) to step into the absent shoes of the private sector in the financial system.

A failure of the initial set of policies to reflate the economy is likely to lead to the next, more risky, set of policy choices – those involving unsterilised intervention.

As the US embarks on the next set of policy choices for curing deflation, as outlined by Ben Bernanke, Fed chairman, in his 2002 speech “Deflation – Making Sure it Doesn’t Happen here” – inflationary risks will begin to rise. With that comes the risk of sustained medium term dollar weakness and the risk ultimately of the demise of the dollar as the world’s sole reserve currency.

Sources:

"Desperate Measures by Desperate Policy Makers in Desperate Times: the Fed Moves to Radically Unorthodox Policies as Economy Is in Free Fall and Stag-Deflation Deepens"
by Nouriel Roubini
RGE Monitor, Nov 26, 2008
http://www.rgemonitor.com/roubini-monitor/254591/desperate_measures_by_desperate_policy_makers_in_desperate_times_the_fed_moves_to_radically_unorthodox_policies_as_economy_is_in_free_fall_and_stag-deflation_deepens

"Insight: US debt puts strain on dollar"
by Chris Watling
Financial Times, November 26, 2008
http://www.ft.com/cms/s/9790f1ba-bbe0-11dd-80e9-0000779fd18c,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F9790f1ba-bbe0-11dd-80e9-0000779fd18c.html&_i_referer=http%3A%2F%2Fwww.nakedcapitalism.com%2F