Thursday, July 12, 2018

US - China Trade War - A Big Show or a Serious Threat to Stability?

With all the news coverage now being devoted to the apparent startup of a huge "trade war" between the US and China, we need to examine this situation to see if there really is a serious threat to the stability of the current global financial system and/or monetary system. That is what we try to do here.

First, below are a few excerpts from a recent article appearing in the South China Morning Post which pretty clearly lay out the position of those who oppose the Trump Administration's handling of this issue. Then some added comments.


"The fact that currencies continually fluctuate against each other in value means it is almost as meaningless trying to “balance” trade in value terms as it would be to insist that equivalent volumes of goods be traded.

This is not an attempt to embark on an economic dissertation, but to point out that under balanced or “managed” trade of the kind that United States President Donald Trump appears in intent on securing with his trade wars, the incentive to manipulate currency values to achieve balance can only increase."

. . . . . 

"Now, China has vaulted over Japan to become the world’s second largest economy behind the US, and again America finds itself unable to compete and get rid of its pesky trade deficits.

Enter Trump’s tariffs war.  . . . . "

. . . . .

"One way that Beijing could hit back is by dumping part of its US$1.2 trillion of US Treasury securities, and President Xi Jinping has hinted just such a tactic."

. . . . .

"But Xi may be playing a clever double game, since the resulting dollar depreciation would help boost the dollar value of US exports and thus provide a face-saving way of allowing Trump to go easy on China over deficits.

It all comes back to the futility of trying to balance external accounts. . . . ."

My added comments: As with most everything related to the Trump Administration we have to toss out the conventional wisdom in trying to analyze what is actually going on. This article in the South China Morning Post clearly attempts to paint President Trump as a naive rookie in terms of understanding a complex global economy to make the case that his attempts to use trade war tactics are a waste of time.

Supporters of President Trump will counter that he knows exactly what he is doing and is not naive. They will say he is using his unconventional "art of the deal" technique to extract better trade terms for the US and is actually fully supportive of "free trade" without tariffs.

By now, we should all be used to the fact that President Trump is not going to operate according to traditionally accepted norms of behavior and has no problems trying new approaches to what he views as old continuing problems that no one else would solve and have been left for him to deal with. Disruption of the norm does not bother him.

So, all this raises a few questions that we should think about in terms of where all this is headed and does it pose a systemic risk to stability of the current financial and monetary system. Below I will try to raise those questions and provide the best answer I can based on the information we have available at this time (my best guess). Reader and expert comments are certainly welcome on this.

Q: Will there really be a serious long term trade war between the US and China or are we just seeing a lot of manuevering by both sides leading up to a new trade deal?

A: It is clear that President Trump believes all this is simply pre deal positioning. We know this because he has stated it clearly in various interviews. What is less clear is whether China views things the same way. We won't know the full answer until it plays out and we either get a massive ongoing full blown trade war or both sides simply negotiate some kind of new deal.

Q: Is the Trump Administration naive and ill informed about the way the global financial system works as is claimed in the South China Morning Post article?

A: I doubt it. While President Trump himself may not be informed on some nuances of how things work, there are plenty of people in his Administration who would fully understand the points made in the SCMP article. It is more likely that they simply believe that they can use brute force to alter the playing field more in favor of the US and don't believe that the potential problems described in the article will ever really happen because a new deal will be agreed upon before that happens. Again, only time will tell us if that attitude is correct or not now that the opening battle of the trade war has begun.

Q: Will this situation lead to the following consequences mentioned in the SCMP article -- trade wars >>>> economic recession>>>>depression>>>>real wars?

A: We can't rule out anything as impossible. But readers need to understand that politics and rhetorical hyperbole are rampant these days from all ends of the political spectrum. Special interests do a lot of public polling and know what issues and key rhetorical phrases get people stirred up. Both sides of the political spectrum will try to use this information to gain political advantage. So, it is almost impossible for the average person to distinguish between what is a true serious threat from hyperbole being used in an attempt to manipulate public opinion. All we can do is keep alert to actual events and watch for signals that would indicate serious actual threats are in play.

Q: What signals can we watch to see if some kine of serious threat to systemic stability is in play?

A: For me, there are three important signals to monitor. 

1- US and other major global equity markets
2- the US dollar index 
3- the price of gold

If we see red flags going up on all three of these signals, it should have our full attention. 

If we see:

1- equity markets diving sharply and far beyond normal corrections (much more than just 10-15% pullbacks)

2- a sharply falling US dollar (or conversely a US dollar moving way too high)     and

3- a sharply rising gold price (beyond normal market moves)

we have real world signals that systemic stability may be at risk.

Another signal that might be a leading indicator to these three would be one or more major financial institutions becoming insolvent very rapidly and unexpectedly. If this were to set off a chain of derivatives defaults, things could escalate pretty quickly and trigger the reg flags in our list just above.

However, my best guess at this time is that until we see these markets giving off these kinds of red flags, there is no reason to think that there is a serious threat to the stability of the present system. We can assume that a lot of hyperbole and dire rhetoric will continue to unfold as different interests (and nations) attempt to gain an advantage. 

But if the markets continue to yawn, it is a good indication that they just see it as political noise, business as usual and that the players involved accept this is as just the "art of the deal" being applied by the Trump Administration. Mohamed El-Erian seems inclined to take this view of things in this CNBC article.

On the other hand, if we see the red flags show up for real in the markets listed above, it will be pretty obvious that a genuine systemic threat may exist. Jim Rickards has just released this new article that says pending legislation before Congress increasing US power to sanction China could in fact trigger a severe negative market reaction, so we can keep an eye on that.

Only time tells us the answer and we will have to monitor events for ourselves in a highly charged political climate.

Added footnotes: I need to add that there are analysts who believe that the markets I have listed above are so heavily manipulated by things like central bank intervention (QE, low interest rates, etc), that the normal red flags or warnings we should see ahead of a major crisis are being hidden or suppressed in order to create a false sense of stability.

I have no way to assess how valid that may be, but let's allow it as a valid assumption for this part of the discussion. If this is true, so long as the relative stability of these markets is maintained (no matter what is causing it), it means that control of the existing system is being maintained. It would not be possible to manipulate prices if control over them was lost assuming central banks even have the power and resources to do that for years at a time. So, I believe my analysis is still valid even granting that assumption. If we see these major markets spinning out of control, it implies that any ability to stabilize the system using any form of manipulation is no longer working by anyone trying to do so. 

Going even further, if you take the view that stability of the existing system might be given up intentionally (as some people do believe) in order to allow the existing system to fail and be replaced with something new (for example the US dollar replaced by the SDR), you would still see the distress of the existing system show up in these market red flags and would need to try and take whatever personal actions you can to weather the storm (no matter what caused the storm). By no means am I suggesting this assumption is true. I have no way to know and have received no expert input that would indicate this is the situation. But I do understand there are some who do believe this to be the case.

The question of who is to blame for the next major global crisis if we have one is really another topic. The public will decide who is to blame and who they think they should trust to try and solve the crisis if one does arrive some day. I do think the better informed the public is, the better off we would be in such a circumstance. 

All that is far beyond the scope of our ability here to discern. What we try to do here is provide high quality information to help people understand these issues better if they have interest in dong so. That involves understanding what are the true systemic risks to the present system as well as proposed reforms to the present system that may be put forward to resolve a crisis and restore public trust. If no crisis arrives, it involves understanding that the current US dollar based system is very firmly entrenched for now and likely to stay in place for some time. Change would take place more gradually.

We have tried to document all of that here in great detail based upon extensive research and direct input from some of the leading experts in the world on these issues. We have attempted to do this with no agenda of any kind other than trying to provide useful information and a variety of credible views from highly credible sources. I am very grateful to those sources who have helped me with direct input and pointed me to key resources. They have helped create a wealth of valuable information that is now archived here on this blog. I encourage readers to utilize the information to become as informed as possible.

All the information here is free and will remain online for anyone who can use it and I will continue to add information if I think it can be of service to anyone who happens upon this blog. Relevant questions and comments are always welcome.

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