President Trump is using all of his financial weapons in his trade war. China is as well. And since the crisis in the Turkish Lira broke out a few months ago, I expected to see China to move to counter the intense dollar diplomacy Trump is engaging in.
The devaluation of the Yuan was serious a few weeks ago. Now, it’s threatening to unravel carefully controlled markets around the world. The Yuan does not freely float, per se, it is allowed by the People’s Bank of China (PBoC). It trades in a +/- 1% band based around a reference exchange rate set daily.
Thursday’s PBoC Yuan “fix” was the weakest since May of last year. And it prompted significant market reaction around the world. Because it happened in response to Trump’s doubling-down on his tariff threats.
Trump declares tariffs of X amount, China devalues, Trump raises tariff threats to 2X to offset the devaluation.
And so on, and so on.
Commerce Secretary Wilbur Ross is playing his part to a tee.
The markets react to this in predictable ways. And one of them is to put pressure on China’s massive pile of corporate debt, which is teetering. So, part of the PBoC’s response in lowering the Yuan reference rate is to shore up the banking system and weather the shocks.
So, all rhetoric from Trump about China being a ‘currency manipulator’ is the same patent nonsense spewed by all Presidents when a country responds to a hybrid war attack by defending themselves.
You may agree with the attack, but don’t delude yourself into thinking the defense put up against it is somehow ‘immoral’ or ‘proof of My President’s argument.”
No, it’s just business. And, believe me, no one in America will like the effects of having to pay 25% more for stuff at Wal-Mart. Because, China isn’t necessarily hurt by this as much as the U.S. consumer is.
And if you want to assuage your economic pain by saying it’ll make our domestic goods more competitive, then you’ve forgotten to ask yourself the basic question, “Why are our goods so expensive?”
17th Century Schizoid President
What we’re seeing across markets however is important. Problems in China have ripples around the world, even if those problems are manufactured by a U.S. President exercising what former OMB Director David Stockman calls “a 17th Century view of global trade.”
That 17th Century outlook creates these policy decisions. Trump refuses to admit that the U.S. gets tremendous value in return for that trade deficit with China. We send out debt thanks to his more than $1 trillion budget deficit and get back goods in return.
This keeps the dollar cheap in foreign markets, stuffing central banks full of U.S. Treasuries, now more than $6 trillion, and their companies undercut their domestic central banks policy efficacy by borrowing in ultra-cheap dollars with WACC’s so small you could fit Hillary Clinton’s empathy inside them.
Then when it suits us, the Fed hikes interest rates and bankrupts them all, while our intelligence agencies and NGO’s (using the money printed by that exported debt) stoke civil unrest around the world causing governments to fall and mass migration movements the now more impoverished U.S. consumer has to pay to build a border wall to defend against?
And somehow China is the currency manipulator?
Trump needs to let go of this idea that the accounting anomaly known as the trade deficit would be improved mightily by the aggressive reduction of regulatory overhead and graft that exists domestically.
As Jordan Peterson would say, “Clean your room, man. Get your own house in order.”
If Trump wants to clean up the world stage on trade fix our own house.
Now, I know he’s trying to do that, with massive backlash from the political left, who got a scalp recently with EPA Chief Scott Pruitt’s resignation. But, it seems Trump is rightly picking a fight with California over CAFE standards for car makers.
Good. CAFE rules are vile. And all Trump wants to do is halt the program’s insanity at 2020. It should be abolished completely.
CAFE is an outdated program that started as a political suck-up to high oil prices in the 1970’s which has morphed into an cause celibre of the environmentalist Left that hates cars. And it has huge influence on the price of cars, how much debt we have to carry to own a car, etc.
Trade Wars, Currency Fallout
A massive trade war between the U.S. and China means the market handicapping a global slowdown of trade. And since the world is stuffed to the gills with dollar-denominated debt issued by emerging market companies, that means a people scrambling for dollars to ensure the next coupon payment to boldholders is met.
It also means ripples through the forex markets.
And when you mix this headline with the headlines coming out of Italy about a clash over the budget you get markets moving to the limits of the current ranges coordinated by the central banks.
There is active intervention this morning in the euro to forestall a massively bearish weekly closing price. Italian bonds are being managed. Gold is getting dumped, again.
And the US dollar ‘trade weighted’ index, the USDX, which by the way still doesn’t reflect our trade with China, has traded in a very tight range now for 10 weeks, despite the massive devaluation in the Yuan, the Bank of England raising rates and the Bank of Japan altering its yield curve target yield on the 10 year JGB to 0.2% from 0.1% for the first time since the policy was introduced in 2016.
And the last couple of points here I need to make about where all this leads are the following.
First, China has a desire to expand the use of the Yuan internally and externally. As U.S. rates rise, which they must, despite Trump’s protestations, China will use its bilateral trade deals to do more business overseas in Yuan, helping its trade partners wean themselves off the dollar over time, paying down that debt and offering a competitive rate on issuing new debt.
Which brings me to point number two, which is that the spread between U.S. and Chinese sovereign debt is shrinking rapidly. China’s sovereign debt is falling in yield while U.S. rates are rising, albeit in fits and starts.
While China’s REER – Real Effective Exchange Rate — is maintained.
That changes the dynamic for countries holding reserves in Yuan rather than dollars, especially if said reserves can be converted to gold via the petroyuan oil futures contract or some other LME-based industrial metals futures contract.
This dynamic will change the face of the settlement mechanisms for global trade over the next decade or two and we’ll trace it back to Trump’s trade war and the internal opposition to fundamental change in the U.S. domestically keeping him from properly Draining the Swamp.
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