Blog Archives

Good Riddance to a “Nothing-Burger” Trade Deal

As I noted in Trade Deal Follies: The U.S. Has Embraced the World’s Worst Negotiating Tactics (April 8, 2019), the trade deal was a Nothing-Burger for the U.S. Without any consequences for violating trade deals, China violates all trade deals, starting with the WTO. (As an example, China has never reported its state subsidies to Huawei to the WTO as required by that treaty.)

The only trade deal that wouldn’t be a Nothing-Burger for the U.S. is one that explicitly gives the U.S. the sole power to decide if the deal has been violated and impose the consequences. Agreements without monitoring, enforcement and severe consequences are meaningless.

Developing nations are prone to cheating on trade agreements, and developed nations are prone to letting them cheat. It’s a simple matter of incentives and self-interest. Developing nations do not have the resources to develop technologies from scratch, so they steal it by reverse engineering, theft of intellectual property (IP) and industrial espionage.

Developed nations are desperate for the new markets, cheap labor and resources of developing nations, so they overlook technology and IP theft as the “cost” of accessing the benefits of new markets, cheap labor and resources.

As a general rule, developing nations want capital to build out industry and markets for their goods (manufacturing) and commodities. Developed worlds are typically post-industrial for a variety of reasons, and what they want is open markets for their services (finance, insurance, entertainment, etc.).

Developing nations have tremendous incentives to limit the goods and services from developed nations, as these would provide too much competition for the domestic sectors they need to build for their export model of development and for domestic employment.

These tensions build as developing nations become wealthier and the inequalities of the trade and capital flows widen. When the developing nations reaches the point of competing in the global market with the developed nations, then the developed nations naturally demand that the playing field become level.

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Trump, Trade and Taxes

Donald Trump has made trade agreements a central issue in this presidential election, declaring trade treaties such as the North American Free Trade Agreement (NAFTA) as unfair and subject to cancellation or renegotiation.

Setting aside the issue of whether presidents can cancel trade treaties via executive orders, let’s look at the underlying issue: the erosion of manufacturing and entry-level job opportunities that lead to middle-class security and pay.

The question then becomes: what are the causes of this erosion of manufacturing and the middle class? Trade is relatively easy to finger because the flood of cheap goods into the U.S. coincided with the wholesale offshoring of manufacturing capacity.

But it isn’t quite that simple. “Free” Trade, Jobs and Income Inequality: It’s Not As Easy As We Might Think (March 22, 2016)

There are many other issues in play, including:

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Bernanke Blew It Big-Time: He Should Have Raised Rates Three Years Ago

It is now painfully obvious that Ben Bernanke blew it big-time by not raising rates three years ago when the economy and markets enjoyed tailwinds. The former Federal Reserve chairperson, who has claimed the mantle of savior of the global economy, foolishly kept rates at zero until tailwinds turned to headwinds, at which point he handed Janet Yellen the unenviable task of raising rates as the headwinds are strengthening.

Ben Bernanke is not the savior who rescued the global economy; he is the clueless fool who plunged a poisoned knife in its back. After weathering the spot of bother in Euroland in 2011-2012, the global economy had multiple tailwinds in 2013–tailwinds that enabled Bernanke and the Fed to raise rates in a series of measured steps.

Tailwind #1: the Fed’s binge-buying of assets (QE3) was still ramping up in 2013:

Tailwind #2: the yield curve spread had bounced off its 2012 low:

Tailwind #3: market speculative positions and sentiment were solidly positive:

Tailwind #4: China’s economy and appreciation of the yuan had not yet weakened:

In April 2013, the market’s “recovery” had already been running for four years.By mid-2013, the S&P 500 had soared from 667 in March 2009 to 1,600, exceeding its previous all-time highs around 1,574–a gain of 930 points or 140% off the 2009 lows.

What else did The Bernank want in mid-2013–an infinite line of credit with the Central Bank of Mars? He had literally every tailwind a central banker could want to support higher interest rates–especially rates that could have clicked higher by tiny .25% increments.

Instead, Bernanke blew it big-time, letting the “recovery” run seven years without any significant increase in rates. Now that the “recovery” is in its eighth year, it’s starting to roll over. All those tailwinds have reversed into headwinds, especially China, which has seen the RMB (yuan) strengthen by 20% as its currency peg to the U.S. dollar has dragged it higher.

The 20% appreciation in the yuan makes China’s exports increasingly costly and thus less competitive globally.

As I explained in Why the Fed Has to Raise Rates (December 4, 2015), the U.S. dollar serves two sets of users: the domestic U.S. economy and the international economy that uses the USD as a reserve currency.

While the Fed poo-bahs are constantly spewing propaganda about how the Fed serves Main Street (well, it does serve Main Street in a manner of speaking–as a tasty snack to Wall Street), the one absolutely critical mission of the Fed in the Imperial Project is maintaining U.S. dollar hegemony.

No nation ever achieved global hegemony by weakening its currency. Hegemony requires a strong currency, for the ultimate competitive advantage is trading fiat currency that has been created out of thin air for real commodities and goods.

Generating currency out of thin air and trading it for tangible goods is the definition of hegemony. Is there is any greater magic power than that?

In essence, the Fed must raise rates to maintain the U.S. dollar hegemony and keep commodities such as oil cheap for American consumers. The most direct way to keep commodities cheap is to strengthen one’s currency, which makes commodities extracted in other nations cheaper by raising the purchasing power of the domestic economy on the global stage.

Another critical element of U.S. hegemony is to be the dumping ground for exports of our trading partners. By strengthening the dollar, the Fed increases the purchasing power of everyone who holds USD. This lowers the cost of goods imported from nations with weakening currencies, who are more than willing to trade their commodities and goods for fiat USD.

The loser as the USD strengthens is China, which must devalue its currency or de-peg its currency from the USD to preserve its export-sector competitiveness. Anything that could disrupt China’s fragile economy, credit expansion and capital flows is a global worry, and Bernanke blew it big-time by not raising rates when global growth was still a tailwind.

Now that the tailwinds have become headwinds, the global economy is like a cracked glass teetering on a fence post in a rising storm. Every move in interest rates has immediate consequences in currencies, bond yields and capital flows, and each of these winds has the potential to topple the increasingly fragile global economy into recession–or worse.

Ben Bernanke blew it big-time, not just for America, but for the world. This reality cannot be dismissed as the luxury of hindsight; it was clear to many observers that after four years of recovery, it was time to start raising rates in 2013. Leaders must lead; if the Fed chair is so weak-kneed that he/she must ask the market’s permission for every decision, that’s not leading–it’s following a short-term profit-obsessed liquidity junkie off the cliff.

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Triffin’s Paradox Revisited: Crunch-Time for the U.S. Dollar and the Global Economy

While all eyes on fixated on global stock markets as the measure of “prosperity” and “growth” (or is it hubris?), the larger force at work beneath the dovish cooing of central bankers is foreign exchange: the relative value of nations’ currencies, which are influenced (like everything else) by supply and demand, which is in turn influenced by interest rates, perceived risk, asset purchases and sales by central banks and capital flows seeking the lowest possible risk and the highest possible return.

Which brings us to Triffin’s Paradox, a topic I’ve covered for many years:

Understanding the “Exorbitant Privilege” of the U.S. Dollar (November 19, 2012)

The Federal Reserve, Interest Rates and Triffin’s Paradox (November 19, 2015)

The core of Triffin’s Paradox is that the issuer of a reserve currency must serve two entirely different sets of users: the domestic economy, and the international economy.

The U.S. dollar (USD) is the global economy’s primary reserve currency. When the Federal Reserve lowered interest rates to zero (Zero Interest Rate Policy, ZIRP), it weakened the dollar relative to other currencies. In this ZIRP environment, it made sense to borrow dollars for next to nothing and use this free money to buy bonds and other assets in other currencies that paid higher yields. Many of these assets were in emerging market economies such as Brazil.

As a result of this enormous carry trade, an estimated $7 trillion was borrowed in USD and invested in other currencies/nations.

Once the Fed started making noises about “normalizing”/raising interest rates in the U.S. (i.e. signaling the markets that a trend change was at hand), the dollar strengthened and the carry trade started reversing: those who had bought assets in other currencies with borrowed USD started selling those assets, which pushed emerging market currencies and markets off a cliff.

Meanwhile, since China pegs its currency the yuan/RMB to the USD, the rising dollar dragged the yuan higher thanks to the peg. A strengthening yuan made China’s exports more expensive and less competitive, the last thing China needed as its domestic credit bubble ran out of steam.

So while the Fed needed to “normalize” rates in the U.S. before the next recession required more Fed stimulus, it also needed to weaken the USD to protect China from a destabilizing currency devaluation.

Those holding millions of soon-to-be-devalued yuan in China were naturally anxious to convert their yuan into USD before the devaluation robbed them of 25% of the purchasing power of their money, and this has created an unprecedented capital flow of cash out of China and into USD and other Western assets, such as chateaux in France, homes in Vancouver B.C., etc.

This mad rush of capital out of China is adding another destabilizing factor to China’s already wobbly debt bubble economy, and China’s weakness has weakened an already wobbly global economy crippled by stagnation and the decline of emerging markets and commodities–two consequences of the rising USD.

This has created a no-win conundrum for the Fed: if it normalizes rates (as it should, after seven years of ZIRP and stimulus) in the domestic U.S. economy, that will strengthen the USD, further pressuring China’s yuan and emerging markets, which in turn will further pressure an already-tottering global economy.

There are no winners, regardless of what policy the Fed chooses to pursue. This is why we see such absurd waffling in the Fed: one statement suggests interest rates hikes are on the way, and the next dovish cooing suggests rate hikes are so far away that global markets can safely ignore the possibility.

This push-pull is reflected in the chart of the USD:

As the Fed waffles in response to global markets, the USD has swung up and down in a trading range.

Sorry, Fed: you can’t have it both ways. Eventually, the domestic economy will pay the price of essentially zero interest rates, or China and the global economy will pay the price of a strengthening USD.

No nation ever achieved global hegemony by devaluing its currency. Hegemony requires a strong currency, for the ultimate arbitrage is trading fiat currency that has been created out of thin air for real commodities and goods.

Generating currency out of thin air and trading it for tangible goods is the definition of hegemony. Is there is any greater magic power than that?

In essence, the Fed must raise rates to strengthen the U.S. dollar (USD) to keep commodities such as oil cheap for American consumers. The most direct way to keep commodities cheap is to strengthen one’s currency, which makes commodities extracted in other nations cheaper by raising the purchasing power of the domestic economy on the global stage.

Another critical element of U.S. hegemony is to be the dumping ground for the exports of our trading partners. By strengthening the dollar, the Fed increases the purchasing power of everyone who holds USD. This lowers the cost of goods imported from nations with weakening currencies, who are more than willing to trade their commodities and goods for USD.

What better way to keep bond yields low and stock valuations high than insuring a flow of capital into U.S.-denominated assets?

There is one more destabilizing possibility: the markets may push the USD higher, regardless of what the Fed says or does. The currency markets trade $5 trillion a day–more than the Fed’s entire $4 trillion balance sheet.

Once traders realize China will have to devalue the yuan by a lot more than a few baby-step devaluations, the stampede into USD could overwhelm even coordinated interventions by central bankers.

Of course no central banker will ever admit that markets could wrest free of central bank control, but the reality is that we’re one panic away from foreign-exchange markets ripping free of central bank manipulation.

 

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“Free” Trade, Jobs and Income Inequality: It’s Not As Easy As We Might Think

Globalization (a.k.a. “free” trade) has become an election issue for two reasons: many voters blame “free” trade with China and other nations for job losses in the U.S. and rising income inequality as globalization’s “winners” in the U.S. outpace its far more numerous “losers.”

A recent article in the New York Times looks at the issue from the perspective of recent economic studies: On Trade, Angry Voters Have a Point (via Lew G.)

The case for globalization based on the fact that it helps expand the economic pie by 3 percent becomes much weaker when it also changes the distribution of the slices by 50 percent.

Before we dig into this complicated set of interconnected macro-dynamics, let’s stipulate that there is no such thing as “free” trade. Every trade agreement defines winners and losers by the very design of the agreement.

Also, other issues that are outside the confines of the actual trade agreement can have outsized influence on trade’s winners and losers.

For example, trade between the U.S. and China cannot possibly be “free” because China pegs its currency to the U.S. dollar (USD). This peg enables China to arbitrarily keep its products cheaper than they might be if the market set the value of China’s yuan.

We must also keep in mind that the owner of the reserve currency, the U.S., must export its currency in size, i.e. run a permanent and substantial trade deficit. I’ve explained Triffin’s Paradox many times; please read (or re-read) these essays if you want to understand why trade deficits are integral to the reserve currency and are not a feature of any particular trade agreement:

Understanding the “Exorbitant Privilege” of the U.S. Dollar (November 19, 2012)

The Federal Reserve, Interest Rates and Triffin’s Paradox (November 19, 2015)

Many overlook the fact that central bank interventions play an enormous role in establishing globalization’s winners and losers. By lowering interest rates to zero (or less than zero) and flooding the banking sector with credit/liquidity, central banks encouraged an explosion of global carry trades, in which financiers borrow cheap in one currency to buy high-yielding assets in another currency/nation.

The central-bank fueled explosion in credit also threw gasoline on speculative investments in emerging market nations, distorting currencies, markets and trade. The point here is that globalization, financialization and central bank interventions are tightly bound together. We cannot talk about any of these drivers in isolation; together, they form one system we loosely call “global trade.”

Let’s move on to globalization’s impact on jobs, income and income disparity.The article linked above notes that one study found trade with China erased 2.4 million jobs in the U.S. Other studies have found an offsetting consequence: the purchasing power of middle-class and working class households rose by 26% due to globalization’s relentless reductions in the cost of imported goods.

We must take all such estimates with a grain of salt, as there are many dynamics in play. The U.S. economy has been roiled by deep structural changes since the late 1960s; there has been no let-up in systemic turbulence: the end of the Bretton Woods stability in foreign exchange markets; the rise of Japanese and Asian imports in the 1970s and 80s; oil shocks and stagflation in the 1970s; the cost of dealing with industrial pollution of our air, water and soil; the tech boom–the cost of processors and memory have fallen while advances in software and robotics accelerate; the explosive changes wrought by the Internet; the rise of China and the Asian Tigers as the world’s low-cost workshop, and various speculative debt/fraud bubbles that burst with catastrophic consequences for participants and non-players alike.

At the risk of overloading you with data, let’s look at a few key charts and mark the rise of China’s influence, the rise of financialization and income inequality and the explosive rise in U.S. corporate profits.

Here are the charts we’ll be reviewing:

— Civilian employment-population ratio (the percentage of the population who are employed in some fashion, including self-employed and part-time)

— Productivity (and income disparity)

— Income inequality

— U.S. Financial profits

— U.S. Corporate profits

On the face of it, the U.S. experienced a multi-decade boom in employment from the early 1980s to 2008. Many have noted that the key demographic driver of this rise in employment was the mass entry of women into the work force. Many believe the loss of purchasing power in the stagflationary 1970s pushed women into the work force as the only means of maintaining household buying power. There were other drivers, of course; nothing this structural reduces down to one single cause.

This chart looks like a giant head-and-shoulders pattern that correlates with the rise and fall of financialization, which is the commodification of previously safe assets such as housing and the explosive rise in debt, derivatives and financial gaming (which quickly morphs into fraud if regulatory agencies fall asleep at the wheel).

It’s difficult to separate China’s rise and the bursting of the tech bubble, as both occurred in the same time frame; undoubtedly both negatively impacted employment.

The disconnect between productivity and wages really took off with the rise of financialization and cheap technology tools in the early 1980s. This is not coincidental, and can’t be pinned on globalization or trade with China, which occurred much later.

As we see in this chart of income inequality, the top 10% (the “winners” in financialization and tech) had already pulled away from the bottom 90% when China entered the WTO in 2001. Clearly, the disparity began before China’s trade was large enough to impact the U.S. economy; the dramatic increase in trade with China post-2001 had little impact on the disparity between the top 10% and the bottom 90%.

This chart of financial profits and debt/GDP shows the dramatic expansion of debt from the early 1980s and the explosive rise in financial profits as interest rates were pushed to zero and the debt/housing bubble #2 took off.

Could globalization have been a factor in this monumental expansion of financial profits? As noted above, it’s clear that the globalization of finance–carry trades, the expansion of financial markets in emerging nations–gave U.S. financiers, corporations and banks an enormously expanded field for skimming fees and profits via debt, derivatives and speculation.

Total U.S. corporate profits soared once trade with China and the financial free-for-all of housing/debt/fraud took off. This chart makes it clear that the winners from 2001 on were financiers and corporations exploiting two dynamics: offshoring production to China and maintaining product costs to reap outsized profits, and borrowing cheap money to expand overseas and skim profits from carry trades.

What do we get if we add these charts up?

1. Offshoring of production jobs to China et al. undoubtedly slashed jobs for the bottom 90%, but these losses were offset (or masked) by the rise of housing/debt/fraud bubbles that boosted employment in the FIRE sector (finance, insurance, real estate).

2. Financialization and central bank intervention greatly rewarded those with the skills and sociopathologies needed to participate in the resulting debt/fraud booms.

3. U.S. corporations reaped the gains from offshoring jobs, and these gains flowed to top management and those who own corporate shares, i.e. the top 5%.

4. The trend of rising income disparity started long before China’s trade was significant enough to impact the U.S. economy, and correlates with the rise of financialization and cheaper technology tools.

5. These trends rewarded management, finance and technology expertise, which are concentrated in the top 10% of the work force.

6. Cheap imports, offshoring of production and the global expansion of financial markets have driven U.S. corporate and financial profits to unprecedented heights. Since these profits largely flow to top management, financiers, technocrats and owners of corporate capital–roughly speaking the top 10% or even top 5%–it’s no wonder wealth and income disparity is rising: there is no other output possible in the current system.

Slapping fees on imports (which by the way is illegal in treaties such as the WTO) will not solve the larger problems of reduced employment, stagnant wages and rising income inequality. To make a dent in those issues, we’ll need to tackle central bank and central-state policies that have pushed finance and speculative churn to supremacy over the productive economy.


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Why the Fed Has to Raise Rates

A great many insightful commentators have made the case for why the Fed shouldn’t raise rates this month–or indeed, any other month. The basic idea is that the Fed blew it by waiting until the economy is weakening to raise rates. More specifically, former Fed Chair Ben Bernanke–self-hailed as a “hero that saved the global economy”–blew it by keeping rates at zero and overfeeding the stock market bubble baby with quantitative easing (QE).

Now that the Fed isn’t feeding the baby QE, it’s throwing a tantrum.

On the other side of the ledger is the argument that the Fed must raise rates to maintain its rapidly thinning credibility. I have made both of these arguments: that the Bernanke Fed blew it big-time, and that the Fed has to raise rates lest its credibility as the caretaker not just of the stock market but of the real economy implodes.

But there is another even more persuasive reason why the Fed must raise rates.

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The Federal Reserve, Interest Rates and Triffin’s Paradox

One result of the global dependence on central bank interventions is a unhealthy fixation on the slightest changes in those interventions, oops I meant policies.

Since the slightest pull-back in central bank inflation of asset bubbles could spell doom for the global economy and everyone holding those assets, the world now hangs on every pronouncement of the Federal Reserve in a state of extreme anxiety.

Why the extreme anxiety? Because any change in Fed intervention creates both winners and losers. There is no way Fed policy can be win-win-win for all participants, and to understand why we turn to Triffin’s Paradox, a.k.a. Triffin’s Dilemma.

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The USD Bull in the Global China Shop

The long-term consequences of primary FX trends may be entirely unintended.

Indulge me two “I told you so’s”:

1. That the U.S. dollar (USD) would rise a lot, confounding those busily digging the dollar’s grave

2. That the stronger dollar would crush U.S. corporate profits earned overseas, negatively impacting U.S. stock valuations and markets.

My call for a significantly stronger USD goes back four years:

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Why the Fed Must Taper

The Fed is being forced to end its bond-buying, cutting off the “free money for financiers” that has sustained a frothy stock market.

While the Federal Reserve presents itself as free to do whatever it pleases whenever it pleases, the reality is the Fed’s own policies are constraining its choices. Take the taper of U.S. Treasury bond purchases–the heart of quantitative easing (a.k.a. QE or more accurately free money for financiers).

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The Golden Era of the 1950s/60s Was an Anomaly, Not the Default Setting

The 1950s/60s were not “normal”–they were a one-off, extraordinary anomaly.

If there is one thing that unites trade unionists, Keynesian Cargo Cultists, free-market fans and believers in American exceptionalism, it’s a misty-eyed nostalgia for the Golden Era of the 1950s and 60s, when one wage-earner earned enough to buy all the goodies of a middle-class lifestyle because everything was cheap. Food was cheap, land was cheap, houses were cheap, college was cheap and most importantly, oil was cheap.

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The Dollar and the Deep State

If we consider the Fed’s policies (tapering, etc.) solely within the narrow confines of the corporatocracy or a strictly financial context, we are in effect touching the foot of the elephant and declaring the creature to be short and roundish.

I have been studying the Deep State for 40 years, before it had gained the nifty name “deep state.” What others describe as the Deep State I term the National Security State which enables the American Empire, a vast structure that incorporates hard and soft power–military, diplomatic, intelligence, finance, commercial, energy, media, higher education–in a system of global domination and influence.

Back in 2007 I drew a simplified chart of the Imperial structure, what I called the Elite Maintaining and Extending Global Dominance (EMEGD):

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Certainty, Complex Systems, and Unintended Consequences

When it comes to complex systems and unintended consequences, the key phrase is “be careful what you wish for.”

A lot of people are remarkably certain that their understanding of how systems will respond in the future is correct. Alan Greenspan was certain there was no housing bubble in 2007, for example (or he did a great job acting certain). There is no shortage of people who are certain the U.S. dollar is doomed to collapse, but only after losing the reserve currency status.

Other people are certain China can launch a gold-backed currency that will replace the dollar as the world’s reserve currency.

Some are certain the U.S. stock market is going to crash this year, while others are equally certain that stocks will continue lofting higher on central bank tailwinds.

Being wrong about the way systems responded in the past doesn’t seem to deter people from being certain about the future.

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