Sunday, December 2, 2018

David Stockman Called It: "The Tariff Pause"

The White House has announced, following a dinner meeting between President Trump and President Xi Jinping of China  at the G20 Summit in Buenos Aries, that President Trump has agreed that on January 1, 2019, he will leave the tariffs on $200 billion worth of product at the 10% rate, and not raise it to 25% at this time as was previously scheduled.

In the essay below, published before the dinner, David Stockman called it:

No MAGA For The Donald: The Problem Is Bad Money, Not Bad Trade Deals
By David Stockman.
Alas, the Donald and President Xi are just hours from their historic confab, but however it turns out it will be a case of no cigar. And that's especially true if their gaggle of advisors come up with some kind of face-saving, can-kicking shuffle of the showdown to another day.
Indeed, we fully expect there will emerge from Saturday's meeting some kind of "pause button" gimmick that will keep the current $250 billion of US tariffs and $110 billion of Chinese tariffs in place, but put the Donald's full monte (25% tariffs on all $526 billion of Chinese imports) on a time-limited fuse designed to enable another futile round of negotiations.
And let us put the emphasis on the "futile" part. While the speculators and rob0- machines in the casino are sure to get excited about the pause button---- that's only because honest price discovery is now deader than a doornail. At any given moment, the only thing getting discounted on Wall Street is a few hours of thrashing around by the chart monkeys looking for the next, fleeting "support" level.
If there were an honest stock market, by contrast, it would be selling off like mad because Mr. Xi and the Donald are on a course akin to that of the Titanic and the llulissat Iceberg of 1911.
That is to say, the former is now a full-fledged communist tyrant who dares not loosen the reins of control on a monstrous Red Ponzi that is an absolute freak of economic history and which is becoming more unstable by the day; and the latter--- for all his occasional subtleties of mind on other issues---is an absolute simpleton on the matter of trade.
As the Donald has made clear in many months of tweet-storming now, he actually believes that trade deficits are tantamount to international theft---stolen money.
Needless to say, there is no conceivable set of Chinese offers---even if Mr. Xi were so inclined----which can do anything about these freakish facts of life. To wit, during 2017 the US bought $526.1 billion of merchandise goods from China, while China bought only $129.8 billion of goods from the US.
But that yawning $396 billion gap had nothing to do with theft, bad trade deals, the WTO or stupid people at the USTR and Commerce Department whom the Donald, presumably, cleaned out long ago. Accordingly, there is virtually nothing under the conventional trade file that can make a material difference---even if negotiators dicker until the cows come home.
For instance, at the 4-digit product code level, the #1 US export to China last year was $12.4 billion of soybeans. But even if China were to remove its current 25% retaliatory tariff on soybeans as a goodwill gesture to Trump's red state farmers, any pick-up would amount to a rounding error in the scheme of things.
Indeed, total US soybean exports to the world in 2017 were just $21.5 billion. So if Xi were to offer to buyout the whole damn US crop, it would still only reduce the trade deficit by 2%!
Or to take another example, the US exported $4.4 billion of petroleum to China last year and $18 billion to the rest of the world. So, again, let Mr. Xi buyout every single barrel available for export and you have only another 4% reduction in the that big red deficit number that truly does cause the Donald to see red.
As we have documented in this series, the trade picture depicted below is the historically putrefied fruit of bad monetary policy.
Three decades of egregious money printing by the Fed had the effect of ballooning US demand for merchandise imports while off-shoring America's supply base of the same--- -even as break-neck credit expansion in China drained its rice paddies of cheap labor and massively subsidized the construction of gleaming new export factories and the related supply chain infrastructure.
So the briefcase toting trade lobbyists on K-Street, WTO apparatchiks and China's trade commissars didn't cause the problem and can't much move the needle on today's freakish imbalance----the one part of the story about which the Donald is absolutely correct.
As it happened, US imports from China grew from a mere $20 billion in 1993 to the aforementioned $526 billion last year (dark blue bars). But nothing grows by 27X in barely two decades in the natural order of markets, and most especially not in world merchandise trade when the US export side of the equation (light blue bars) stands at a tiny 25% of imports.
That is to say, there can be large trade imbalances between countries owing to comparative advantage and specialization, as well as to mercantilist trade practices.
But imbalances this freakishly large and persistent cannot be attributed to either economics or protectionism.
They are a function of money gone bad during the Fed-driven global central banking print-a-thon of the last several decades. Yet it goes without saying that if China were to curtail its runaway $40 trillion credit machine, the Red Ponzi would collapse instantly and Mr. Xi and his cronies would find themselves hanging from one of the skyscrapers in Beijing.
At the same time, the only thing that can even begin to wean America's borrow and shop until you drop economy from its $526 billion China import habit is a rip-roaring recession brought on by a return to sound money policies at the Fed.
Yet when it comes to the prospect of the political gallows, Samuel Johnson had the Donald well pegged two centuries ago: "It concentrates the mind wonderfully", said he-- -meaning that even if Powell & Co were inclined to let the purge begin, the Donald's attack on the Fed would make FDR's 1937 court-packing escapade look like sunday school picnic.
In a word, there is no way out. And most especially not from the Trade Nanny agenda being pushed by America's corporate crybabies and the Bob Lighthizer/ K-Street lobbyist brigade who shill for them.
The Business Roundtable crowd doesn't really give a rip about the Donald big red $396 billion deficit ogre---they just want to be treated more nicely when they put their capital in harms' way by investing and operating in the Red Ponzi.
What we mean is that you could get rid of every one of China's allegedly onerous requirements for technology sharing and other conditions of doing business there, and it wouldn't make one bit of difference on the Donald's China trade scoreboard.
In fact, the K-Street agenda which Lighthizer shills for is about boosting corporate profits among the Big Cap companies that operate businesses there. Even if the White House got 90% of its ask on these investment and intellectual property issues, it would add nary a job in the burned out precincts of Flyover America.
The Freakish Evolution Of The US/China Trade Imbalance
The intractability of the monetary roots of the China Trade deficit are shown in the chart below. The People's Printing Press of China (light blue) was a major contributor to the explosion of central bank balance sheets since the late 1990s.
At the essence of the matter, the Chinese radically depreciated their currency by 60% in 1994 and thereafter pegged the Yuan to the dollar (rigidly between 1995 and 2004 and
loosely thereafter). The purpose was to prevent their exchange rate from soaring in the face of huge trade surpluses with the US and the rest of the world.
So doing, China acquired huge FX reserves, which went hand in hand with the massive expansion of their own domestic banking system and credit levels. That obviously happened because they had to print Yuan in order to buy-in dollars and other foreign exchange as part of their pegging operation.
The consequence, however, was not merely a massive explosion of domestic credit, which, in fact, grew by 80X or from $500 billion to $40 trillion between 1995 and the present. By the lights of Keynesians and monetarists alike---that was supposed to be their problem, not ours.
But what it really did was totally block the natural adjustment of trade balances which would have occurred under either a gold-based sound money regime or even under an honest free-market based floating currency regime.
In the former case, the US would have lost massive amounts of gold reserves, causing the domestic banking system to contract, credit to be curtailed and domestic wages, prices and costs to decline until imports abated and exports picked-up.
And under an honest free market float, the adjustment would have occurred via massive appreciation of the Yuan exchange rate versus the dollar. That would have dramatically reduced the competitive advantage of China's cheap labor economy while opening the door to a higher level of US exports.
To be sure, China would have undoubtedly maintained a material trade surplus with the US owing to the inherent advantage of low cost labor and newly constructed manufacturing plants and related infrastructure.
But it would have been nothing like the trade balance aberration shown above, which is what drove the off-shoring of American industry, the equally freakish election of Donald
Trump and, now, the Titanic and Iceberg collision warming up in Buenos Aires.
Needless to say, this all started on the US side during the Greenspan era of monetary central planning. Under a sound monetary system, the US would have experienced systematic and persistent internal deflation of prices, wages and costs in the face of the mobilization of the east Asian economies out of the rice paddies of subsistence agriculture.
That means, in turn, that interest rates would have been peristently high to generate larger domestic savings and efficiency-driven investment, while credit expansion to finance excess consumption would have been sharply curtailed.
In that context, there was no need for the Fed's balance sheet of $200 billion (1987) to expand at all. As it happened, of course, the Fed's balance sheet more than quadrupled during Greenspan's 19-year tenure to $830 billion; and then it was off to the races under his successors, who brought it to a peak of $4.5 trillion or a 23X gain in barely 27 years.
In a word, excess dollar liabilities became America's #1 export----a plague on the world economy which naturally caused the statist and mercantilist governments of Asia and the EM world generally to massively intervene against the Fed's dollar tsunami in desperate efforts to hold down their own FX rates and keep their export factories humming.
Needless to say, the freakish explosion of China's FX reserves pictured below is exhibit #1.
Not surprisingly, the massive and chronic FX interventions of China and the EM economies linked to it ended-up fueling out-of-this-world credit growth in their domestic economies.
For instance, between the year 2000 and the present, credit outstanding in the non- government, non-financial sector of the Chinese economy grew from 10 trillion Yuan to 180 trillion ($26 trillion).
That's an 18X growth in 18 years, and is what makes Red Ponzi sui generis. That is to say, a debt-fueled economic mad houses that only resembles a stable capitalist economy because the Red Suzerains of Beijing are pleased to keep up the pretense; and because Wall Street long ago lost its capacity to assess reality.
18X Explosion Of Business Credit Growth In The Red Ponzi
Yet this is the house of cards that the Donald's trade war is now frontally attacking. The potential earth-shattering consequences of toppling it are difficult to even imagine, but below is a reminder of why the Red Ponzi is a trainwreck waiting to happen.
Given China's insane 80X credit growth since the mid-1990s, it is no wonder that the Red Ponzi consumed more cement during three years (2011-2013) than did the US during the entire twentieth century.
Enabled by an endless $40 trillion flow of credit from its state controlled banking apparatus and its shadow banking affiliates, China went berserk building factories, warehouses, ports, office towers, malls, apartments, roads, airports, train stations, high speed railways, stadiums, monumental public buildings and much more.
If you want an analogy, 6.6 gigatons of cement is 14.5 trillion pounds. The Hoover dam used about 1.8 billion pounds of cement. So in 3 years China consumed enough cement to build the Hoover dam 8,000 times over----160 of them for every state in the union!
The New Middle Kingdom Of Concrete In effect, the Middle Kingdom has been reborn in towers of preformed concrete. They now rise in their tens of thousands in every direction on the horizon. They are connected with ribbons of highways, which are scalloped and molded to wind through endless forests of concrete verticals.
Some of them are occupied, a lot of them are not.
In fact, there are upwards of 60 million empty apartment units in China, most of them never occupied. They stand as a tribute to the insane notion that rent-less real estate is a wonderful investment because it never stops appreciating and the government will never let prices fall----even if the implied rental yields are unaffordable to the overwhelming share of the population.
The point is, China's economy is a complete artifact of the craziest credit expansion in recorded history. Now even the Red Suzerains of Beijing know they are sitting on a time bomb, and are desperately attempting to rein-in their credit machine.
But that also means that they are being forced to stop "printing" GDP----meaning that 40-50% of growth has been from spending on industrial and public infrastructure and housing construction. Yet as they have attempted to drawdown the rate of credit growth, GDP expansion has deflated virtually dollar for dollar.
Can they bring the ship of state into a soft landing?
Absolutely not, and the longer they temporize, the harder the eventual landing will be. That's because their debt-to-GDP or economic leverage ratio is already at Peak Debt and beyond.
Needless to say, the full monte Trump tariffs on China will prove to be the coup d grace.They will impact about $1.7 trillion of US goods consumption of which China supplies about 30%. This means China is the overwhelming marginal supplier to the domestic market for goods, and the China Price drives the world supply curve.
So as the prices of imports from China rise by 10% now and 25% if (when) the full monte becomes effective next year, prices for the 67% share of China supplied goods which comes from other foreign suppliers or residual domestic producers will rise toward the tariffed price umbrella.
To be sure, prices won't go all the way to the notional +25% price umbrella because competitors will come in just under the landed price of China goods plus the tariff, thereby taking market share. Depending upon supply elasticities, and whether we are talking about the short run or longer time periods, price increases will be lower than the full tariff percentage.
Needless to say, the lower the price increase (and the lesser the burden on US consumers), the greater the implied supply elasticity and loss of market share and volume by China producers to other foreign and domestic US producers. Even then, China suppliers----especially state owned companies that are in the social policy and jobs-support business---will have the option to cut prices to offset some or all of the tariff, and thereby slice their already razor thin profit margin even further.
But in general, we expect that the Trump tariffs will lift prices on the China end of the supply curve significantly higher, thereby whacking domestic US consumers and moving volume and profits away from current Chinese suppliers.
So who will be the winners from the massive price umbrella that the Donald is in the process of erecting?
Why, it will be low wage places like Mexico, Vietnam, Indonesia, India, Bangladesh etc. And also Taiwan and South Korea, too, all of whom will be enabled by the Donald to steal market share from China and get a windfall gain from higher prices on their current shipments.
No wonder the new quasi-socialist government of Mexico, for example, appears not to be at all troubled by the Donald's Trade war. They are getting $16 per hour auto worker wages from their sidebar NAFTA redo with the Trump trade team and, soon, a huge gain in market share from China, too.
For instance, at the four digit product code level, China's imports to the US last year totaled $124 billion for the top two categories----cell phones/cellular network gear and computers and related peripherals. Those Chinese supplied iPhones and computers accounted for 63% of America's total $198 billion of imports in these two leading categories during 2017.
But it isn't hard to guess who was the next largest supplier. Namely, Mexico at $31 billion, and then South Korea with $6.5 billion and Taiwan with $5.5 billion. In all, the next three suppliers after China accounted for $43 billion of imports, and therefore clearly have the production base to rapidly cut into China's share.
Accordingly, the fundamental flaw in the Donald's tariff strategy is blindingly obvious and can't be emphasized enough. Namely, historic protectionism generally involved high tariffs against all or most foreign suppliers, not just those of one country. For better or worse, the aim was to give domestic producers a cost advantage against all foreign producers up to the percentage level of the tariff.
The theory, of course, was that this cost advantage would enable production and jobs to migrate back home en masse.
The rejoinder of free market economists, however, has always been to point out the adverse trade-offs. That is, the higher costs to domestic consumers and the weakening of competitive pressures in the domestic supplier markets far outweigh the benefits of shifting production from foreign to domestic factories.
The Donald's Trade War Against China---A Weird Exercise In Global Philanthropy
But the Donald's Trade War is a wholly different kettle of fish. Whether he understands it or not, his China tariffs amount to a weird exercise in global philanthropy. They will tax US consumers---and especially the Red State constituencies which live hand-to- mouth at Walmart----in order to transfer jobs and incomes to, among others, Mexico and Vietnam!
Our impression was that the Donald got elected by demonizing Mexico---so the likely outcome of his tariffs are more than a little bit ironic. But at least the production which gets shifted to Vietnam has a bit of logic----America probably does owe them some war reparations.
Yet what is not going to happen from the China tariffs is a material reduction in the $800 billion US trade deficit, nor any material return of production and jobs to the US.
When it comes to in-place production capacity the US isn't even in the game and has no obvious way to get there.
On the fully loaded global cost curve, in fact, the US is stranded up near the top due to the Fed's decades of 2%+ inflation. This means essentially that the Donald will be
monkey-hammering US consumers with higher prices, but the output gains and windfall profits will go to other foreign suppliers much lower down on the supply curve.
We'd call this the art of madness, not deal-making of the type described in the 1987 book that the Donald, alas, didn't even write, or, according to the actual author, even proof- read.
Consider, for example, the top 25 four-digit product codes, which accounted for $286 billion of imports from China last year; and which comprised about 55% of total Chinese imports in the thousands of four-digit categories.
In addition to all the Apple products made by more than 1.0 million Foxcon workers at $4 per hour or less in factories mostly in the interior of China, other leading categories include tricycles and wheeled toys, furniture, monitors and television equipment, lamps and lighting fixtures, trunks and suitcases, printing machinery, videogame consoles, electrical transformers, footwear, numerous apparel categories etc.
The key point is that these $286 billion of Chinese imports accounted for 52% of total US imports of $556 billion reported in these 25 categories. But when it comes to where the balance---the other $270 billion---- of these goods came from and where they are positioned on the global labor and cost curve, the answer is again dispositive.
To wit, the next $61 billion came from Mexico!
That is to say, from supply bases that are low on the wage and cost curve, and which will be ideally positioned to grab market share from the Red Ponzi as the Donald's tariffs begin to bite.
And there something else. The slickest way to beat the Donald's tariff hammer will be for Chinese suppliers to ship-----in lieu of fully assembled iPhones----an alternative package of quasi-finished kits to Mexico for final assembly, packaging and re-export to the US.
To prevent that kind of natural market circumvention, of course, the Donald's Trade Nanny operation will have to drastically expand its rules-of-origin regulatory dragnet to stop the rampant end runs that are sure to follow.
After all, consider the $556 billion of imports in these top 25 mostly labor intensive categories. Exactly $286 billion of those goods originating in China will be taxed at up to 25%, while another $270 billion of identical goods in the same categories originating from the rest of the world will be taxed at 0%.
Can you say arbitrage?
The Donald's idiotic tariff-war-on-one-country is fixing to cause more upheaval and dislocation in global trade channels than can scarcely be imagined. But for what?
Indeed, the net of it is stunningly perverse: US consumers will get the inflation part; low-wage foreign competitors will get the re-located production and jobs; and the Red Ponzi will suffer a devastating loss of profitability on the US exports it does manage to retain.

As we said, the Titanic is heading for the Iceberg and this weekend's putative "pause" will prove to be but a momentary way station before the conflagration sure to come.
David Stockman was Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.

The above originally appeared at David Stockman's Contra Corner.

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