Thursday, May 9, 2019

The Orange Swan Cometh, Part 2

By David Stockman

The Donald may yet pull a last minute double backflip-and-flop on the China Trade War, which would be quite a feat for anyone, but especially a politician of his considerable girth.

What we mean, of course, is that the Donald isn't remotely the agile and savvy deal- maker he claims to be. That's because when it comes to economics, his primitive "low- interest" populism and crude mercantilism weigh him down far more than even his legendary gulps of cheeseburgers, fries and 42 oz King Size Burger King cokes.

So when push-comes-to-shove Thursday night, we'd bet the odds are with the full monte 25% tariff on the $200 billion now being taxed at 10%. The open space under the orange mop is just too saturated with dumbkopf protectionism for the Donald to see that his playing with economic fire.

After all, no US politician since the President William McKinley more than a century ago has claimed to be a Tariff Man.

All the GOP breaches of free trade since the Reagan era, in fact, have been done more in sorrow than overt praise. That is, protectionist measures for steel, autos, machines tools, Harley Davidson's etc. were rationalized as negative inducements to get the other side to purportedly remove their own protectionist roadblocks to US exports, not as constructive steps in and of themselves.

Not so with the D0nald, however. You really don't make the following claim, as he did yesterday, if you have even a vague clue about the economics of global trade:
For 10 months, China has been paying Tariffs to the USA of 25% on 50 Billion Dollars of High Tech, and 10% on 200 Billion Dollars of other goods. These payments are partially responsible for our great economic results.
He actually said that?

Why, yes, he did. And that's why he's completely off his rocker, actually believing that his tariff ploy is a win-win formula: Either China capitulates and he chalks up another "win" of the kind that we allegedly won't be able to stand much longer---or the tariffs stay in place and by the Donald's lights America wins just the same.

Moreover, Trump is utterly delusional about the state of the US economy and the reasons for the stock market's lofty aspect. Therefore, believing that the purportedly booming US economy and stock market have plenty of room to absorb a temporary setback, he is liable to press his advantage hard with the Chinese.

Doing so, however, he could end up bringing the whole house of cards down upon his own head. That's because the manic bubble now embedded in the stock averages hangs over the debt-entombed main street economy like an economic sword of Damocles. Accidently trigger a runaway sell-off in the casino, and you can be absolutely certain what happens next.

To wit, for 20 years now US businesses (corporate and noncorporate) have been accumulating debt like there is no tomorrow. Since late 1998, outstanding loans and bonds issued by US businesses have nearly tripled---rising by $10 trillion or at a rate of nearly 5.5% per annum, while nominal GDP has grown at a far slower rate of 4.2% per annum.

In a word, US business is leveraged to the hilt, and the overwhelming share of this staggering $10 trillion of debt accumulation was channeled into financial engineering, not the expansion of productive assets.

That's why, in turn, the near record 118 month age of this present tepid business expansion is so critical. It is not age per se; it's that for 10-years the drastic mispricing of debt and financial assets that is the essence of Keynesian central banking has functioned as a devil's workshop.

In a word, balance sheet capacity and cash flow has been diverted to massive uneconomic M&A deals, excess returns to equity owners and management enrichment schemes that would never occur on an honest free market.

So unleash the proverbial black swan and the next recession---totally invisible at the moment---gets triggered in a heartbeat. That's because panicked C-suites will seek to purge the rot that has built up during more than two decades of artificial Bubble Finance by frantically throwing workers, inventories and impaired assets overboard via sweeping restructuring plans designed to appease the angry trading gods of Wall Street.

Needless to say, the Donald does not remotely appreciate the risk, and no only because he is an economic ignoramus with virtually no grasp on the real facts of economic and financial reality.

Worse still, Donald Trump is actually the poster boy for the devil's workshop embedded in the $10 trillion explosion of business debt depicted in the chart below. That is to say, whether the Trump Organization is worth $10 billion or no billions (and based on today's leak of 10-years worth of giant tax losses it is likely the latter), it was built on the back of massive leverage and the egregious inflation of real estate assets that have been part and parcel of Keynesian central banking since the Greenspan era.

So does the Donald even remotely appreciate that he is playing with fire as his foolish Trade War with China reaches its penultimate stage?

He absolutely does not.

By the same token, does he also have any inkling at all that he is being played by his so-called trade policy advisors?

Not in the slightest is the answer to that even more crucial question. What we mean is that the Donald is a crude paint-by-the numbers protectionist, as his own tweet-storms make abundantly clear. He wants to bring down the bilateral trade balance with the Red Ponzi and to do so massively and abruptly.

By contrast, his neocon and K-Street oriented advisors have totally different agendas. In part 3, we will take up the phony neocon claim that the Red Ponzi is an incipient existential threat to America's prosperity and security. But suffice here to say that it is actually the opposite---the greatest agglomeration of debt, speculation and malinvestment in human history, which like the Soviet Union before it, will collapse of its own weight in due course.

But in the near-term---that is to say, the next days and weeks----it is the crew with actual loaded weapons, Bob Lighthizer and his negotiating team, that is actually liable to catalyze the crash.

In a word, they have already bamboozled the Donald into imposing $30 billion of tariffs on $250 billion of Chinese imports in order to pressure the Red Ponzi into putting out the welcome mat for US corporate investment in China and under more amenable terms. Bringing production and jobs back to Flyover America---the Donald's decades- old obsession---is hardly an afterthought in their agenda.

As we indicated a while back, the proof of this proposition can be readily established by turning to the foundation document on which the Donald's entire Trade War against China was launched in the spring of 2018.

We are referring to the Section 301 investigation and its 215 pages of "findings" with respect to China's alleged "unfair acts, policies and practices". The latter, however, are almost entirely focussed on the purported bad things that happen to American companies when they attempt to operate in the Red Ponzi or when willing US owners sell some or all of their company to Chinese acquirers.

Stated differently, the entire document has virtually nothing to do with bilateral merchandise trade between the US and China; nor did it essay the whys and wherefores of the freakish fact that China exported $563 billion of goods to the US in 2018 but bought only $120 billion of goods from US based suppliers.
The resulting $443 billion deficit is what has the Donald's orange hairs standing on end, of course, and to some substantial degree does measure the off-shoring of US production and jobs that have left Flyover America high and dry. But the 301 findings don't even bother to document how China discriminates against US imports or unfairly subsidizes its exports.

To be sure, even if the Chicoms commit either of these follies, that would not be a valid reason for starting a trade war or for Washington's meddling in the bilateral flow of goods between the two countries. Instead, it would just implicate another case of the age old mercantilist error---the proposition that if foreigners fill their harbors with rocks to discourage or even preclude imports, we should imitate their stupidity by doing the same.

In fact, however, the Donald has already triggered retaliatory actions and pre-emptive behavior on the merchandise trade front that has exacerbated the very bilateral imbalance that he wishes to drastically reduce; and in the process has clobbered the very constituencies that he claims to champion: Namely, hand-to-mouth Walmart customers, farmers and workers in US export industries.
US exports to China, for example, dropped from just under $130 billion in 2017 to $120.3 billion in 2018, representing a reduction of 7.4%; and that was owing to only one-half year of retaliation by China, which imposed tariffs on $110 billion of US goods after mid-year. The actual annualized run-rate of export loss, in fact, has been estimated at $40 billion or nearly one-third of the 2017 baseline level of US exports to China.

Indeed, that is being born out be recent results for 2019: US exports to China were down 26% in March and April versus prior year, while orders from US companies at the recent Canton Fair, the world's largest trade expo, fell 30% from a year earlier.

At the 4-digit product code level, however, the full extent of the blowback damage to US producers can be graphically seen. Thus, soybean exports dropped to just $3.7 billion in 2018---compared to $12.9 billion in 2017 and a high of $14.9 billion in 2016. No wonder bankruptcies are soaring in the farm belt.
Likewise, US auto exports to China plunged from $10.3 billion in 2017 to just $6.7 billion last year, while wood and pulp exports dropped by 5%, copper and aluminum exports by 26% and hides and skins by 30%. Even waste and scrap paper exports were off by 21%----to name but a few examples.

At the same time, US importers---rushing to beat the Donald's tariffs-- turned on the afterburners. They were especially desperate to bring in goods before January 1, when tariffs were originally scheduled to escalate sharply. As a result, imports actually surged by $37 billion in 2018 or 7%.

Altogether, US imports from China of $563 billion in 2018 were up by a whopping $81 billion from the actual level of $482 billion in 2016---a level which the Donald harpooned during the campaign as prima facie evidence of America's failed economic policies.

To be sure, it could be argued that a fair portion of this sharp deterioration in the US/China trade balance is temporary---the bargaining chips that must be spent to clear the decks for the future.

Unfortunately, however, an improved bilateral trade balance isn't really on the bargaining table----China's promises of stepped-up purchases of US goods notwithstanding.

Actually, there isn't all that much headroom to expand US exports to China in categories like aircraft, auto, farms products, energy and raw materials, as we will show in Part 3.

At the same time, the massive US imports of consumer goods from China are driven by a huge labor arbitrage that stems from 30-years of bad money, and couldn't be made to disappear by Houdini himself.

Nevertheless, the Donald's chief negotiator, Bob Lighthizer, is a K-Street racketeer of the first order and has spent his entire career in the service of expanding the reach, power and pelf of the Leviathan domiciled on the Potomac. What he is attempting to do on the backs on American consumers, farmers and exporters, therefore, is to erect a Washington run Industrial Policy to counter the inherent industrial policy of a centrally planned communist economy.

Consequently, a Chinese agreement to ease or even eliminate the pressure on American companies operating in China to share technologies or business know how will please the Business Roundtable lobby mightily, but what good will it do for jobs and production in Wisconsin?

The same is true, for example, of the 301 investigation's whining about a 20% limit on the US equity share of JVs in China's financial sector, 50% in the auto industry and various other constraints in between.

The appropriate response, of course, is a great big so what?

If the Red Suzerains of Beijing wish to be inhospitable to foreign capital, that's their sovereign prerogative, and its also their loss. After all, autarky and statist protectionism has never been a sustainable recipe for prosperity in all of recorded economic history.

Besides that, no one is forcing US companies to operate in China. They go there voluntarily for new markets and to brag on CNBC about the gangbusters growth they expect from their operations in China.

But if the inconvenience or cost of playing by the rules of the Red Ponzi outweighs the benefits, then they only need to do what capital has done from time immemorial: That is, depart for shores where it is treated more kindly.
And that gets us to the Washington focussed, statist industrial policy predicate behind the entire Lighthizer brief. It amounts to saying that Washington policy-makers are supposed to scour the global economy to insure that everywhere and always the rules of the economic game meet with the approval of US based companies and their Washington lobbies.

Needless to say, this takes crony capitalism to a whole new level. And as we will show in Part 3, it will do very little to close America's giant merchandise trade deficit, which hit a record $950 billion in 2018, or bring back the jobs and production that has been massively off-shored by three decades of monetary central planning at the Fed.

As we said, the Orange Swan now cometh.

And without even a inkling of the calamity he is fixing to unleash, as we elaborate further here:

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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