Debt Bomb

We all know that one sad day in the future our debt bomb will explode ... and America will have a very painful period digging our way out of the unsustainable national debt we have been accumulating over the last half century. (Zero or negative interest rates are now just too tempting for pols to resist.) The pain might be another period of crippling inflation ... or maybe even a debt default which would also destroy the wealth of most retired people ... and turn the American dollar into un-Sani-wipes. Circumstances might even force us into a kinetic war with our hegemonic rivals ... which would likely devastate much of what we enjoy today.

Why are we doing this to ourselves ... flying like a moth to the flame? Simple ... because we can. The rest of the world is also printing money like there will be no accounting ... so why shouldn’t we? President Trump suffers from this same tropism ... saying that zero interest rates allow us to nonstop borrowing. Just wait till rates go negative! And most politicians of both stripes of course stand and cheer.

If we can just postpone this day of reckoning until we, dear readers, will no longer be around ... just kidding. Our issue don’t need this issue too!

Yuan More

China, in response to Trump’s threatened additional 10% tariffs on $300 billion of its exports, has weakened its currency, the yuan, to above 7 to the dollar ... see: CNBC Story. This retaliatory move proves President Trump is right when he says that China pays for these tariffs and not US companies.

But it also makes it more difficult for American farmers to sell produce into China ... somewhat offset by our recent farm subsidies ... and huge problems with Chinese hog production.

However, to this observer, it is conclusive proof that China is a currency manipulator ... which should remove all hope that its currency will replace the dollar as the basis of international trade ...  something that Beijing has been angling for as a sign that it is the economic powerhouse it claims to be.

And, finally, it puts indirect pressure on the Fed for more rate cuts this year which should have the effect of weakening the dollar relative to all currencies ... and buoying up our economy.

Trump is playing a very complicated economic game ... with lots of dials to turn and levers to pull ... and he seems to be playing it well, IMHO.

Market Deflators

The stock market is in the red for the year ... for a number of reasons ... whose priorities seem to change from day to day. Today, it seems that the following are the reasons, in order of descending importance, for what are depressing the stock market ... or keeping it from going up as fast:

- Fed's stance on raising interest rates and outlook for same

- Status of tariff war with China

- Fed's monthly $50 billion reduction of its balance sheet and economic liquidity

- Slowing worldwide economic growth/US corporate profits and outlook for same

- Strength of the dollar and outlook for same

- Growth of US budget deficit

- Status of trade negotiations with the EU, Britain and Japan

- Brexit morass

- Potential US government shutdown over immigration

- Mueller's investigation and possible political repercussions

- Trump's tweets

Tomorrow all these things could be shuffled ...

Xi and Me

I have written before about the contest for world hegemony between the United States and China ... see: China vs. U.S. ... in which I discussed the strategic advantages of each. Since then I have had four more thoughts on this subject:

- One advantage I had given to the U.S. was that it sits between two oceans ... something China could not correct. Well, it seems that it is trying ... with an initiative called the New Silk Road ... see: Building the New Silk Road. I somehow doubt that this opening to China's west will equate to another ocean, hut, at least, China seems to recognize that it does have a geopolitical problem.

- China does have ambitions to make the yuan the basis of international trade ... replacing the U.S. dollar. However, it is clear that China has been recently devaluing the yuan as part of its trade war with the United States ... see: Bloomberg Article. This duplicity does nothing but undermine China's currency ambitions.

- One issue I did not previously address was the language differential between these two countries. The incredibly complicated nature of the Chinese alphabet and spoken language, I believe, gives the strategic nod to English and America. Yes, computer software has ameliorated this edge somewhat, but will never eliminate it.

- Although"diversity" is argued by the liberal left to be a strategic advantage, clearly China is far less diverse than the U.S. ... and seems to deem it a disadvantage as it cleanses itself of dissents. Diversity in America might end up being a plus ... but only after these diverse groups are assimilated ... which may take many years into the future.


These four points seem to shift the strategic advantage of America over China further to the plus side, albeit only slightly.  The real pudding tasting will be in how the current trade skirmish with China turns out. Stay tuned.

Economic War?

Last week I commented on the possible trade war between the U.S. and China ... see: Soybeans and  Trade War? for some perspective on this pissing contest. Since these mentioned events, Trump has pushed more chips on the table threatening to add another $100 billion of new tariffs to the bundle. China has not responded with more threatened tariffs ... probably because they might be running out of  U.S. products to punish. So China has shifted its focus from tariffs and is now threatening to devalue its yuan in order to keep its mercantile edge in trading with the U.S. ... see: Bloomberg Article.

Now this currency threat tells me a few things:

- China realizes that it cannot win this trade war with tariffs alone. So, it  might have to escalate things to an economic war using its currency. This would dash its hopes of making the yuan an international currency of trade.

- Although China might devalue the yuan just relative to the dollar, the dollar is a powerful arbitration unit in international commerce ... meaning most of the rest of the world would be adversely affected ... not something China may want to do.

- The U.S. Is not likely to respond in kind to such a currency devaluation which would further besmitch the almighty dollar. But we do have other arrows in our quiver in such an economic war. One of which might be to reduce our interest payments on the $1.3 trillion of our debt by the degree of China's currency devaluation. After all such a devaluation by China artificially increases its local currency benefit of America's interest payments. This would, of course, reduce the value of this treasury hoard that China holds.

- The U.S. might adjust any threatened tariffs upward to compensate for any yuan currency devaluation. This wold be difficult for China to respond  to.

And there are many other arrows: WTO sanctions, a coordinated international response to China's mercantilism, subsidies to U.S. industries affected by any trade or currency war, restrictions on Chinese investment in the U.S., etc., etc. This is a complex chess game being played by two very smart players. But the U.S. does have more experience playing this game (although it hasn't looked like we have utalized this edge until just recently.)

Yeasty

There is an old Wall Street adage for investors, “Don’t fight the Fed,” meaning the Federal Reserve bank has a lot to do with the direction of the stock market. If the Fed is reducing interest rates and expanding the money supply, then the stock market should go up … and vice versa. Over the last eight months we have seen a perfect example of this working in Japan where its national bank has been engaged in this very process, it’s own version of “quantitative easing” (QE) … see: The Economist Explanation.  It is basically printing yen to a fair-thee-well while holding interest rates at zero (see: Trading Economics.) The result … the Nikkei 225, the primary stock index in Japan has been quite yeasty … going from 14,000 to 17,900 in just the past eight months, a 29% gain (almost 42% on an annualized basis) … see the chart below:

Nikkei 225

And this has occurred during a period of effectively an economic recession in Japan. Also note that the yen has weakened considerably against the U.S. dollar … going from 102 per dollar to now almost 120 per dollar. This obviously helps the Japanese exporters but does nothing for American investors in Japanese stocks as it has cut into their gains in yen after converting these yen back into dollars.

Now comes the rub. The American stock market has been on a roll ever since the U.S. Federal Reserve Bank started its own QE back in 2009 (see: NY Times Article.) This impetus has also helped the U.S. stock market considerably … boosting the American stock market’s Dow Jones Average from below 7000 to 17900 during this same six year period … also quite frothy ... see the chart below:

Dow Jones Average

The issue then becomes, will the U.S. stock market continue on its extended roll even after the Fed stopped the money supply expansion part of its QE program two months ago? The next shoe to drop will be when it increases interest rates ... maybe next summer.

Personally, I’m not one to fight the Fed …

Race to the Bottom

The world is taking a dangerous and rocky path to universal monetary collapse.  Japan is now following the United States's Federal Reserve in devaluing its currency ... in order to give its economy a shot in the arm, see: CNBC Story.  The U.S. Fed’s Chairman, Ben Bernanke, has been pushing “quantitative easing” (QE) for the last three years in order to sop up all the debt that this country is forced to issue to cover it’s fire-hose federal spending … to the point where it has expanded our money supply (and its balance sheet) by $3 trillion.  And, in order to keep this crushing debt burden from sinking things further, it has kept generic interest rates artificially low with its banking muscle.  It has been able to run the monetary printing presses night and day without setting off crushing inflation because our economy is still so weak …  reflected in our poor employment and wage-increase statistics.

But one economic “benefit” of this monetary expansion is a weak U.S. dollar which tends to help export markets and crimp importers.  Given how poor the U.S. balance of payments actually is … image what a disaster it would be without the Fed’s dollar deflationary measures?  However, our trading partners are losing patience with us and, as indicated in the referenced article, are now mimicking Bernanke’s strategy.  The European Central Bank (ECB), China, Great Britain, Japan, and even Switzerland (for heaven’s sake) are falling over one another to try to devalue their currencies with their own QEs.  A U.S. Dollar slide begets a Chinese Yuan slide which begets an Euro slide which begets a Japanese Yen slide which begets a British Pound slide which begets a Swiss Pound slide.  This is all a very dangerous race to the bottom.

How will this end?  With all this quantitative easing, the world will be, in short order, awash in money.  The balance sheets of the central banks will have reached unsustainable levels … probably the ECB first; and the only way out will be for them to let the dogs out … allow inflation to reduce the carrying-cost pain of their excessive debts.  And, this time, run-away inflation will not be as localized as it was in Germany in the 1920s.  It will be world-wide and will engender political upheavals that are likely to be quite painful.  (At this point Bernanke will not look quite so angelic.)  So be forewarned and be prepared … own real hard assets (not cash) and owe lots of money … and live in an area of relative political sanity.

The Big Mac Index

Being that my wife and I are traveling to France this fall, I am watching the euro, hoping against hope that it will deflate relative to the dollar before we have to pay the bills then.  One of the more interesting ways of comparing monetary exchange rates is by using the Big Mac index created by The Economist magazine.  I won't go into the details of this calculation here but those of you who are curious please visit The Economist for its very interesting algorithm.  The bottom line is that the euro seems to be overvalued by about 35% ... which means that the euro should currently trade at about $1.10 per euro ... not the current $1.45 per euro.  Wouldn't it be nice if this adjustment were to occur before our trip?

Another salient part of this investigation involves what might happen to the economy in the European Economic Community before and during our trip.  Any shocks here might well affect the exchange rates to which we would be subjected  To pursue this analysis I have found an interesting website that shows the cost of credit default swaps (CDSs) in many countries (see: Credit Default Swap Costs).  Think of this credit default swap data as the cost to buy insurance against a particular country defaulting on $10 million of its 5-year sovereign debt.  Obviously, the higher the cost ... the greater the risk of default ... and the greater the chance of this country's currency deflation. 

Today, it costs $47.35 for such insurance against the U.S.'s sovereign debt versus $164.84 against France's (and $2,218.27 to insure Greece's).  Now the euro is used in many of the countries represented in this table so to be very accurate, one would have to use a GDP-weighted average of these CDS figures.  So, forgetting about how our Federal Reserve Bank and the European Central Bank intervene to manipulate these exchange rates, surely the cost of the euro would/should move close to the Big-Mac-index parity figure by the time of our trip.  If it doesn't, I think then my wife and I will be buying lots of Big Macs in France this fall.