Between a Rock ...

... and a hard place.

It’s not there now, but the US Federal Reserve Bank might be in this predicimant in the not-to-distant future. Let me explain:

If Trump’s new-found infatuation with tariffs produces, as predicted by many “pundits,” higher inflation rates ... then the tool that the Fed uses to keep the lid on this ogre, higher interest rates, can’t be as effective in the sense that it strengthens the dollar which boosts imports ... working against Trump’s trade war ... and also makng the job of financing American deficits more difficult.

However, if the Fed night chose to let inflation rip, it would be effectively monetizing our national debt ... good for our country but bad for those elders on fixed incomes ... and China which would own a lot of this devalued debt.

At least two factors are working counter to inflation spikes — massive illegal immigration which holds down wages on the low end ... and huge increases in energy production which holds back gas price increases. And this is further complicated by the Fed’s desire to reduce its inflated balance sheet, a legacy of the Obama-era quantative easing.

So, in a way, the Fed is boxed in when it tries to set monetary policy ... not a happy place to be. I don’t envy Chairman Powell.

Soybeans

China has matched the U.S.'s intended $50 billion of tariffs causing a trade-war panic in the financial markets (see the featured posting on the left). The two key products threatened by China are airplanes (Boeing) and soybeans ... see: CNBC Article to understand the hysteria that gripped the stock market early yesterday. So, are China's tariff threats to be taken seriously?

Let's start with Boeing. The purchaser of airplanes in China is the government itself ... so there is little pain for them to take money from one pocket and put it in another. And secondly, "if it ain't Boeing, I ain't going" means that China would be very reluctant to lose its place in line for plane deliveries given the tightness of this marketplace. Conclusion: an empty threat.

Next soybeans ... here are some key soybean send soybeans meal statistics: USDA Soybean Stats. Note three things from this data: 1) over the last five years soybean prices have been falling precipitously, 2) allocated acreage and total production have been growing (the likely cause of falling prices) and  3) China is by far the largest buyer of US soybeans (9x the next biggest). So clearly US soybean farmers have a lot at stake if their Chinese market dries up.  However, so do the Chinese who use the soybean meal to fatten its huge population of pigs ... and much of the soybeans themselves for human consumption. A 25% tariff on U.S. soybeans would be a tax on Chinese consumers.

The 64K yuan  question is: Could the rest of the soybean growing world (primarily Argentina and Brazil ... see: Exports by Countries) ... pick up the slack from any falling U.S. exports.? Possibly, but because of a drought in Argentina, world supplies of soybeans and soybean meal are back in short supply. Resides this is harvest time in South America ... meaning the US. Has most of the high cards, at least for a year, in this poker game.

Overall conclusion: the Trump administration might well call China's bluff in this dueling tariffs contest ... particularly if we are willing to compensate any damaged industries.

Afterward: Many pundits feel that China, because it is central-planned capitalism, would have a natural advantage in a trade war. Maybe so. However, market-driven capitalism like the U.S. iterates to the best solution ... which takes longer and can be more painful than China's. However, if China gets it wrong to start, there is very little market self-correction ... which can be disastrous.

Trade Wari?

China has recently threatened $50 billion in tariff retaliation against the equivalent planned tariffs by the United States against China ... thus raising the spectre of a trade war. Is this a serious threat? Let's first look at the numbers: in 2017 China exported $560 billion of goods and services to the U!S. and we, $185 billion to it ... for a total U.S. trade deficit of $375 billion, see: NY Times Article. Although China is the second largest economy in the world, it exports to the U.S. represent a far bigger proportion of its GNP than our exports to them.

Now there is in game theory the notion of the optimal gaming strategy being minamax ... minimize your maximum loss. Therefore, if China and the U.S. get into an all-out trade war, reducing both these trade numbers to zero, China would be far more damaged ... probably to the point of massive social disruption. Using game theory, which I am sure China understands, the United States does have the strategic high ground in this pissing contest.

OK, but China does own well over a trillion dollars in American government debt. Can't they use this as a cuddle against Trump's tariffs? But Trump knows this game quite well from his previous banking relations  -- when you owe the banks a huge amount of money, they don't own you ... you own the banks. If China were to start selling this U.S. debt, it would drive down the prices on that which it still holds ... and also, in the process, make the Federal Reserve Bank's job of paring its balance sheet easier.

Trump has stated that his objective is to reduce our trade deficit with China by $100 billion over the next year. Obviously, an all-out trade war would accomplish this ... but also would serious talks with China wherein Trump uses our above negotiating leverages effectively ... much more likely the latter than the former.

VAT

Unraveling trade deficits might be very simple. Let me try to explain.

President Trump complains that the United States is stupid and being hosed in its trading with most other nations. One focus of this gripe centers around the innocuous value added tax (VAT) which, in most cases is a cumulative tax paid to the nation host during the various manufacturing sequences  ... but which is then removed when such products are exported. This very much is effectively a national subsidy for exporters. And most countries with whom we trade have VATs therefore put us at a trading disadvantage. Here is a compendium of countries with VATs: US Council for International Business List.

And in most cases these same countries impose a VAT on goods that are being imported into their countries ... see: VAT on Imports. This is the equivalent of a tariff or duty. So VAT, which seems so innocuous to the layman, is an insidious way of beefing up exports and discouraging imports. No wonder the United States has been running huge balance of payments deficits and Trump is down on our trade negotiators.

Rather than adding Trump's "border tax," perhaps we should also jump into the VAT to fix things?