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Tuesday, April 4, 2017


Market News  notes that on “Dec. 15, 2016, 10-year U.S. Treasury yields topped out at 2.639%, the highest since the Sept. 19, 2014, peak near 2.655%. A decisive break above 2.655% would set the stage for a larger move to 3.0%, a year-end yield target for several firms.”

The Bund is quoted at 0.265% from 0.309% yesterday and 0.427% a week ago Friday. Market News notes “On Jan. 26, German yields topped out at 0.499%, which was the highest since mid-January 2016. Ten-year Bund yields last traded above 0.50% in January 2016. The 2016 10-year Bund yield high was 0.627%, seen Jan. 4 of last year.”

If the dollar were simply following the 10-year yield, it would be falling. But it’s not. It’s following the 10-year yield differential, and the Bund is falling by more than the note. But the two PMI’s yesterday were both pretty grim and generate an aura of gloom. The dollar may be on borrowed time. Today we get factory orders, the energy department inventory report, the last Fed minutes, the service sector PMI—and the trade deficit.

The Feb trade balance is forecast at a deficit of $44.8 billion after an especially big $48.5 billion in Jan. When you are the world’s biggest economy and have the biggest and most varied capital markets, trade may seem like a back-burner factor. Besides, over two-thirds of GDP is services, many of which cannot be exported. Economists say more jobs are lost to automation than to imports, but never mind. Citizens are outraged that US companies move overseas to get cheap labor, which is an entirely different thing from moving production overseas to sell overseas (but still cuts exports).

We never know when Trump will zero in on trade as something to use as an excuse for a noisy clamorous. Trump singled out China and Mexico on trade and Mexico for character assassination. Trump’s mistreatment of Mexico is so outrageous he has fostered sympathy for Mexico among Americans, who are fully aware that Mexicans in the US are exceptionally hard-working. And Mexico is not sitting back and waiting for another Trumpian slap in the face. Reuters reports this week Mexico is in Round 3 of a new free trade deal with the EU, possibly by year-end. “Brussels is particularly keen on scoring successes on the trade front to show it is moving on from Britain's planned exit from the bloc and to prove it is a champion of free trade to counter Trump's protectionist stance.”

In other words, both parties are unusually well-motivated. More talks are scheduled for May and June. The EU comes third after the US and China among Mexico’s three biggest trade partners and EU-Mexico trade has already more than doubled between 2000 and 2015 to €53 million. To be realistic, the EU will not substitute for the US, where the Mexican trade surplus is some $63.2 billion (2016) and $3.9 billion in Jan, or 8% of the deficit. But it’s a start. And they haven’t gotten to China yet.

But the bigger trade (and national security) issue is China. Trump and Xi meet on Thursday. There the US deficit is $347 billion, with $31.3 in Jan 2017 or 65% of the Jan deficit. And Trump is botching relations with China as much or more as with Mexico. It’s perfectly true that China got pulled itself out of the dumps with two decades of rising exports on an undervalued currency and the US was a top recipient. The chart is from Mauldin, who notes almost 20% of Chinese exports went to the US in 2015. Mauldin thinks China is in no position to get uppity with the US. It may be transitioning to a less export-oriented economy, but the US and China still need one another.

Besides, we tend to exaggerate the vast holdings by China of US debt as a trump card China holds over the US head. See the chart. We can’t vouch for its accuracy but it looks about right. Mauldin writes “In fact, China’s holdings of US debt securities are more indicative of China’s economic problems than anything else. China runs a massive trade surplus with the US and other countries, but China cannot have that money flowing back into the Chinese economy. If it did, the yuan’s value would rise, making Chinese exports less competitive. China invests in US debt securities not to increase its leverage over the US but because US debt securities are some of the most reliable and attractive investments in the world and China needs a place to park its money.”

Leading foreign holders of US Treasury securities as of January 2017
CountryBillions of dollars (est.)Ratio of owned US debt
to 2015 GDP (est.)[110][111]
Percent change since
January 2016
 Japan1,102.523%− 2%
 Brazil257.715%+ 1%
 Cayman Islands257.2n/a+ 3%
  Switzerland226.434%− 5%
 Luxembourg218.9359%+ 9%
 United Kingdom214.08%+ 2%
 Hong Kong189.460%− 6%
 India113.75%− 5%
 Saudi Arabia112.318%− 9%
 Singapore103.335%− 9%
Others1,520.5n/a− 1%
Grand total5,956.1n/a− 4%

Well, no. It’s not the amount of money at issue. It’s the Shock Value of a major sovereign investor announcing it no longer has confidence the US can be trusted. The lack of trust can take any of several forms. Expropriation is probably not on the table, but as with the ratings agencies, China could say its outlook for management of the US economy has turned negative. Not to be a scare-monger, but the US federal government runs out of money on April 28 and we will need Congress not to close down the government, again. With this batch of unqualified and temperamentally unfit clowns in the White House, we can’t count on a government shut-down to be the same non-event it has been in the recent past.

And it gets worse. Trump is giving China an opening for “global leadership,” something it craves as a sign of being a member of the top Boys Club. The latest data show that nobody much is using the yuan as a reserve currency, despite the IMF giving it reserve status last fall. How to get reserve currency status? It’s the merchants who decide and they decide on convenience, convertibility and liquidity. AS the US withdraws from the region, the natural take-over is by China. It’s a big deal.

A former State Dept Asia hand writes at the think-tank JustSecurity.org that Trump policy toward Asia started out with self-inflicted wounds, including the Taiwan debacle, hanging up on the Australian prime minister, and terminating the TPP trade deal. “It’s a major blow to U.S. credibility after U.S. of-
ficials negotiated the TPP for a decade. It also exacerbates the feeling that countries have no alternative to China’s economic dominance.

Trump started out overly aggressive and is now swinging the other way. Reversing on One China “tells Xi that Trump can easily have his mind changed and that what he says — or tweets — should not always be taken seriously, a confusing and dangerous way to run policy.” Trump has no Asia experts. And “Top Trump advisor Steve Bannon – who runs his own foreign policy operation in the White House – said last year that “we’re going to war in the South China Sea in five to ten years… there’s no doubt about that.” Hardly anyone believes the US will honor long-standing commitments in Asia.

“The results of a withdrawal of American leadership in Asia would be debilitating. Allies could begin hedging against the possibility that the US won’t have their back, moving quietly to accommodate Beijing – or conversely preparing for more direct conflict. China and North Korea may believe they can take advantage of Washington’s inconstancy and growing divisions between the US and its allies. Over time, America would find itself out in the cold in Asia, and Asia’s stability and prosperity would be at risk.”

The first critical issue is that Trump does not have a Plan and is just winging it, with any error or setback claimed to be part of his “deal-making” process. This is non-sense. Another important issue is that special advisor Kushner has unspecified but undoubted authority over many trade and security related issues in both Mexico and China. Trump has put him in charge of a dozen things, including trade with Mexico and China, the Wall, Middle East peace talks and the Veterans Administration. Kushner may be a nice guy but he certainly not qualified and even if he were, this is too many jobs for one guy.

The third issue is that wild-card Bannon actually prefers things to fall apart. If he believes will have war in the South China Sea, who is to hold him back from instigating it? Observers hope it’s the family advisors Ivanka and Jared. This is the key reason Washington is not up in arms over nepotism— everyone hopes the daughter and son-in-law will serve as a counterweight to the dangerous Bannon. What a sorry state we are in.

We continue to believe that Trump will not succeed in getting trade deals that favor the US, including the border adjustment tax. Trade deficits will not contract. At some point, Trump’s failure will become too frustrating for him and we know what he does then—he tweets. At some point we are going to get a series of tweets about the too-strong dollar and how Trump wants a weaker dollar to promote exports. Anyone who ever took Econ 101 knows this is overly simplistic and won’t work—the US has run a trade deficit from before the time the dollar was floated in 1973—but historical facts and economic logic do not impress Trump. He wants a shock effect and he will get it. Ironically, at the same time we could be seeing a floppy economy not living up to the 4% growth Trump promise, so the dollar could already be on the downswing at the time of the anti-dollar tweets. In economics, we call this a double whammy.

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