In an interview at CNBC's Delivering Alpha conference in New York, Kudlow said: “I don’t think President Xi at the moment has any intention of following through on the discussion we made and I think the president is so dissatisfied with China on these so-called talks that he is keeping the pressure on — and I support that.”
In response, China’s foreign ministry spokesperson Hua Chunying said: “That the relevant United States official unexpectedly distorted the facts and made bogus accusations is shocking and beyond imagination.”
“The United States' flip-flopping and promise-breaking is recognized globally," she added during a regular briefing in Beijing on Thursday.
There’s no chance China will cut its trade surplus with the U.S. in response to President Donald Trump’s tariff threats. For starters, Washington has made no specific demand to which Beijing can respond. But its efforts may have an unexpected side effect: a debt crisis in China.
The 25 percent additional tariffs on exports of machinery and electronics looked, at first blush, like a stealth tax on offshoring. The focus on categories like semiconductors and nuclear components, in which U.S.-owned manufacturers in China are strong, recalled Trump’s 2016 promise to tax “any business that leaves our country.”
It seems, though, that offshoring wasn’t the target after all. Now, with the imposition of new tariffs on low-value exports that mostly involve Asian value chains, the simple fact of selling cheap products that the U.S. buys has become the problem.
Either way, the administration appears set on shrinking its current-account deficit (which, at a moderate 2.4 percent of GDP, is far lower than the 6 percent clocked in 2006-7) just as the Federal Reserve raises interest rates. Distress has already been registered in China. On July 13, the yuan (also known as the renminbi) hit 6.725 to the dollar, the weakest in a year and 5 percent lower than at the end of May.
Such a move is nothing earth-shaking for less controlled currencies. But a stable renminbi is a key plank in the leadership’s promise to its people, and the exchange rate is tightly managed by the central bank.
There are many other signs: The Shanghai Composite Index of stocks has declined 7 percent in a month, dropping below the government’s red line of 3,000 for the first time since September 2016. Corporate bonds are about to set a record for the most defaults in a year. Junk bond yields are spiking. The chorus of anxiety about debt is reaching a crescendo, with daily press reports on governments that can’t pay their employees or meet pension obligations. Property prices are tumbling in some cities and frozen in others whose governments have placed a finger in the dyke by halting transactions.
That the massive burden of debt will drag the economy into recession is as obvious as the empty towers that rise on every landscape. Precise estimates are difficult, since the government’s dedication to the optics of invincibility induces financial institutions to push debt into alternate, opaque channels. But on any metric, the amount of new lending each year grows faster than the economy, and the interest newly owed exceeds the incremental rise in GDP. In other words, the whole economy is a Ponzi scheme.Click here to download a pdf of this article, Missile.pdf
Game Theory and Tariffs
Here are some insights from game theory on what to watch and expect.
These seven insights are key to assessing the benefits, costs and risks of the Trump administration’s unconventional approach to international trade. They go beyond the arguments underpinning the markets’ consensus baseline view that the tit-for-tat measures should not have a significant and lasting downward impact on the economy and stocks and, ultimately, may help bring about trade that is still free but fairer. They also trace a fuller distribution of possible outcomes that includes a rather fat left tail (a full-blown trade war) and a smaller right tail — that is, a more fundamental realignment of the global system that favors American interests, counters the multiyear erosion of its international standing and allows it to benefit more from its core position in the international economy.Click here to download a pdf of this article, Missile.pdf
Most U.S. business economists expect corporate sales to grow over the next three months and hiring and pay to rise with them.
But a majority of the economists surveyed by the National Association for Business Economics say the corporate tax cuts that the Trump administration pushed through Congress have yet to affect their plans for hiring or investment. The administration had promoted its tax cuts, which were heavily tilted toward corporations and wealthy individuals, as likely to raise worker pay and promote corporate investment and expansion over time.
The NABE also said a majority of respondents from goods-producing companies said their companies were delaying investment, raising prices or taking other steps in response to the Trump administration's trade conflicts with other nations.
The results of the quarterly survey being released Monday reflect responses from 98 of the NABE's members between June 14 and June 27.
Sixty-eight percent of the business economists said they foresee sales growing over the next three months. And for a fourth straight quarter, a higher proportion of respondents reported rising sales at their companies. All the panelists expect the U.S. economy, as measured by the gross domestic product, to expand over the next 12 months.
Goods producers — a category that includes manufacturers, farmers and construction — are most optimistic, with 94 percent saying they expect sales to rise over the next three months.
Fifty-one percent of the economists said wages rose at their companies between April and June, and they expect pay to keep rising over the next three months. It was the first time since the NABE began analyzing such data in 1982 that it has reported such strong wage growth over two quarters. Forty-one percent of respondents said their companies expect to hire in the next three months.
"Labor market conditions are tight, with skilled labor shortages driving firms to raise pay, increase training, and consider additional automation," Sara Rutledge, chair of the NABE's Business Conditions Survey, said in a statement.
Overall, the respondents reported little impact so far from the Trump administration's tariffs against China, the European Union, Canada and Mexico. A majority — 65 percent — said the trade disputes haven't led their companies to change hiring, investing or pricing so far.
But among goods-producing companies — which are directly affected by the tariffs and the counter-tariffs by America's trading partners — a majority said they had made one or more such changes. Twenty-six percent of the goods-producing companies said they had delayed investments, and 16 percent said they had raised prices.Click here to download a pdf of this article, Missile.pdf
“Protectionism is something he’s come back to like a homing pigeon,” Flake told reporters. “I mean, there are very few principles that he sticks with and that’s one of them."
House Speaker Paul Ryan, who rarely directly criticizes Trump, said tariffs “are not the solution,” and warned that pulling out of trade pacts -- as the president did with the Trans-Pacific Partnership -- threatens the U.S. economy. But the most searing comments came later in the day from Senator Jeff Flake, an Arizona Republican who isn’t running for re-election and is often critical of the president.
The Senate on Wednesday overwhelmingly approved a symbolic motion backing a role for Congress in requiring tariffs on national security grounds, such as those Trump imposed on steel and aluminum imports and is considering on autos.
Flake said he thinks it’ll take another month for GOP lawmakers to approve legislation as Trump’s approach fails.
The impact of earlier tariffs on washing machines is already showing in a pocket of the CPI data. The index for laundry equipment was up 13.1 percent from a year earlier, a record in figures going back to the 1970s, though its effect on the broader CPI is negligible.
A U.S. Agriculture Department report released Thursday, the first that takes account of recent tariffs on American farm goods forecast that soybean stockpiles will be 51 percent higher next year than had been expected a month earlier as China cuts imports and Brazil gobbles up market share.
The expected drop in the price of soybeans, the second-most-valuable U.S. crop, would translate to a loss of almost $3.2 billion for soybean farmers.
"It is pretty apparent we don’t have a stated plan from a marketing or business standpoint," said Senator Johnny Isakson, a Georgia Republican. "We are going to be in a terrible situation because we don’t have a plan."
Senator Bob Corker, a Tennessee Republican who is chairman of the committee, said tariffs imposed on steel and aluminum on national security grounds are disrupting supply chains and hurting businesses.
House Financial Services Chairman Jeb Hensarling, a Texas Republican, questioned Trump’s trade policies in an interview on Bloomberg Television. He said the U.S. shouldn’t impose tariffs on auto imports on national security grounds.
"Why are we picking a fight with the whole world?" Hensarling said
A bipartisan bill unveiled this week in the House would require congressional review of any tariffs proposed on national security grounds. Ryan, however, said such legislation isn’t going to pass and that it’s “more effective and constructive” to work with the administration.
“Half the alliance — 16 of the 29 countries — don’t even spend 1.5 percent (of gross domestic product) let alone 2 percent that we all agreed on four years ago (at a NATO summit) in Wales,” Michael Fallon, who served as secretary of state for defense from 2014 to 2017, said Tuesday.
“Four years on, and not enough European countries are making progress towards it and they need to do that and the president’s criticisms are quite valid.”
Trump is due to attend a NATO summit in Brussels on Wednesday and the thorny issue of how much the alliance’s individual members spend on defense is certain to arise. On Tuesday, Trump was still tweeting his annoyance.
In 2014, NATO members agreed to target spending 2 percent of gross domestic product (GDP) on defense, although the contributions remain voluntary. In 2017, only the U.S., U.K., Greece, Poland and Estonia reached the 2 percent target.
In 2017, the U.S. spent (at current exchange rates) an estimated $685.9 billion on defense, NATO data shows, the U.K. spent $55.3 billion and Germany $45 billion, compared to Canada’s $22.4 billion. The U.S. represented a 71.1 percent share of the alliance’s combined defense expenditure.
NATO collects defense expenditure data from each member’s defense ministry. The latest data from the organization, released Tuesday, estimated that for 2018 the U.S. will spend 3.5 percent of GDP on defense, while NATO Europe and Canada are expected to both spend 1.47 percent.
Hans Binnendijk, from the Center for Transatlantic Relations, and Magnus Nordenman, from the Atlantic Council think tank, concluded in a report entitled “NATO’s Value to the U.S.: By the Numbers” and published in April that the U.S.’ relationship “with its friends and allies is not a one-way street, where the United States makes, and the allies take.”
They noted that the specified NATO commitment of 2 percent of GDP “is the most visible metric used to measure allied political commitment to burden-sharing across the alliance. However, that metric does not measure the output and quality of allied defense contributions. It says even less about how NATO relates to broader U.S. security and economic interests.”
For instance, the writers noted: “France and the U.K. contribute about 30 percent of the total ballistic-missile-submarine deterrent fleet held by NATO members” and that “NATO countries also host sites for U.S. B-61 nuclear gravity bombs, and maintain dual-capable aircraft for nuclear delivery, which further enhance deterrence.”
With these other strategic interests in mind, Fallon said the U.S., which has 1.3 million military personnel with around 15 percent of these stationed outside the U.S., mainly in Europe and Asia, would not withdraw troops from NATO operations.
“There’s no sign of that. On the contrary, they’ve sent troops into Poland, they’re deploying more in Europe and they’ve been committing more to NATO operations, particularly in Afghanistan. So there’s going to be a lot of lively discussion, but I don’t see any sign of withdrawal.”
Few countries manage to pull off soft landings, and trade conflict makes the task even trickier. China's size means its domestic choices ricochet beyond its shores. If ever there was a test of China's readiness and willingness to be a global economic leader and not just a big economy, this is it.
There are signs that China is worried by the risk of too great a slowdown and is starting to tweak its monetary policy. The People's Bank of China declined to follow the Federal Reserve's increase in interest rates last month, contrary to the predictions of many economists. Then on June 24, the PBOC said it would lower the amount of cash some lenders must hold as reserves. For the better part of two years, China has been tapping the brakes on its $12 trillion economy. While gross domestic product grew almost 7 percent last year, the expansion is forecast to slow to about 6 percent over the next couple of years. That's still solid, but because China is the world's largest manufacturer and biggest exporter, and because it accounts for more than a third of global economic growth, the slackening matters. It's showing up in weaker euro-zone growth and a slide in South Korean exports.
The trade war will be another factor weighing on China as its expansion slows. Industrial production and retail sales fell short of forecasts in May, while investment in fixed assets like factories, roads, power plants and the like had its worst start to the year since data began to be published in 1999.
The meshing of the domestic and international challenges was perfectly illustrated by the cut in reserve requirements. While it was announced on June 24, the reduction was timed to take effect on July 5, the eve of Trump's imposition of the first $34 billion in tariffs on imports from China. The sequencing links the step to trade without explicitly saying so.
The easing was designed to achieve two things. Five hundred billion yuan ($75 billion) was unlocked for big banks to facilitate debt-for-equity swaps, which can reduce debt and help spruce up balance sheets. Another 200 billion was freed for smaller lenders to help small businesses. The PBOC was at pains to emphasize that this wasn't a vanilla-flavored loosening of policy.
The central bank said it will "keep implementing prudent and neutral monetary policy, and create a favorable monetary and financial environment for high quality development and supply-side reform." Translation: We aren't reversing course (yet), but we are alert to the risks and want to take out a bit of insurance. There's little prospect China will roll back on its tough overall line, given that President Xi Jinping has cited financial risks as a "critical battle," according to Hayden Briscoe of UBS Asset Management.
The U.S. president’s spontaneous approach to negotiations, and the inscrutable style of the Kremlin leader, make predicting the outcome of the summit with any accuracy close to impossible.
We do however, have a reasonable idea of the issues the two leaders and their aides will have mapped out before the meeting: the areas where they each want something from their counterpart, and the places they are willing to give ground.
ARMS RACE RHETORIC
Both Trump and Putin have been using bellicose rhetoric about their nuclear arsenals, drawing their countries closer to a new arms race. Trump has said the U.S. nuclear capability needs renewing. He told Reuters last year, “if countries are going to have nukes, we’re going to be at the top of the pack.” Putin in March this year unveiled an array of new nuclear weapons, and warned Western governments “now they need to take account of a new reality.” An arms race would be dangerous and expensive for both sides. An agreement to scale back the rhetoric would be a win for both Putin and Trump. Progress towards extending the New Start arms treaty, which expires in 2021, would give substance to that agreement.
Putin would like Trump to soften sanctions that Washington imposed over the annexation of Ukraine’s Crimea region and backing for separatists in eastern Ukraine, involvement in the Syrian civil war and allegations of Russian meddling in the U.S. elections in 2016. While a 2017 law bars Trump from easing many sanctions without Congress’ approval, he can offer some relief without a nod from Congress. The Republican president, who did not want to sign the law and has missed several deadlines for imposing sanctions included in it, could send a signal that the administration does not plan to expand the list of Russian firms and individuals subject to economic and travel restrictions. That would unfreeze much-needed investment and lending from international investors who, at the moment, are reluctant to commit to Russia for fear of the sanctions’ impact.
Washington ally Israel is anxious that, with the conflict in Syria entering its end game, Iranian and Iran-backed forces will be left gathered around Israel’s borders. At the summit, Trump may ask Putin, the most powerful outside player in Syria since Russia’s military intervention there, to use his influence with Tehran to curb Iran’s military presence. This would be tough to deliver for Putin: it would risk a rupture with his allies in Tehran, and could leave Russian forces having to do the lion’s share of the remaining fighting in Syria, a burden that Moscow does not want to shoulder.
Russia’s diplomatic presence in the United States, and the U.S. missions in Russia, are depleted after two rounds of tit-for-tat diplomatic expulsions in the past two years. The first was over alleged Russian meddling in the U.S. election, and the second, this year, was in response to the poisoning in England of former Russian spy Sergei Skripal and his daughter. Putin and Trump could agree in Helsinki to restore the full complement of diplomatic staff. That would not change the substance of the U.S.-Russia relationship, but it would be a symbol of a new start.
Since Russia’s annexation of Crimea in 2014, the NATO alliance has stepped up military exercises in eastern Europe. The aim, according to NATO leaders, is to reassure alliance members who fear a Russian incursion. That has angered Russia. It says NATO is bearing down on its backyard. The Kremlin has likened it to Russia stationing missiles in Mexico. If Trump scaled back the exercises, that would be a big win for Putin. Two senior NATO diplomats told Reuters they are prepared for a worst-case scenario that Trump would announce a freeze on U.S. military exercises or withdraw troops from the Baltics in a gesture to Putin. At the NATO summit in Brussels that precedes Helsinki, NATO states will seek Trump’s assurances that he will stand firm on the exercises.
Washington has stood by Ukraine’s pro-Western leaders in their stand-off with Russia. That has included the United States providing Kiev with hundreds of millions of dollars worth of military aid. Helsinki would be a triumph for Putin if he persuaded Trump to drop that military aid. Ukrainian officials say they have assurances from Trump aides he won’t do this, but acknowledge anything can happen when Trump and Putin are in a room together. In return, the Russian leader could make concessions over eastern Ukraine, where pro-Moscow separatists control swathes of territory. Diplomats say there is a deal to be done allowing armed international peacekeepers to patrol the area. However, Putin will not contemplate any concessions over Crimea.
Chinese President Xi Jinping has an ambitious master plan for his country’s transformation into a wealthy, technology-driven global economic power. And U.S. companies need not apply.
On a deeper level, the standoff reflects an escalatingeconomic and military rivalry between a status quo power and one of the most remarkable growth miracles in history. It’s a clash between two divergent systems, (one state-directed, the other market-driven) with markedly divergent world views and national aspirations. That strategic tension seems likely to intensify, regardless of how the current brinkmanship over tariffs plays out.
It’s also a battle for global influence. Whereas the U.S. has long sought to spread democracy and free markets to other nations, China’s ruling Communist Party is just starting to pitch its heavy-handed growth model as an alternative for developing nations. And Xi is backing it up with hundreds of billions of dollars in loans for infrastructure projects from Asia to Europe and beyond.
In the U.S., a bipartisan consensus has begun to emerge that now is the time to stand up to China, even if many oppose President Donald Trump’s tactics. Senate Minority Leader Chuck Schumer, a Democrat, has attacked Trump for not being tougher on China, saying last week that failure to change Beijing’s behavior now could hurt the U.S. economy “for generations to come.”
The aim is to produce global champions -- not just national ones -- and Xi’s government is ready to use the commanding heights of its one-party state to steer subsidies and use preferential policies and ambitious local content rules favoring Chinese companies to get there. At stake are industries that make up about 40 percent of China’s value-added industrial manufacturing sector, according to an analysis by the U.S. Chamber of Commerce, citing data by the Rhodium Group, a research firm.
China is the single largest foreign purchaser of U.S.-manufactured goods -- led by transportation, chemical, computer and electronics -- outside of North America, according to the National Association of Manufacturers. Chinese goods have also flooded across American shores, pushing up the U.S. trade deficit with China more than fourfold to $375 billion last year.
U.S. Defense Secretary Jim Mattis labeled China a “strategic competitor using predatory economics” in January as he unveiled the Pentagon’s National Defense Strategy.
Xi views his economy’s shift into higher-tech manufacturing not only as a crucial part of its development, what with surging labor costs, a rapidly aging population and high corporate debt levels -- but also as a fulfillment of China’s destiny.
Talks to avoid a trade war have stalled in part over U.S. demands that China reduce state support for high-tech industries. While China has signaled a willingness to buy more American goods to balance out the deficit, it has refused to trade away what it views as an essential part of its economic future.
Some prominent academics are calling for more drastic measures to undercut China’s practice of trading market access for technology transfers, such as unwinding Asian supply networks in high-end tech sectors.
Harvard Business School Professor Willy C. Shih favors tax incentives, and even setting up import processing zones in the U.S. to repatriate offshore suppliers for the likes of Intel, Apple and Microsoft. “It would strengthen our ability to sustain the most advanced semiconductor fabs in the United Sates,” Shih said.
In the end, the U.S. and China economic rivalry probably won’t be decided by administrative law judges or trade negotiators, but in the global marketplace. Right now, the U.S. still enjoys a lead in many tech and manufacturing sectors, particularly aerospace and biotech.
Yet the days when China could be dismissed as merely a low-wage assembly center for Western manufacturers are long gone. This is a country on what it views as a historic mission to become a 21st century economic power, and the contest is just beginning.Click here to download a pdf of this article, Missile.pdf
“The tail risk of a Sino-US trade war is getting fatter,” said Chi Lo, greater China senior economist at BNP Paribas Asset Management in Hong Kong. “The two sides may misjudge each other’s intentions when patriotism takes over rationality, and push themselves into an escalating series of attacks and retaliation.”
President Donald Trump said the U.S. would begin charging additional duties of 25 percent on $50 billion worth of Chinese imports in response to what he says is theft of American intellectual property. That’s split into two rounds - $34 billion now and $16 billion later.
According to the commerce ministry’s Gao, $20 billion of the $34 billion in goods to be hit with U.S. tariffs from Friday are produced by foreign companies, including from the U.S.
In the scenario where the U.S. and China just stick to this round of tariffs -- $50 billion of imports -- and go no further, then the drag on China’s economy would be 0.2 percentage point of growth in 2019, according to Bloomberg Economics’ calculations.
If things escalate, then the hit will be bigger, cutting as much as half a percentage point from growth. China’s economy grew by 6.9 percent in 2017 and the government has set a target of 6.5 percent for the current year.Click here to download a pdf of this article, Missile.pdf
© 2015 R.J. O'Brien & Associates LLC
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