trump’s recipe for...

Trump’sRecipeForDisaster

RichardDuncan

h5p://www.richardduncaneconomics.com

MACROWATCHAvideo-newsle-eranalyzingtrendsinCreditGrowth,LiquidityandGovernmentPolicytoan>cipatetheirimpactoneconomic

growthandassetprices

h-p://www.richardduncaneconomics.com

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It’sTooSoonToKnow,But…

•  Wesimplydon’tyetknowwhateconomicpoliciesPresidentTrumpwillputinplace.

•  However,basedonhiscampaignpromisesandwhatwe’velearnedsincetheelec>on,there’srealcauseforconcern.

•  Acombina>onoftaxcuts,increasedgovernmentspendingandpoliciesthatcurtailtradewouldbearecipefordisasterbecauseitwouldpushupinterestratesandcrushthehighlyleveragedUSeconomy.

•  Fivethingswilldeterminewhichwayinterestrateswillmove–and,therefore,thedirec>onofallassetpricesandtheeconomyoverall.

Here’sWhyInterestRatesAreSoImportant

•  TheglobaleconomicbubblecameveryclosetocollapsingintoanewGreatDepressionin2008.

•  ThatdisasterwaspreventedbyultralooseMonetaryPolicy.

•  Centralbanksslashedshortterminterestratesto0%andthen“printed”trillionsofdollarsworthofnewmoneyandusedittobuyfinancialassets.

•  Thatstrategyallowedcredittoexpandandcausedassetpricestosoar,therebyrefla>ngtheglobaleconomicbubbleandstavingoffeconomiccollapse.

•  Whathappensnextwilldependoninterestrates.

10.00%

12.00%

14.00%

16.00%

1980Q1

1982Q1

1984Q1

1986Q1

1988Q1

1990Q1

1992Q1

1994Q1

1996Q1

1998Q1

2000Q1

2002Q1

2004Q1

2006Q1

2008Q1

2010Q1

2012Q1

2014Q1

2016Q1

10-YearUSGovernmentBondYieldvs.CredittoGDPRa\o

1980topresent

10-YearUSGovernmentBondYield(le^axis) DebttoGDP(rightaxis)

Source:TheFed

Asinterestratesfell,creditbecamemoreaffordable.CreditexpandedandCreditGrowthdroveEconomicGrowth.

But,now,ifinterestratesrise,creditwillcontractandtheeconomywillcrash.

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

19521954195619581960196219641966196819701972197419761978198019821984198619881990199219941996199820002002200420062008201020122014Q22016

USTotalDebt=TotalCreditUS$millions,1952to2016

$65Trillion$10trillionhigherthanthepre-crisispeak.

CreditGrowthDrivesEconomicGrowth.1964=$1trillion2016=$65trillion

Source:TheFed

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

195519561958196019621963196519671969197019721974197619771979198119831984198619881990199119931995199719982000200220042005200720092011201220142016

HouseholdNetWorthUS$Billions,1980toQ32016

And,asInterestRatesfell,AssetPricesrose.A^er2008,QEpushedupNetWorthby$35trillion(+60%).RisingassetpricecreatedaWealthEffectthatboostedconsump\onandeconomicgrowthintheUS.

Source:Fed

$90Trillion

1951-10-01

1953-10-01

1955-10-01

1957-10-01

1959-10-01

1961-10-01

1963-10-01

1965-10-01

1967-10-01

1969-10-01

1971-10-01

1973-10-01

1975-10-01

1977-10-01

1979-10-01

1981-10-01

1983-10-01

1985-10-01

1987-10-01

1989-10-01

1991-10-01

1993-10-01

1995-10-01

1997-10-01

1999-10-01

2001-10-01

2003-10-01

2005-10-01

2007-10-01

2009-10-01

2011-10-01

2013-10-01

2015-10-01

HouseholdNetWorthasa%ofDisposablePersonalIncome

%,1951to2016

Source:Fed

Thisra\oofWealthtoIncomeisnearrecordhighlevelsbecauseverylowinterestratesandQEhavepushedupassetprices.

Ifinterestratesnowrise,assetpriceswillspiralbackdown,crea\nganega\veWealthEffectthatwillpushtheeconomyintocrisis.

TheFiveFactorsThatWillDetermineInterestRates

1.  TheGovernment’sBudgetDeficit.2.  TheUSCurrentAccountDeficit3.  Quan>ta>veEasingbycentralbanksoutsidetheUS.4.  TheInfla>onRate5.  TheChineseRMBExchangeRatevs.theUSDollar.

1.TheBudgetDeficit

•  PresidentTrump’splanstocuttaxesandincreasegovernmentspendingonthemilitaryandinfrastructurearequitelikelytocausethegovernment’sbudgetdeficittoincreaseverysignificantly.

-1,600,000

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-600,000

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-200,000

200,000

400,000

2018est

2020est

USGovernmentBudgetSurplusorDeficit(–)US$Millions,1960to2021es\mates,(FiscalYearsendingSept30)

Thebudgetdeficitsarecurrentlyprojectedtoaverage$519billionayearfrom2017to2021.Thoseprojec>onsdon’tincludethelargeincreaseintheannualdeficitsthatislikelytoresultfromPresidentTrump’sproposedtaxcutsandincreasedgovt.spending.

Es\mates

Source:OfficeOfManagement&Budget

2.CapitalInflows

•  BeforeBre-onWoodsbrokedown,tradeimbalancesandcapitalflowsbetweenna>onswereverylimited.

•  Butnowtheyhavebecomeverylarge.•  CapitalinflowsintotheUnitedStateshavebecomeanenormouslyimportantsourceoffundingfortheUSBudgetdeficit.

•  Thelargerthecapitalinflowsare,theeasieritistofinancethegovernment’sbudgetdeficitatlowinterestrates.

-100,000

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

TheUSFinancial&CapitalAccountUS$millions,1960to2015

Source:BureauofEconomicAnalysis

CapitalInflowsintotheUnitedStates.

$807bn

$463bn

MirrorImage

•  TheCapitalInflowsarethemirrorimageoftheCurrentAccountdeficit.

•  WhentheCurrentAccountDeficitgrowslarger,theCapitalInflowsalsogrowlarger,makingiteasiertofinancethebudgetdeficit.

•  But,whentheCurrentAccountDeficitshrinks,CapitalInflowsalsoshrink,makingitmoredifficulttofinancethebudgetdeficitatlowinterestrates.

-1,000,000

-800,000

-600,000

-400,000

-200,000

200,000

400,000

600,000

800,000

1,000,000

TheCurrentAccount=TheFinancialandCapitalAccountUS$millions,1960to2015

Financial&CapitalAccount CurrentAccount

MirrorImage

1987StockMarketCrash

CapitalInflowshaveapowerfuleffectonUSassetprices.

PropertyBubble

CapitalInflowsMayShrink

•  Trump’splanstoforceUScompaniestobringtheirfactoriesbacktotheUS,torenego>atetradedealsand/ortoimposetradetariffsonChinaandMexicowouldallcausetheUSCurrentAccountdeficittoshrink.

•  AsmallerCurrentAccountdeficitwouldcausethecapitalinflowsintotheUnitedStatestoshrink,too.

•  LesscapitalinflowswouldmeanlessdemandforUSgovernmentbonds.

•  Thatwouldpushupinterestratesandpoptheassetpricebubble.

•  So,wemustkeepacloseeyeontheUSCurrentAccountDeficitbecauseitwilldeterminethesizeofthecapitalinflows.

3.Quan\ta\veEasing

•  Quan>ta>veEasingisthethirdfactorwemustwatch.

•  Clearly,whentheFedprintsmoneyandbuysgovernmentbonds,thatpushesupthepriceofthebondsandpushesdowntheiryields.

•  Addi>onalQEfromtheFednowlooksunlikely,atleastinthenearterm.(We’regoingtohavefiscals>mulusinsteadofmonetarys>mulus.)

OtherCentralBanks

•  However,wemustalsomonitortheQuan>ta>veEasingbeingcarriedoutbyothercentralbanksaroundtheworldbecauseQEoverseasimpactsUSinterestrates,too.

•  Currently,theECB,BOJandBOE(combined)areprin>ngtheequivalentofroughly$500billioneverythreemonths.

•  Theyusethatnewmoneytobuytheirgovernments’bonds.Thatpushesupthepriceoftheirbondsandpushesdowntheiryields.

•  LoweryieldsinEurope,JapanandtheUKarenowpunngdownwardpressureonUSgovernmentbondyields.

•  However,ifthosecentralbanksprintlessmoneyinthefuture,USinterestrateswouldprobablyrise.

Global QE

Per Month

US$ Exchange Rate

US$ billion per Month

US$ billion per Quarter

BOE £70 billion over 8 months £8.75 billion 1.3 11.4 34.1

BOJ Yen 80 trillion per year Yen 6.67 trillion 100 66.7 200.1

ECB Euro 80 billion per month Euro 80 billion 1.13 90.4 271.2

Total 168.5 505.4

HalfATrillionDollarsPerQuarterTheBOJandtheECBarenowcarryingoutQuan\ta\veEasingonaverylargescale.

Herearethedetails:

Source:CentralBanks

Central Bank Holdings Of Government Debt Converted into US Dollars, billions

US$ Exchange Rate US$ billions BOE £375 billion 1.3 488 BOJ Yen 368 trillion 100 3,700 ECB Euro 1,326 billion 1.13 1,500 Fed $2,462 billion 2,462

Total 8,150

US$8.15trillionGovernmentDebtCancelledThusFar

ThistotalisscheduledtoincreasebyUS$1trillionoverthenext6months.

Source:TheBOE,BOJ,ECB,Fed

BOE 25% BOJ 35% ECB 12% Fed 13%

TheAmountOfGovernmentDebtCancelled*SoFarCentralBankHoldingsOfGovernmentDebt

Asa%ofTotalGovernmentDebt:

Note:ThenumbersfortheBOJandECBareslightlyoverstatedbecausesomeoftheassetstheyhaveacquiredarecorporatebonds(butonlyasmallpart).TheimportanceoftheFed’sQEisunderstatedbecauseinaddi>ontoowningUS$2.5trillionofgovernmentbonds,theFedalsoowns$1.7trillionofasset-backedmortgagedebt.

Source:RDes>mates*Effec>velyCancelled

4.Infla\on

•  Infla>onalsoaffectsinterestrates.•  Iftheinfla>onrategoesup,thedemandforbondswillgodown–unlesstheyieldofferedonthosebondsincreases.

•  Noonewilllendmoneyfor3%iftheinfla>onrateis5%.

•  InrecentyearstheInfla>onRatehasbeenexcep>onallylow–despiteallthemoneythatthecentralbankshavebeenprin>ng.

1.6%inOct.2016

Source:StLouisFed

WhatCouldCauseInfla\onToRise?

•  Infla>onhasfallensincetheearly1980sbecauseincreasingtradewithlowwagecountrieshaspusheddownUSwagesandthepriceofconsumergoods.

•  Now,however,iftheUSimportslessfromlowwagecountries,thepriceofmanufacturedgoodswillrise,USwageswillrise,andinfla>onwillrise.

•  ForcingcompaniestobringtheirfactoriesbacktotheUnitedStatesorimposingtradetariffsonimportedgoodswouldcauseinfla>ontoincrease.

•  Increasedgovernmentspendingcouldalsocauseinfla>ontopickup.

5.TheChineseRMB

•  Finally,thevalueoftheRMBcouldalsoimpactUSinterestrates.•  TheUnitedStateswillimportnearlyHalfATrillionDollarsworthof

goodsfromChinathisyear.•  IftheRMBcon>nuestoweakenagainsttheDollar,thoseimports

willbecomecheaperandputdownwardpressureonUSinfla>onrates.

•  IftheRMBweretostrengthen(whichisunlikely),thenthatwouldputupwardpressureonUSinfla>on.

•  Ofcourse,iftheUSputstradetariffsonChinesegoods,thatwouldcauseaspikeintheUSinfla>onrate,whichwouldpushupUSinterestrates.

•  Bytheway,in2015theUSimported$483billionofgoodsfromChinaandexported$116billionofgoodstoChina,resul>nginaUStradedeficitwithChinaof$367billion-orroughly$1billionaday.

01/1980

01/1982

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01/1990

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01/1994

01/1996

01/1998

01/2000

01/2002

01/2004

01/2006

01/2008

01/2010

01/2012

01/2014

01/2016

ChineseRMBperDollar1980toDecember2016 From2006to2013,

theRMBappreciated.But,now,itisfallingagain.TheGreatChinaBoom

wasfuelledbyaveryweakcurrency.Itfellfordecadesun\l1994.

Source:CEIC

TheUSTradeDeficitIsToBlame

•  PresidentTrumpbelievestheUStradedeficithasbeenresponsibleforthelossofmanufacturingjobsintheUnitedStatesandthedownwardpressureonUSwagesthathasoccurredoverthelastseveraldecades.

•  Iagree.•  I’vewri-enabouttheharmtheUStradedeficithasdonetotheUnitedStatesandaboutthedestabilizingimpactit’shadontheglobaleconomyinallthreeofmybooks.

TheDollarCrisis

Herearetheopeninglinesfrommyfirstbook,TheDollarCrisis:

“Theprincipleflawinthepost-Bre-onWoodsinterna>onalmonetarysystemisitsinabilitytopreventlarge-scaletradeimbalances.ThethemeofTheDollarCrisisisthatthoseimbalanceshavedestabilizedtheglobaleconomybycrea>ngaworld-widecreditbubble.”

NotEasy

•  However,unwindingtheUStradedeficitisgoingtobeverydifficult.

•  Overthepast35years,thatdeficithasbecomeTHEdriverofglobaleconomicgrowth.

•  Infact,theen>reglobaleconomyhasbeenconstructedaroundunbalancedtrade.

•  Atthispoint,thea-empttoeliminatetheUStradedeficitcouldveryeasilycausetheglobaleconomytocollapseintoanewGreatDepression.

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-300,000

-200,000

-100,000

100,000

USCurrentAccountBalanceUS$Millions,1960to2015

Fromtheearly1980s,theUSCurrentAccountDeficitbecameTHEdriverofglobaleconomicgrowth.Aslongasthedeficitexpanded,theglobaleconomyprospered.

TheUndesirableConsequencesofElimina\ngTheTradeDeficit

1.  IftheUSreducesitsimports,theglobaleconomywillshrink.2.  IftheUSeliminatesits$1billionadaytradedeficitwith

China,China’seconomycouldcollapseintoadepressionthatwouldseverelyimpactallofChina’stradingpartners,andpoten>allyleadtosocialinstabilitywithinChinaandtomilitaryconflictbetweenChina,itsneighborsandtheUS.

3.  IftheUSCurrentAccountdeficitreturnstobalance,theglobaleconomywillsufferfrominsufficientDollarliquidity,whichcouldcauseeconomicstagna>onorworse.

4.  Areduc>onofimportsfromlowwagecountrieswouldcauseUSinfla>ontorise,whichwouldpushupUSinterestrates.

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

USImports&ExportsUS$Millions,1990to2015

Exportsofgoodsandservices Importsofgoodsandservices

IfUSImportsfall,USExportswillfall,too.

WhentheUSbuyslessfromtherestoftheworld,therestoftheworldbuyslessfromtheUS.

500,000

1,000,000

1,500,000

2,000,000

2,500,000

China'sExports&ImportsUS$Millions,1990to2015

Exports

Imports

WhenChinaExportsless,itImportsless.AndwhenChinaimportsless,commoditypricesfall,hur\ngtheeconomiesandcurrenciesofthecommodityproducingcountriesallaroundtheworld.

Source:CEIC

IfChina’sEconomyImplodes

•  China’seconomyisalreadyvergingoncrisis.Ithasmassiveexcesscapacityacrossprac>callyeveryindustry.So,productpricesarefalling,companiesareloss-makingandthebankingsystemisstuffedwithunrecoverableloans.

•  IfChina’stradesurpluswereeliminated,thenega>veimpactonChina’seconomywouldbedevasta>ng.

•  Inalllikelihood,Chinawouldexperienceaseveredepression,thatcouldthreatentheruleoftheCommunistParty.

•  Chinamightrespondmilitarily–justasJapandidatPearlHarborarertheUSimposedanoilembargoonJapanin1941.

•  Nooneshouldunderes>matethedamagethatcouldresultfromaneconomiccrisisinChina.

GlobalLiquidityWouldDryUp

•  Whentheworldwasonthegoldstandard,“globalliquidity”dependedonthediscoveryofnewgoldmines.Some>mestherewastoomuchgold(16thCenturyEurope,whichcausedinfla>on)andsome>mesnotenough(late19thCenturyAmerica,whichcauseddefla>on).

•  ButunderTheDollarStandard,globalliquidityisdeterminedbythequan>tyofDollarsintheglobaleconomy;andtheprincipalwayinwhichDollarsareinjectedintotheglobaleconomyisthroughtheUSCurrentAccountdeficit.

•  IftheUSCurrentAccountDeficitwereeliminated,thesupplyofDollarliquiditywouldbetoo>ghttosupporteconomicexpansion.

•  Thatwouldprobablyresultinglobaleconomicstagna>onorworse.

5.  Theelimina>onoftheCurrentAccountdeficitwouldcauseasharpreduc>onincapitalinflowsintotheUS,whichwouldalsocauseUSinterestratestorise.

6.  HigherinterestrateswouldcausecredittocontractandtheUSeconomytogointorecession.

7.  HigherinterestrateswouldalsocauseasharpfallinUSassetprices.That,too,wouldalsocausetheeconomytogointorecession.

8.  HigherinterestratescouldcauseawaveofcreditdefaultsintheUSandaroundtheworld,poten>allyleadingtoanewsystemicfinancialsectorcrisis.

ABe5erWay

•  Forallofthesereasons,I’mveryconcernedthatitwillnotbepossibletoeliminatetheUStradedeficitwithoutcausingtheglobaleconomicbubbletoimplodeintoanewgreatdepression.

•  Ratherthana-emp>ngtoeliminatethedeficit,itwouldbewiserfortheTrumpAdministra>ontoallowthedeficittopersist,buttopursuepoliciesthatwouldincreaseaggregatedemandinthecountriestheUStradeswithandalsointheUnitedStatesitself.

ABe5erWay

•  Forinstance,theUScouldenactpoliciesthatwouldforceChinatoincreasewagesinitsmanufacturingsector.ThatwouldincreaseChina’sdemandforUSgoodswithoutcausingacrisisinChina.

•  Athome,theUSgovernmentcouldsharplyincreaseitsinvestmentinnewindustriesandtechnologies.ThatwouldboostUSpurchasingpowerandgrowth–and,thatinvestmentcouldbefinancedatverylowinterestratesthankstothedefla>onarypressuresandthecapitalinflowsresul>ngfortheUStradedeficits.

Conclusions

•  TheproposalsoutlinedthusfarbyPresidentTrumpsuggestthat:

1.  Thebudgetdeficitwouldgrowlarger(duetotaxcutsandincreasegovernmentspending);

2.  Thecurrentaccountdeficitwouldshrink(duetorenego>a>ngtradedeals,bringingUSfactoryjobsbacktotheUSandpossiblytradetariffs);

3.  Andinfla>onwouldpickup(duetoincreasedgovernmentspending,higherUSwages,pressureonChinatopushuptheRMBand,possibly,tariffs).

ARecipeForDisaster

•  Ifthosepoliciesreallyareadopted,theywouldbearecipefordisasterbecausetheywouldpushUSinterestratessignificantlyhigher–andthatwouldpoptheglobaleconomicbubble.

•  Ifitpops,itmaybepossibletoreflateitagainwithevenlargeramountsofQuan>ta>veEasing.

•  Ontheotherhand,itmightnotbe,inwhichcasetheworldcouldbeplungedintoanewGreatDepression.

•  Inthatscenario,massivewealthdestruc>onwouldonlybethebeginningofourproblems.Ourpoli>calins>tu>onswouldprobablynotsurvivethestrain.

MACROWATCHAvideo-newsle-eranalyzingtrendsinCreditGrowth,LiquidityandGovernmentPolicytoan>cipatetheirimpactoneconomic

growthandassetprices

h-p://www.richardduncaneconomics.com

ToSubscribetoMacroWatchata50%discount,visittheMacroWatchwebsite,clicktheSubscribetaband,when

prompted,usethediscountcouponcode:financial

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