trump’s recipe for...

Trump’sRecipeForDisaster

RichardDuncan

h5p://www.richardduncaneconomics.com

MACROWATCHAvideo-newsle-eranalyzingtrendsinCreditGrowth,LiquidityandGovernmentPolicytoan>cipatetheirimpactoneconomic

growthandassetprices

h-p://www.richardduncaneconomics.com

ToSubscribetoMacroWatchata50%discount,visittheMacroWatchwebsite,clicktheSubscribetaband,when

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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.

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10-YearUSGovernmentBondYieldvs.CredittoGDPRa\o

1980topresent

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

Source:TheFed

Asinterestratesfell,creditbecamemoreaffordable.CreditexpandedandCreditGrowthdroveEconomicGrowth.

But,now,ifinterestratesrise,creditwillcontractandtheeconomywillcrash.

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19521954195619581960196219641966196819701972197419761978198019821984198619881990199219941996199820002002200420062008201020122014Q22016

USTotalDebt=TotalCreditUS$millions,1952to2016

$65Trillion$10trillionhigherthanthepre-crisispeak.

CreditGrowthDrivesEconomicGrowth.1964=$1trillion2016=$65trillion

Source:TheFed

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HouseholdNetWorthUS$Billions,1980toQ32016

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

Source:Fed

$90Trillion

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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.

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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.

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TheUSFinancial&CapitalAccountUS$millions,1960to2015

Source:BureauofEconomicAnalysis

CapitalInflowsintotheUnitedStates.

$807bn

$463bn

MirrorImage

•  TheCapitalInflowsarethemirrorimageoftheCurrentAccountdeficit.

•  WhentheCurrentAccountDeficitgrowslarger,theCapitalInflowsalsogrowlarger,makingiteasiertofinancethebudgetdeficit.

•  But,whentheCurrentAccountDeficitshrinks,CapitalInflowsalsoshrink,makingitmoredifficulttofinancethebudgetdeficitatlowinterestrates.

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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.

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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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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.

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USImports&ExportsUS$Millions,1990to2015

Exportsofgoodsandservices Importsofgoodsandservices

IfUSImportsfall,USExportswillfall,too.

WhentheUSbuyslessfromtherestoftheworld,therestoftheworldbuyslessfromtheUS.


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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

trump’s recipe for...

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