Fed needs to wake up and admit the economy is overheating

US central bank risks having to slam on the brakes if it persists with gradualism

Jason Cummins



In Newton’s First Law, an object in motion stays in motion until a force acts upon it. Under new leadership, the Federal Reserve’s monetary policy strategy appears to be following the same logic. In his June press conference, chairman Jay Powell said the Fed would raise interest rates until “we get a sense that the economy is reacting badly”.

The latest numbers suggest the US economy is doing anything but reacting badly. The unemployment rate declined to 3.75 per cent, a 48-year low and three-quarters of a percentage point below the Fed’s median estimate of its long-run sustainable rate. Consumer prices rose 2.3 per cent in May from a year earlier. Excluding volatile food and energy categories, core personal consumption expenditures inflation moved up to 2 per cent, matching the Fed’s target for the first time in more than six years.

Despite downside risks from trade tension, these trends look set to continue. Monetary policy is still expansionary on top of the sizeable fiscal expansion that will build in the coming years. The labour market is poised to get tighter and put continued upward pressure on inflation.

With its latest increase in the federal funds rate to a range of 1.75 per cent to 2 per cent, the Fed has finally brought real interest rates to approximately zero. With further gradual increases every quarter, interest rates would end the year at the lower end of Fed policymakers’ range of neutral — ie, the rate that neither stimulates nor slows economic activity. Given the gradual pace outlined in the Fed’s Summary of Economic Projections, monetary policy would eventually become modestly restrictive sometime in 2019 or later.

Mission accomplished? Economic theory and history suggest otherwise. With long and variable lags between monetary policy and its effect on economic activity, theory teaches that interest rates need to be restrictive before the economy overheats. The likelihood is the Fed will enable an even hotter economy and then really have to cool it down. With markets discounting an even more gradual path of rate rises, the central bank risks a sharp financial snap back when it has to slam on the brakes.

International financial markets are responding to the prospect of tighter US monetary policy by bidding up the value of the US dollar against other currencies. In the past, this has been a key catalyst for international financial crises.

With the Fed raising rates and the People’s Bank of China cutting reserve requirements in June, the renminbi slid more than 3 per cent against the US dollar, its largest ever monthly drop for the tightly managed currency. Continued depreciation risks a replay of the destabilising capital outflows seen in 2015 when US and Chinese monetary policies also diverged. At that time, a mild financial panic that played out into early 2016 stoked fears of global recession.

Elsewhere in emerging markets, central banks are under pressure to respond to a stronger US dollar by defending their currencies with rate rises. The most vulnerable economies like Argentina and Turkey already demonstrated acute strain with sharp depreciations in their currencies and capital outflows.

It’s not just the most mismanaged economies that are vulnerable. Indonesia surprised the market by raising rates 50 basis points last month. Mexico is raising rates to defend its currency and some observers think the next move in Brazil will have to be a hike as well. In these countries, equity markets are down on the year and the appreciation in the US currency is making it harder for domestic borrowers to pay back more expensive dollar-denominated debt.

Back home, the Fed has largely shrugged off the international consequences of its actions. Gradualism seems to pose manageable risks because inflation only recently hit 2 per cent and probably will remain contained in the near-term given how flat the Phillips curve appears to be.

Unfortunately, history teaches that the Fed has never successfully managed a soft landing with the current set of macroeconomic conditions. In every case when the Fed tightened policy by enough to raise the unemployment rate by more than four-tenths of a percentage point, it caused a recession.

However, Powell said at his last press conference that it’s “very possible” the long-run sustainable unemployment rate is lower than 4.5 per cent. There is surely uncertainty about the unobservable variables that guide policy. But, if there’s uncertainty, why conduct policy as if the true value is 75 basis points or more below your official estimate?

A high-pressure economy feels great during the party. But the recessionary hangover can be brutal. A better strategy would be more forward-looking. Recognise the economy is overheating rather than hoping that it’s not, announce that policy will need to be more restrictive sooner than expected, and get on with it. Policymakers would have to endure some pain in the short run as they realign market expectations to a more hawkish rate path. But that’s better than the gradualism that virtually guarantees a larger, more painful realignment later on.


Jason Cummins is chief US economist at Brevan Howard


Has One Tweet Reversed Gold’s 3-Month Downtrend?



(Kitco News) - While one tweet has helped to reverse gold’s near-term fortunes, some analysts have said that more work needs to be done to end the yellow metal’s three-month downtrend.

Although gold is ending is second week in negative territory, the market is well off its one-year lows as the U.S. dollar bulls reacted to comments from President Donald Trump. Gold’s bounce started Thursday afternoon after Trump said, in an interview with CNBC, that he was “not thrilled” with rising interest rates as they are hurting economic growth.

August gold futures have managed to hold on to its gains heading into the weekend, last trading at $1,229.20 an ounce, down almost 1% from last week.

The President doubled down on his comments Friday morning in a tweet questioning why the U.S. is raising interest rates as debt is growing and coming due. He also called out China and the European Union for manipulating their currencies, taking away the U.S.’s competitive edge.


China, the European Union and others have been manipulating their currencies and interest rates lower, while the U.S. is raising rates while the dollars gets stronger and stronger with each passing day - taking away our big competitive edge. As usual, not a level playing field…

Donald Trump

....The United States should not be penalized because we are doing so well. Tightening now hurts all that we have done. The U.S. should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals. Debt coming due & we are raising rates - Really?

Donald Trump
 
 
While gold is testing critical resistance just below $1,236 an ounce, some analysts are questioning whether these comments will reverse gold’s downtrend.
 
 

“I think we could see some short-term short squeeze through next week as investors digest all the geopolitical risk in the marketplace,” said Phillip Streible, senior market analyst at RJO Futures. “But I don’t know if this completely saved the gold market. Trump’s comments are not going to stop the Fed from raising interest rates.”

Streible added technical momentum indicators are still bearish for gold and that the downward trend is still fairly strong.

However, for investors who are interested in testing the gold waters at current levels, he likes the idea of buying October $1,250 calls.

Colin Hamilton, managing director of commodity research at BMO Capital Markets, is not paying attention to Trump’s latest comments. In an email comment to Kitco News, he said that the U.S. central bank “seems pretty committed to two more rate hikes this year.”

For gold, Hamilton said that while physical demand is expected to pick up with prices hovering near a one-year low, the market needs a weaker U.S. dollar to attract major asset managers.

Trump Did Not Reveal Anything New

Neil Mellor, senior currency strategist at BNY Mellon, said that he doesn’t see the President’s tweets shifting the strong bullish U.S. dollar sentiment in the marketplace.

“We already know that he doesn’t like a strong U.S. dollar. Nothing he said was new for the market,” he said.

Mellor said that the price action he currently sees is more an indication of investors taking profits, rather than a reversal of futures.

“Gold has seen some major selling this week. At the same time, the U.S. dollar has made some big gains so investors are taking some profits off the table ahead of the week,” he said. “Next week, I think we will see fresh buying in the U.S. dollar.”

Mellor also said that he doesn’t think that Trump’s tweets will stop the U.S. central bank from raising interest rates. He also said that China has no choice but to continue to devalue its currency to support its economy.

“China is trying to deleverage the biggest credit bubble in history,” he said. “A weaker yuan is the only option for the government right now.”

At the same time, Mellor added that European economic growth would support any hawkish comments from Mario Draghi, president of the European Central Bank, next week.

“I think we are going to see some fresh euro selling and that will continue to support the U.S. dollar and hurt gold,” he said.

Gold Is Still The Best Safe-Haven Asset

But not everyone is negative on gold in the near term. Eugen Weinberg, head of commodity research at Commerzbank said that the market reaction to Trump’s central-bank comments is proof that investors should not completely ignore gold.

“We can see how much market reaction there was to just one tweet,” he said. “Investors will start looking at gold again because they will want to focus on security and stability.”

While investors having been swept up in the euphoria of near-record equity valuations, Weinberg said that cracks are starting to show in the global economy and he expects safe-haven demand to grow in the coming months.

George Milling-Stanley, head of gold investments at State Street Global Advisors, said in a recent interview with Kitco News that he expects recession fears to eventually push gold prices higher through the rest of the year.

“I can’t understand why people’s perception of risk seems to have ratcheted down quite significantly in the last few months,” he said. “Circumstances have not improved to the extent to where I would personally want to be taking on more risks. If anything, the circumstances have deteriorated with the continued rise in equities.”

Levels To Watch

Although gold is seeing a healthy jump off its recent one-year low, Weinberg said that more work needs to be before the metal attracts more buying momentum. He said that gold needs to push above $1,250 an ounce before investors feel confident that the current downtrend has finished.

Streible added that he is also watching $1,250 an ounce in the near term.

Chris Beauchamp, market analyst at IG, said that gold prices have to push above $1,265 an ounce before the trend of lower highs is broken.

The Final Say

The economic calendar next week is fairly sparse with little major data to be released. The markets will receive some important housing sales data and preliminary manufacturing data.

The big economic reports come at the end of the week with the release of U.S. durable-goods numbers published Thursday and then the first reading of second quarter U.S. gross domestic product Friday. Economists are expecting that the U.S. economy grew 4% in the second quarter.

In his testimony before Congress this week, Fed Chair Jerome Powell presented a fairly optimistic view on the U.S. economy.

“The FOMC believes that--for now--the best way forward is to keep gradually raising the Federal funds rate,” he said.

With little economic data on tap next week, commodity analysts will also keep an eye on more rhetoric on global trade. According to reports, Trump has said that he is “ready to go” to launch $500 million in tariffs on imported Chinese goods.

“Increasing trade wars raises the risk of slower economic growth so we could see more movement into gold,” said Weinberg.


Thinking About the Trump-Putin Meeting

 

By and large, high-level summits don’t matter. Agendas are set weeks in advance. A series of agreements – mostly symbolic – are negotiated ahead of time, with documents ready to be signed. Private meetings usually involve several aides to help the leaders and to ensure that they stick to the script.
President Donald Trump approaches summits differently from his predecessors. Rather than months of preparation at lower levels, he enters meetings prepared to improvise. He has been deeply criticized for this approach, particularly by those officials who would normally be called upon to prepare for meetings, but it isn’t clear that the old method worked. It tended to minimize gaffes, but it also homogenized the meetings, tying the hands of the president – who was elected, after all, whereas the minions were appointed. Trump’s desire to be free to interact and deal is not inherently a bad idea, as it would turn summits into authentic meetings, but the complexities of domestic and foreign politics require discipline.
Only a handful of people know exactly what was said during the private meeting on Monday in Helsinki between Trump and Russian President Vladimir Putin, but the world bore witness to the post-summit Q&A with the media. The American president was not restrained by his advisers, nor was he bound by his prepared remarks. He was, however, constrained by domestic politics. World leaders are politicians, and politicians have publics – whether in democracies or dictatorships – that they must answer to.
The weaker the political positions of leaders are – or the weaker they perceive their positions to be – the more they will speak to their public. Their statements will shift away from the matter at hand to try to buttress their political position at home. They can do this in several ways, including by using the occasion as a platform to attack domestic opponents. This is what happened at the Trump-Putin meeting. Putin is politically strong, and for him, simply appearing confident was enough. But Trump is embattled, and he chose to focus on domestic issues. A major one is the investigation into Russian interference in the 2016 U.S. election. Since the summit was with Putin, and Trump’s focus was on domestic politics involving Russia, the confluence led him into difficult places.
Trump’s most interesting comment came as a tweet before the press conference, though he reaffirmed the comment’s sentiments during the conference. He said that U.S.-Russian relations had reached their lowest point ever and that it was the United States’ fault. The first part is suspect given events like the Cuban Missile Crisis, but the startling part was the assertion that the U.S. was to blame. What I think Trump was trying to do was to attack the Obama administration for trying to isolate Russia rather than engage it. There is an argument to be made for that position, but it wasn’t clearly expressed in the tweet.
The decision by Robert Mueller, the special counsel leading the investigation into Russian meddling, to indict 12 Russians the Friday afternoon before the summit clearly threw Trump off balance. It isn’t clear that Mueller had to do this when he did, given that there was no chance whatsoever that the Kremlin would extradite them. Putin hinted that if Mueller wanted to question them, the Russian government would then want to question Americans accused of committing crimes in Russia, citing one case in particular. Since U.S. foreign intelligence must break laws daily in Russia to do its job, an agreement on this would open a can of worms no one wants.
One explanation for the timing of the indictments is that Mueller was oblivious or indifferent to the fact that there was a summit meeting the following week. Another explanation is that in performing his job as special counsel, Mueller saw an opportunity to fluster Trump and he used it, prioritizing his role in the investigation over U.S. foreign policy. In any event, the indictments dominated the press conference, with American reporters hammering on whether Trump endorsed them. Trump could have answered that they were only indictments and not convictions and that he would let the judicial system decide this, but instead, he essentially took Putin’s line, dismissing U.S. intelligence findings. (Trump walked back those remarks on Tuesday.)
This brings us to the subtext of the investigation, which is that Trump is in some way under the control of Russian intelligence. The press conference should put those concerns to rest. If he were, the Russians never would have permitted Trump to reject U.S. intelligence findings or side with Putin. Indeed, it would have been unwise to hold a private meeting between the presidents in the first place. The Russians would be doing everything in their power to enhance Trump’s political standing in the United States and to make him appear anti-Russian. They would never allow anyone to imagine he was working for them. They would use him in different ways. Trump would have attacked Putin directly at the press conference.
The pressures on Trump are mounting, whether he is concerned about something he did or simply under the normal pressure that comes with being under constant investigation. His desire to challenge what he sees as tormentors on all fronts has become powerful, and it broke out around the meeting in Helsinki. Putin undoubtedly was pleased, and the world media declared it a major setback for the United States.
In actuality, at most it hurt the career of a single politician, and more likely it didn’t do even that. The American public is fully aware of Trump’s personality quirks and public statements. His approval rating has ticked up in recent months, reaching as high as 47 percent according to Rasmussen for the month of June. This is one of the higher results, but it’s pretty strong for a president at this point in his presidency. There are voters who will despise him regardless of what he does, and others who will admire him regardless of what he does. Trump’s popularity won’t surge or plummet simply because he behaved like himself.
As to American standing on the world stage, that too is consistent. Most dislike the United States, but none can dismiss it. In my travels, I found many countries that held President Barack Obama in withering contempt. President George W. Bush was regarded as incompetent. Dislike of the president for being unsophisticated, or the U.S. for being naive or ruthless (sometimes both, somehow), is not new, although there is no question that Trump has created vast new opportunities for critics.
But the United States is the world’s largest economy, the engine of global technological innovation and the only global military force in the world. It is also the largest importer, and Germany’s largest customer, for example. German Chancellor Angela Merkel may be offended by Trump, but in the end, her country needs the American market. The objective realities of U.S. power trump the behavior of the president. Similarly, summits must be put into context. They are meetings between people, some of whom have enough political support to do what they say they will, others who do not. But both will pass the scene long before the deep power of either country passes away. The balance of power shifts, but, except in time of war, ever so slowly. A sense of proportion is needed, but that has never been abundant in the world.


China Fights the Trade War at Home

Beijing is preparing the public for the coming storm.

By Phillip Orchard


 
The first round of U.S. tariffs and Chinese counter-tariffs came into effect on Friday.

All told, they will directly affect some $68 billion in goods. On July 15, the U.S. is expected to impose more tariffs targeting $16 billion in Chinese goods, with proportional Chinese retaliatory measures to follow. Things are likely to escalate from there. Whether or not this spat should be defined as a full-blown trade war, both sides are now firing with live ammunition, and neither side will escape unscathed.
In some ways, it’s not an equal fight. China is more dependent on U.S. exports than the U.S. is dependent on Chinese imports, and the Chinese economy is far more fragile than that of the U.S., so it’s reasonable to conclude that the United States is heading to battle from a position of strength. Still, it’s not just about who can punch the hardest on the economic front, but also about who can take the most hits without facing major political blowback at home. And here, China’s ability to direct state support to targeted industries, crack down on dissent and shape public perceptions gives it some advantages, especially against a divided adversary heading into an election season.
Earlier this week, we got an inside look into how China is attempting to use its media controls to steel public resolve for the hits to come. The China Digital Times, a U.S.-based censorship-monitoring site, published what it claims is a leaked circular from Chinese authorities outlining how state media should cover the trade spat. We cannot confirm the document’s authenticity, but its contents jibe with narratives Chinese state media has begun pushing – and hint at intensifying pressures that Beijing is most certainly feeling. Below we provide some excerpts from the allegedly leaked document and outline how these statements can be used to shape public discourse on trade.
 
What Beijing Is Really Saying
“The trade conflict is really a war against China’s rise, to see who has the greater stamina. This is absolutely no time for irresolution or reticence.”
The theme of “us against the world” has been central to sustaining public support on any front where Beijing’s moves have triggered an international backlash, from human rights crackdowns at home to assertiveness in the South China Sea. And it’s a potent one. It reflects a historical effort to perpetuate and harness the power of China’s defining narrative since its defeat in the First Opium War in 1842: that China was bullied, carved up and subjugated by foreign imperialists during the so-called Century of Humiliation, subjecting what was once the world’s pre-eminent civilization to untold suffering. And if the Chinese people fail to unite behind their leaders, according to this narrative, outside powers would readily do it again. Chinese leaders have been adept at nursing collective grievances as part of the never-ending quest for national rejuvenation since even before the Communist Party took power in 1949. But it’s not just propaganda. Rather, it speaks to an enduring anxiety embedded deep in the national psyche that, despite China’s more recent gains and burgeoning national confidence, it could all come undone yet again.
“All media should prepare well for protracted conflict. Don’t follow the American sides’ fluctuating declarations.”
China thinks the trade fight won’t be over quickly. This is, in part, because it’s unclear what the White House would need to claim victory and move on. If the fight were just about the trade deficit, this wouldn’t necessarily be the case. In trade negotiations, China reportedly offered to buy between $25 billion and $70 billion more in U.S. stuff (mostly energy and agricultural goods) annually to bring the deficit down somewhat. And as the Chinese consumer market grows, it’s likely to be buying more and more U.S. goods in the coming years anyway. Already, China is the fourth-largest market for U.S. exports, with China-bound goods growing some 115 percent over the past decade to nearly $130 billion each year.
But the real fight is over China’s quest to become a dominant technological power – and the mercantilist policies it’s using to leapfrog the U.S. and other Western powers in the high-tech realm. Here, it cannot back down without undermining its core national strategy. Its reliance on low-cost manufacturing has left it vulnerable to rising competition from its lower-cost neighbors, productivity declines as its workforce ages, and downturns in Western economies – as was exposed following the global financial crisis beginning in 2008, when Chinese exports contracted sharply. If anything, the U.S. moves to squeeze it on this front will only reinforce the belief in Beijing that it must become less reliant on foreign technology by whatever means necessary. But the U.S. is loath to back down as well. Its comparative advantage over lower-cost manufacturers like China is in high-tech goods and services. And the real Chinese threat to long-term U.S. economic competitiveness and strategic interests is that China eats into this advantage.
“Do not make further use of ‘Made in China 2025,’ or there will be consequences.”
“Made in China 2025” is China’s contentious plan to become a leader in the industries likely to matter most over the coming century (for both commercial and military applications), such as semiconductors, robotics, aerospace, green energy and biotech. It was conceived as a rallying cry at home, a roadmap for how the Communist Party would fulfill its pledge to make China a world-class power. But Beijing now sees the slogan as giving the U.S. a fixed target with which to galvanize support for President Donald Trump’s tariffs and shift focus from the trade deficit to the technological threat.
The trade war is divisive, and Trump doesn’t have much support on either side of the aisle or with allies for tariffs intended to revive U.S. steel and aluminum industries at the expense of U.S. consumers, industries that rely on cheap Chinese imports and industries likely to be harmed by Chinese retaliatory measures. But there’s broad agreement among both parties and abroad that China’s mercantilist tech policies are a threat (even if there are major disagreements in the U.S. over Trump’s plan to address them). To curry support from Trump opponents in the U.S. and abroad, Beijing is trying to portray itself as a champion of free trade fighting back against a president hellbent on dismantling a system that made much of the world rich, however disingenuous this portrayal may be. In other words, Beijing is trying to change the subject. Relentlessly touting a high-profile plan that involves practices like forcing foreign firms to hand over technology in exchange for the right to operate in China – not to mention activities like outright technological theft – wasn’t helping.
 


 



“[China should] strike accurately and carefully, splitting apart different domestic groups in US.”

China’s best hope is that the trade war becomes politically untenable for Trump, particularly with midterm elections just around the corner. And this means directing countermeasures at politically influential interest groups. According to Brookings, for example, Trump won 82 percent of the counties expected to see job losses from Chinese retaliatory measures. American farmers, who’ve routinely exercised considerable sway on U.S. trade policy, are squarely in Beijing’s crosshairs, with key U.S. crops like soybeans, wheat and corn facing 25 percent tariffs.
China has ample options in this regard. According to a study by Oxford Economics, some 2.6 million jobs in the U.S. were created by the combination of U.S. exports of goods and services to China and bilateral foreign investment flows. The same study said cheap Chinese goods such as washing machines and solar panels (both of which were targeted with tariffs in January) have saved the average American household some $850 annually. General Motors sold more than a million more cars in China last year than in the United States. According to the Peterson Institute, some 60 percent of U.S.-bound exports from China were produced by multinational firms, some of them American, rather than Chinese-owned companies.
“Don’t attack Trump’s vulgarity; don’t make this a war of insults.”
Know thy enemy’s strengths. Don’t rally his base. Keep him focused on trade disputes with Canada, Japan and the European Union. Don’t give him reason to put the spotlight on alleged Chinese human rights violations that speak louder than the president’s words.
China’s Chrome-Plated Fragility
Beijing’s ability to control media narratives and shape public perception at home is indeed a strength. But its need to do so points to its underlying weaknesses. China is facing an economic reckoning as it enters a prolonged phase of slowing growth, and Beijing is trying desperately to push through ambitious economic reforms before that day comes. Its need to restructure its economy, whittle down a staggering debt load and wrestle pollution into submission, while also maintaining high employment and broad backing for the regime, has it performing a high-wire act. Already, amid Beijing’s crackdown on shadow lending, we’re seeing a growing wave of defaults among private sector firms that had grown fat on limitless credit. Last winter, anti-pollution measures led to widespread natural gas shortages. In May, the coal-rich city of Leiyang failed to make payroll amid revenue shortfalls stemming from Beijing’s crackdowns on high-polluting industries and overcapacity reforms. Growth in exports, retail sales and fixed-asset investment is slowing.
So the trade war is coming at a precarious time for China. And in recent weeks, we’ve started to see hints of dissent from influential figures and media outlets asking the question if China can really afford to fight a two-front war against the U.S. on trade and against its own internal woes. Beijing doesn’t exactly have a choice in either matter. Dark clouds are gathering either way; perhaps its only option is to prepare the public for the storm.


The Dollar Will Eventually Pay the Price for U.S. Deficits

In the long run, the dollar should be weaker. But when will the long run arrive?

By Richard Barley


DOLLAR POWER
Second-quarter performance of U.S. dollar against selected currencies

Source: FactSet




The U.S. dollar’s startling rally has upended markets around the world. Burgeoning U.S. deficits due to tax cuts and higher spending should mean a weaker dollar in the long run, as investors demand a discount to buy U.S. assets. But when will the long run arrive?

The dollar’s second-quarter rise was as sharp as it was unexpected. It rose 5.5% against the euro and racked up double-digit percentage gains against emerging-market currencies like the Brazilian real and South African rand. The rout reached China late in June, with the yuan falling 4% in just a couple of weeks.

The greenback rose as U.S. growth barreled along while the rest of the world proved less buoyant than hoped. Additional fuel for the move has come from concerns about an escalating trade war—the U.S. and China imposed tariffs on each other’s exports Friday—and political stresses in Europe and some developing countries.


CORPORATE COST
Total return on ICE BofAML U.S. investment-grade corporate bond index

Source: FactSet



For now, the rush of better U.S. growth has proved stronger than the fear of the consequences of wider U.S. budget and current-account deficits that have to be financed. The gain has been taken before the potential pain.

That could persist for a while yet. There have been tentative signs of stabilization in economic data outside the U.S., but the idea of synchronized global growth has taken a hammering.

Trade-war fears are still concentrated outside the U.S. and the Federal Reserve is alone in methodically raising interest rates. 

   An exchange bureau advertisement in Cairo on Wednesday. Photo: mohamed abd el ghany/Reuters 



At the same time, longer-term concerns haven’t gone away. For signs of when then might become a problem for the dollar, investors should pay attention to the U.S. corporate-bond market, thinks Morgan Stanley . Low interest rates globally have led foreign investors to pile in, chasing higher returns. For instance, Japan’s holdings of U.S. corporate debt have risen by more than 50% to nearly $250 billion since the start of 2016, according to U.S. Treasury data.

However, corporate bonds have turned into a losing trade, hit by both higher Treasury yields and wider credit spreads. If foreign investors start to pull back, pushing up borrowing costs further, that could weigh on prospects for U.S. growth—and on the dollar.

With the rest of the world facing challenges, the dollar’s strength can continue for now. But the bill for the higher growth the U.S. is currently enjoying can’t be put off forever. Eventually, the dollar will have to pay the price.


America the Loser

J. Bradford DeLong




BERKELEY – The Washington Post’s Catherine Rampell recently recalled that when US President Donald Trump held a session for Harley-Davidson executives and union representatives at the White House in February 2017, he thanked them “for building things in America.” Trump went on to predict that the iconic American motorcycle company would expand under his watch. “I know your business is now doing very well,” he observed, “and there’s a lot of spirit right now in the country that you weren’t having so much in the last number of months that you have right now.”

What a difference a year makes. Harley-Davidson recently announced that it would move some of its operations to jurisdictions not subject to the European Union’s retaliatory measures adopted in response to Trump’s tariffs on imported steel and aluminum. Trump then took to Twitter to say that he was, “Surprised that Harley-Davidson, of all companies, would be the first to wave the White Flag.” He then made a promise that he cannot keep: “… ultimately they will not pay tariffs selling into the EU.”

Then, in a later tweet, Trump falsely stated that, “Early this year Harley-Davidson said they would move much of their plant operations in Kansas City to Thailand,” and that “they were just using Tariffs/Trade War as an excuse.” In fact, when the company announced the closure of its plant in Kansas City, Missouri, it said that it would move those operations to York, Pennsylvania. At any rate, Trump’s point is nonsensical. If companies are acting in anticipation of his own announcement that he is launching a trade war, then his trade war is not just an excuse.

In yet another tweet, Trump turned to threats, warning that, “Harley must know that they won’t be able to sell back into U.S. without paying a big tax!” But, again, this is nonsensical: the entire point of Harley-Davidson shifting some of its production to countries not subject to EU tariffs is to sell tariff-free motorcycles to Europeans.

In a final tweet, Trump decreed that, “A Harley-Davidson should never be built in another country – never!” He then went on to promise the destruction of the company, and thus the jobs of its workers: “If they move, watch, it will be the beginning of the end – they surrendered, they quit! The Aura will be gone and they will be taxed like never before!”

Needless to say, none of this is normal. Trump’s statements are dripping with contempt for the rule of law. And none of them rises to the level of anything that could be called trade policy, let alone governance. It is as if we have returned to the days of Henry VIII, an impulsive, deranged monarch who was surrounded by a gaggle of plutocrats, lickspittles, and flatterers, all trying to advance their careers while keeping the ship of state afloat.

Trump is clearly incapable of executing the duties of his office in good faith. The US House of Representatives and Senate should have impeached him and removed him from office already – for violations of the US Constitution’s emoluments clause, if nothing else. Barring that, Vice President Mike Pence should have long ago invoked the 25th Amendment, which provides for the removal of a president whom a majority of the cabinet has deemed “unable to discharge the powers and duties of his office.”

And yet, neither Speaker of the House Paul Ryan nor Senate Majority Leader Mitch McConnell nor Pence has dared to do anything about Trump’s assault on American democracy. Republicans are paralyzed by the fear that if they turn on Trump, who is now supported by roughly 90% of their party’s base, they will all suffer at the polls in the midterm congressional election this November.

It is nice to think that the election will fix everything. But, at a minimum, the Democratic Party needs a six-percentage-point edge to retake the House of Representatives, owing to Republican gerrymandering of congressional districts. Democrats also have to overcome a gerrymandering effect in the Senate. Right now, the 49 senators who caucus with the Democrats represent 181 million people, whereas the 51 who caucus with the Republicans represent just 142 million people.1

Moreover, the US is notorious for its low voter turnout during midterm elections, which tends to hurt Democratic candidates’ prospects. And Trump and congressional Republicans have been presiding over a relatively strong economy, which they inherited from former President Barack Obama, but are happy to claim as their own.

Finally, one must not discount the fear factor. Countless Americans routinely fall victim to social- and cable-media advertising campaigns that play to their worst instincts. You can rest assured that in this election cycle, as in the past, elderly white voters will be fed a steady diet of bombast about the threat posed by immigrants, people of color, Muslims, and other Trump-voter bugaboos (that is, when they aren’t being sold fake diabetes cures and overpriced gold funds).

Regardless of what happens this November, it is already clear that the American century ended on November 8, 2016. On that day, the United States ceased to be the world’s leading superpower – the flawed but ultimately well-meaning guarantor of peace, prosperity, and human rights around the world. America’s days of Kindlebergian hegemony are now behind it. The credibility that has been lost to the Trumpists – abetted by Russia and the US Electoral College – can never be regained.


J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.


Donald Trump has sounded America’s global retreat

Russia and China will be the big winners from the end of US leadership

Philip Stephens



The guiding assumptions of modern American foreign policy were set out in a document written in 1950 for president Harry Truman. NSC-68 as it was called (the paper was prepared at the National Security Council) was Washington’s answer to Soviet communism. At its core was a belief that US national interests were best pursued through international leadership. This is the foundation stone to which Donald Trump has taken a sledgehammer.

Much of NSC-68 focused on countering the military threat from the Soviet Union. Signed off by Truman at the start of the Korean war, it was the basis for a rapid build-up in US defence spending. But mindful of how the national mood could turn to isolationism, it also aimed to quash the idea that America could retreat again into its own hemisphere.

Thus: “Our overall policy at the present time may be described as one designed to foster a world environment in which the American system can survive and flourish. It therefore rejects the concept of isolation and affirms the necessity of our positive participation in the world community.” Here was the strategic rationale, lasting beyond the cold war, that enmeshed the US in the fabric of what we call the west.

When today’s US diplomats remark they expect Russia’s Vladimir Putin to take great care in preparing for his Helsinki meeting with Donald Trump this month, they leave the next thought hanging in the air. The US president, they know, has already decided how he wants to spend the time immediately preceding the encounter. He intends to be hitting a golf ball in Scotland.

If the only concern was Mr Trump’s preference for watching Fox News over reading anything resembling an official policy brief, it would be manageable. After all, Ronald Reagan stole time at international meetings to watch videos of old Hollywood westerns. But Helsinki will follow on the heels of a Nato summit in Brussels. The fear among diplomats, US as well as European, is of a rerun in Brussels of the angry exchanges at the G7 meeting in Canada.

A shouting match with America’s allies might then be followed by a day of backslapping with Mr Putin. The president, after all, has made plain his disdain for Nato. He says the Europeans set up the EU as part of an economic conspiracy against the US. His response to the myriad allegations of Russian interference in the 2016 presidential election campaign has been to double up on his professed admiration for Mr Putin.

The mistake made by the rest of us has been to imagine that Mr Trump could somehow be managed through his presidency — that the ignorance and prejudice that inform his worldview could be sidestepped and softened. With enough teeth-gritting indulgence and flattery, the argument has run, the president could be kept within boundaries. Yes, he wanted to shake things up, but to tilt them to US advantage rather than to bring the house down.

The evidence is increasingly otherwise. The more persuasive explanation of the US president’s behaviour is that he simply does not accept the assumptions made by the authors of NSC-68 about global leadership, alliances and international institutions. Instead his instincts say that, as the world’s most powerful nation, the US is better off setting its own, bilateral, terms with allies and adversaries alike. Donald Tusk, the president of the European Council, got it right when he remarked the other day that “He [Trump] has a method and is serious in his mission against an international rules-based order . . . He is on a mission against what we stand for.”


Seen through this lens, Mr Trump’s admiration for Mr Putin is readily explicable. They are both self-declared strong men. They share an outlook that says the prizes should go to the powerful, that multilateral institutions and rules are calculated to ensnare them, and that norms, values and what they call moralism do not have a place in the conduct of relations between states. As for the weak, well they can go hang.

This is the mindset that leads Mr Trump to tear up the Iranian nuclear accord, to suggest that Mr Putin has a point in wanting to run Russia’s near-abroad, to tell French president Emmanuel Macron France should leave the EU to do a trade deal with Washington, and to indicate he will bargain away America’s security commitments to east Asia in return for trade concessions from China’s Xi Jinping. Infusing it all is a powerful dose of manic self-delusion. Thus, against all the evidence, Mr Trump may really believe that after their recent summit in Singapore North Korea’s Kim Jong Un will give up his nuclear weapons programme.

On Mr Trump’s present course — and even his unashamedly America-first national security adviser John Bolton is showing signs of alarm at the president’s behaviour — the concept of a western order will be drained of substance and meaning. US allies, in Asia as well as Europe, will have to find other ways to safeguard their security. Some may look to China; others may think about a nuclear deterrent; Europe may understand it has to be able to defend itself.

The big winners of course are Mr Putin and Mr Xi. Their shared strategic goal has long been to put an end to the American-led order sketched out by Truman. China has bristled at the US presence in Asia; Russia wants a return in Europe to 19th-century power balancing. They could never have imagined that a US president would deliver to them such a prize.


Europe’s Nativist Swing Casts Shadow Over Establishment

German immigration shift, rise of Italian far right pressure continent’s status quo

By Marcus Walker in Rome and Valentina Pop in Vienna
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German Chancellor Angela Merkel is has pledged to tighten immigration controls to prevent the collapse of her governing coalition, a sign of the nativist wave sweeping the EU. Photo: Emmanuele Contini/NurPhoto/Zuma Press 


In Europe’s long struggle between the political establishment and its challengers, the momentum this year is shifting toward nativists, deepening doubts about the continent’s multilateral order and divisions about how to respond.

German Chancellor Angela Merkel survived the near-collapse of her governing coalition this week by pledging to tighten immigration controls, backing further away from her pro-refugee stance at the height of Europe’s migration crisis, which continues to reverberate around the continent.

Few in Germany expect the calm to last. The European Union’s most powerful member is also becoming its central battleground in a rancorous debate over immigration, sovereignty and political leadership. 
In Italy, the relentless rise of Matteo Salvini and his nativist League party is creating a new hub of opposition to Ms. Merkel and the multilateral Europe she wants to defend. Mr. Salvini, Italy’s interior minister and on paper the junior coalition partner in the Rome government, is dominating his country’s discourse with blunt rhetoric against immigrants and EU authorities. His open challenge to Ms. Merkel’s vision of Europe is emboldening politicians in other countries who want a looser EU, and to put their own nation first.

    Italian Interior Minister Matteo Salvini visited a farm confiscated from the mafia in Siena, Italy on Tuesday. Photo: fabio di pietro/EPA/Shutterstock 



Austria’s vice chancellor and far-right Freedom Party leader Heinz-Christian Strache said on Thursday he is “very thankful” for Mr. Salvini. “We agree with him on his positions on Europe, we have very good cooperation,” Mr. Strache told a news conference.

“Bringing down the Berlin Wall seemed impossible. We will bring down the wall of Brussels,” Mr. Salvini said at the weekend, referring to the seat of the EU’s administration.

The challenge from the nationalist right is dividing Europe’s established conservative parties, including Ms. Merkel’s Christian Democrats, who helped build the EU and are now unsure how to defend it.

President Donald Trump’s verbal attacks on the EU, as well as his questioning of the North Atlantic Treaty Organization and multilateral trade rules, are adding to the sense in EU capitals that the integrated Europe of the post-Cold War era is under siege.

Some EU countries are even challenging the bloc’s norms on liberal democracy, with Hungary’s Viktor Orban saying he wants to build an “illiberal state” inspired by authoritarian regimes and Poland accused by the EU of weakening the rule of law.

Central Europe’s nationalists, as skeptical about non-European migrants as they are about checks and balances, are becoming another schism within the EU, challenging the post-Cold War belief that Europe would converge on a single model of governance.

“We are seeing a continentwide struggle about what we perceived as the permanent status quo, the multilateral order of the West,” said Ulrich Speck, a foreign-policy scholar at the German Marshall Fund of the United States.

Austria, the small Alpine country sandwiched between Germany and Italy, has gained an outsize role in the struggle for Europe’s soul. 
Austria’s 31-year-old chancellor, Sebastian Kurz, has gone further than any other leader from the EU’s center-right establishment in co-opting the far-right in a quest to tame it, bringing a nativist party into his coalition and championing border controls as the only way to stop migrants and save the EU.

On Saturday, as Austria took over the EU rotating presidency for six months, Mr. Kurz hosted some EU leaders on a mountain top. Surrounded by hikers wearing traditional Alpine garb, he lauded the “magnificent view over our beautiful country,” and promised to focus the EU’s agenda on homeland security. Mr. Kurz has aligned himself with Ms. Merkel’s German critics who want a migration crackdown.

Only a year ago, EU supporters were celebrating the landslide election of fresh-faced French President Emmanuel Macron, who trounced a nationalist rival after campaigning for deeper European unity.

Today, Mr. Macron looks like Europe’s exception, rather than the herald of a centrist surge. His proposals for revitalizing the EU, including with common fiscal policies to bolster the euro currency zone, have found few takers.

Instead, questions of immigration and security continue to dominate European voters’ concerns, surveys show, and politicians’ attempts to shore up their support.

Today’s pressure on Europe’s status quo from the nationalist right is as serious as the ideological challenge from the anticapitalist left after 1968, says Ivan Krastev, a Bulgarian political scientist and author of the book “After Europe,” focused on the strains in the EU.

The challenge for mainstream politicians, as in the 1970s, is “how to integrate some of the legitimate concerns of the voters, without giving in to the extremes,” Mr. Krastev says.

Germany’s latest drama erupted when Ms. Merkel’s junior partner, the conservative Christian Social Union from the region of Bavaria, threatened to pull out of her coalition unless she agreed to block migrants from entering Germany who have already registered an asylum application in another EU country.

Ms. Merkel insisted that such cases should be handled only in agreement with neighboring countries, reflecting her belief that Europe needs a collective response to the heavy migration pressures from the poor and war-torn continents that surround it.

Her CSU critics argue she is falling behind the zeitgeist. “In Europe and the world,” Bavarian regional Premier Markus Söder said last month, “the time of orderly multilateralism is being superseded somewhat by individual countries that can make decisions too.” German authorities “should think also of the indigenous population and not always just of Europe as a whole,” he said.

The CSU fears losing its ruling majority in Bavarian regional elections in October, thanks partly to the rise of the far-right Alternative for Germany, which has garnered votes from Germans angry about Ms. Merkel’s decision in 2015 to take in nearly a million Syrian refugees. 
That decision continues to define Ms. Merkel in the eyes of many in Germany and Europe, even though Ms. Merkel has repeatedly tightened Germany’s immigration policies since 2016.




The chancellor’s bruising argument and last-minute compromise with the CSU concerned policy measures that would in practice affect only a small subset of migrants. But the details mattered less than what Ms. Merkel symbolizes to her critics: a Germany that can’t control its borders.

The CSU’s quest to show the public that asylum seekers can be refused entry to the country has created an awkward tactical alliance around Europe: between establishment conservatives who want a migration crackdown, and some of the nativist insurgents who want to destroy them. Hostility to Ms. Merkel binds them together, as well as a sense that the chancellor’s authority is waning.

Mr. Salvini openly encouraged the CSU to challenge Ms. Merkel and push for unilateral border controls, even as he rejected taking back any migrants refused entry to Germany.

At a raucous rally on Sunday of his League party, Mr. Salvini launched his manifesto for the year ahead, vowing to build a pan-European alliance of nationalist movements, “a league of leagues,” to sweep away Europe’s old political elites.

“They accuse us of xenophobia, but the Italy that we will govern for the next 30 years…has no fear of anyone,” Mr. Salvini told the sea of flags.


Is Cyber the Perfect Weapon?

Joseph S. Nye



CAMBRIDGE – For years, political leaders such as former US Secretary of Defense Leon Panetta have warned of the danger of a “cyber Pearl Harbor.” We have known for some time that potential adversaries have installed malicious software in our electricity grid. Suddenly the power could go out in large regions, causing economic disruption, havoc, and death. Russia used such an attack in December 2015 in its hybrid warfare against Ukraine, though for only a few hours. Earlier, in 2008, Russia used cyber attacks to disrupt the government of Georgia’s efforts to defend against Russian tropos.

Thus far, however, cyber weapons seem to be more useful for signaling or sowing confusion than for physical destruction – more a support weapon than a means to clinch victory. Millions of intrusions into other countries’ networks occur each year, but only a half-dozen or so have done significant physical (as opposed to economic and political) damage. As Robert Schmidle, Michael Sulmeyer, and Ben Buchanan put it, “No one has ever been killed by a cyber capability.”

US doctrine is to respond to a cyber attack with any weapon, in proportion to the physical damage caused, based on the insistence that international law – including the right to self-defense – applies to cyber conflicts. Given that the lights have not gone out, maybe this deterrent posture has worked.

Then again, maybe we are looking in the wrong place, and the real danger is not major physical damage but conflict in the gray zone of hostility below the threshold of conventional warfare. In 2013, Russian chief of the general staff Valery Gerasimov described a doctrine for hybrid warfare that blends conventional weapons, economic coercion, information operations, and cyber attacks.

The use of information to confuse and divide an enemy was widely practiced during the Cold War. What is new is not the basic model, but the high speed and low cost of spreading disinformation. Electrons are faster, cheaper, safer, and more deniable than spies carrying around bags of money and secrets.

If Russian President Vladimir Putin sees his country as locked in a struggle with the United States but is deterred from using high levels of force by the risk of nuclear war, then perhaps cyber is the “perfect weapon.” That is the title of an important new book by New York Times reporter David Sanger, who argues that beyond being “used to undermine more than banks, databases, and electrical grids,” cyberattacks “can be used to fray the civic threads that hold together democracy itself.”

Russia’s cyber interference in the 2016 American presidential election was innovative. Not only did Russian intelligence agencies hack into the email of the Democratic National Committee and dribble out the results through Wikileaks and other outlets to shape the American news agenda; they also used US-based social-media platforms to spread false news and galvanize opposing groups of Americans. Hacking is illegal, but using social media to sow confusion is not. The brilliance of the Russian innovation in information warfare was to combine existing technologies with a degree of deniability that remained just below the threshold of overt attack.

US intelligence agencies alerted President Barack Obama of the Russian tactics, and he warned Putin of adverse consequences when the two met in September 2016. But Obama was reluctant to call out Russia publicly or to take strong actions for fear that Russia would escalate by attacking election machinery or voting rolls and jeopardize the expected victory of Hillary Clinton. After the election, Obama went public and expelled Russian spies and closed some diplomatic facilities, but the weakness of the US response undercut any deterrent effect. And because President Donald Trump has treated the issue as a political challenge to the legitimacy of his victory, his administration also failed to take strong steps.

Countering this new weapon requires a strategy to organize a broad national response that includes all government agencies and emphasizes more effective deterrence. Punishment can be meted out within the cyber domain by tailored reprisals, and across domains by applying stronger economic and personal sanctions. We also need deterrence by denial – making the attacker’s work more costly than the value of the benefits to be reaped.

There are many ways to make the US a tougher and more resilient target. Steps include training state and local election officials; requiring a paper trail as a back-up to electronic voting machines; encouraging campaigns and parties to improve basic cyber hygiene such as encryption and two-factor authentication; working with companies to exclude social media bots; requiring identification of the sources of political advertisements (as now occurs on television); outlawing foreign political advertising; promoting independent fact-checking; and improving the public’s media literacy. Such measures helped to limit the success of Russian intervention in the 2017 French presidential election.

Diplomacy might also play a role. Even when the US and the Soviet Union were bitter ideological enemies during the Cold War, they were able to negotiate agreements. Given the authoritarian nature of the Russian political system, it could be meaningless to agree not to interfere in Russian elections. Nonetheless, it might be possible to establish rules that limit the intensity and frequency of information attacks. During the Cold War, the two sides did not kill each other’s spies, and the Incidents at Sea Agreement limited the level of harassment involved in close naval surveillance. Today, such agreements seem unlikely, but they are worth exploring in the future.

Above all, the US must demonstrate that cyber attacks and manipulation of social media will incur costs and thus not remain the perfect weapon for warfare below the level of armed conflict.


Joseph S. Nye, Jr., a former US assistant secretary of defense and chairman of the US National Intelligence Council, is University Professor at Harvard University. He is the author of Is the American Century Over?


Can US triple C-rated bonds stay ahead of the pack?

High-yield debt is looking vulnerable after strong outperformance in the first half

Alexandra Scaggs 
 

For the US corporate bond market, current conditions can be described with a comparison made famous in the financial crisis film Margin Call: the proverbial game of musical chairs is still on but the pace of the song has become more frenetic.

This year, the corporate bond market has been defined by a marked shift away from quality with lower-rated issues outperforming bonds from companies with stronger balance sheets.

This has been driven by expectations that the economy will continue to expand. But with the US Federal Reserve now raising rates, investors who ploughed into lower quality credit are now clearly vulnerable to the turn in the market cycle.

Investment grade companies rated at triple B minus and higher lost 3.1 per cent this year through to the end of June, according to ICE BofAML indices, while those rated in the junk tier (double B plus and below) have eked out a positive return of 0.1 per cent.

The divergence is even starker in the lowest triple C-rated tier of debt that makes up just 12 per cent of the high-yield market’s value. Triple C plus, triple C and triple C minus bonds have outperformed the rest of the market by a wide margin in the first half, posting a total return of 3.9 per cent, according to ICE BofAML indices.

Some of the outperformance is due to simple supply and demand. Investors had anticipated a much sharper drop-off in the supply of investment grade bonds in the first half of this year than the 5 per cent drop estimated by Bloomberg.

Demand from foreign investors was also 13 per cent lower than last year as hedging costs increased with rises in US short-term interest rates and the dollar, according to estimates from strategists at Bank of America Merrill Lynch.

But the shift also reflected reduced perceptions of risk. The gauge of market risk implied by the spread between the yields on those securities and government debt has narrowed by 135 basis points, according to CreditSights.

The question for the second half of the year for high-yield debt is trade and the economy. Many of the US’s junk-rated companies are plays on global growth, which could be hamstrung by a trade war if one comes to pass.

More broadly, the question is how high the Fed can raise rates before companies struggle to service their cost of debt and whether companies in the triple B segment will be downgraded to junk after piling on leverage in deals.

When that happens, higher quality and less leveraged companies will probably benefit — but at that point, equity markets and other risky securities might start to struggle as well, which would hurt investors’ ability to earn returns.