Iran Calls Trump’s Bluff

The President is caught between hawkish goals and dovish means.

By The Editorial Board

Photo: jim lo scalzo/Shutterstock

President Trump called off a military strike against Iran in mid-mission Thursday, and his supporters and even some of his critics are hailing it as an act of restraint and courage. The question for American interests is whether Iran and other adversaries will see it instead as a sign of weakness and indecision.

“We were cocked & loaded to retaliate last night on 3 different sights when I asked, how many will die. 150 people, sir, was the answer from a General. 10 minutes before the strike I stopped it, not proportionate to shooting down an unmanned drone,” Mr. Trump tweeted Friday morning.

It’s important to understand how extraordinary this is. The Commander in Chief ordered ships and planes into battle but recalled them because he hadn’t asked in advance what the damage and casualties might be? While the planes were in the air, he asked, oh, by the way? This is hard to take at face value.

More likely, he changed his mind because he had second thoughts about the military and political consequences of engaging in a conflict he promised as a candidate to avoid. Mr. Trump may have saved Iranian lives now, but his indecision and professed fear of casualties may be risking more American lives later.

Squeezed by the U.S. “maximum pressure” campaign, Iran’s rulers are trying to pressure Mr. Trump in return. In recent weeks they have attacked oil pipelines, mined oil tankers, and this week brazenly shot down a $130 million U.S. drone monitoring shipping lanes over international waters. Iran’s bet is that Mr. Trump is so averse to military confrontation that he will ease U.S. sanctions. On the evidence of the aborted mission, they may be right.

The damage from Mr. Trump’s stand-down depends in part on how Iran’s leaders respond. If they agree to talks to revise the 2015 nuclear agreement, the restraint might pay off. Yet Iran’s leaders have shown no interest in talking as long as U.S. sanctions are in place. If Mr. Trump eases sanctions to get Iran to the bargaining table, he is back to the Obama nuclear deal.

On the other hand if the Iranians escalate again, Mr. Trump’s restraint will look misguided and weak. If Americans are now killed by Iranian proxies, his failure to use force to deter attacks will deserve some of the blame.

Laying out these potential stakes isn’t “war mongering,” as the new isolationists on the right claim. This is the reality of geopolitics in which credibility is crucial to deterrence. The more that adversaries think Mr. Trump’s threats of force aren’t credible, the more they will seek to exploit that knowledge.

After Barack Obama failed to enforce his “red line” in Syria in 2013, adversaries soon took advantage. Vladimir Putin snatched Crimea from Ukraine and moved into Syria, China pushed further into the South China Sea, and Iran expanded its proxy wars in the Middle East. Will they draw similar license now from Mr. Trump’s stand-down?

The great weakness of Donald Trump’s foreign policy is its volatility. He is unpredictable to a fault. He has doubted his own Venezuela policy from the first week he signed off on it. He called Kim Jong Un crazy but now says he’s a swell guy. He signed a trade deal with Mexico then threatened it with new tariffs.

On Iran he has adopted a policy goal favored by hawkish Sen. Lindsey Graham but wants to use only the means of isolationist Sen. Rand Paul to achieve it. He warned that “if Iran wants to fight, that will be the official end of Iran,” but he lets Iran shoot down a drone and interfere with international shipping.

If Mr. Trump’s real policy is Mr. Paul’s, then he should be honest with Americans and return to the Obama nuclear deal. In the meantime, Iran appears to be calling Mr. Trump’s bluff.

Gold Decisively Breaches Major 2013 Overhead Resistance Wall

by: Gordon Long
- The $1,360/oz price level has acted as an invisible "Maginot Line" since 2013. The wall was decisively breached this week.

- The blow to the wall was decisive and a retreat by the Bullion Banks to a new higher resistance zone of $1,470/oz looks likely.

- Both the fundamentals and technicals suggest that there is just too much force to be held back for the $1,470 and $1,650 levels not to be tested in 2019.

The $1,360/oz price level has acted as an invisible "Maginot Line" since 2013. The wall was decisively breached this week as both Chairman Powell and ECB President Draghi signaled monetary easing was ahead. This was sufficient confirmation to the gold market that currency debasement was again soon to be ignited.
The gold market delivered a crushing blow to once impenetrable wall. However, those that trade gold know only too well that gold is a manipulated market and will be looking for another "fat finger": billions of dollars of notional value of gold; in the middle of the night; offshore; executed in seconds; and sell order - thereby crushing price (once quadruple-witch is in the rear view mirror)! Where is the SEC?
However, the blow to the wall was decisive and a retreat to a new resistance zone is likely. $1,470/oz looks likely...
...but momentum may force the troops to select $1,650.
Both the fundamentals and technicals suggest that there is just too much force to be held back for these levels not to be tested.
FUNDAMENTALS: De-Dollarization is a core driver (See June 15th Seeking Alpha post: Gold Likely To Soon Be Lifted By Rising De-Dollarization Surge)
TECHNICALS: We have gold technicals which haven't looked stronger in a long time:
  • A Bullish "Ascending Triangle"

  • A Completed "Cup & Handle"

  • An "Inverse Head & Shoulders"

The International Man, Nick Giambruno, lays out eight reasons in a multi-article analysis why a huge Gold-Mania is about to begin:
  • No. 1: Basel III Moves Gold Closer to Officially Being Money Again

  • No. 2: Central Banks Are Buying Record Amounts of Gold

  • No. 3: Oil for Gold - China's Golden Alternative

  • No. 4: The Fed's Dramatic Capitulation

  • No. 5: Takeover Frenzy in the Gold Mining Industry

  • No. 6: President Trump Is Pro-Gold

  • No. 7: Socialism Is on the Rise

  • No. 8: Gold-Backed Cryptos - A Monetary Revolution
We may have a perfect storm which the Bullion banks are ill prepared to combat!

How Inflation Could Return

After years of low inflation, investors and policymakers have settled into a cyclical mindset that assumes advanced economies are simply suffering from insufficient aggregate demand. But they are ignoring structural factors at their peril.

Mohamed A. El-Erian


NEW YORK – Debates about inflation in advanced economies have changed remarkably over the past decades. Setting aside (mis)measurement issues, concerns about debilitatingly high inflation and the excessive power of bond markets are long gone, and the worry now is that excessively low inflation may hamper growth.

Moreover, while persistently subdued – and, on nearly $11 trillion of global bonds, negative – interest rates may be causing resource misallocations and undercutting long-term financial security for households, elevated asset prices have heightened the risk of future financial instability. Also, investors have become highly (and happily) dependent on central banks, when they should be prudently more fearful of them.

In search of new ways to produce higher inflation, the major central banks have tended to favor a cyclical mindset, making frequent references to insufficient aggregate demand. But what if that is the wrong lens through which to view current conditions, and we are actually in the middle of a multi-stage process in which strong disinflationary supply-side forces eventually give way to the return of higher inflation? In that case, monetary policymakers and market participants would need to consider quite a different opportunity-risk paradigm than the one currently being pursued.

To be sure, after coming close to central banks’ 2% target in 2018, core inflation rates in Europe and the United States have since been declining. The conventional measure of market expectations for inflation – the break-even rate on five-year US Treasuries – remains stubbornly below target, even though the six-month moving average pace of job creation is almost 50% above the historical level needed to absorb new labor-market entrants so deep in the economic cycle. Though the US unemployment rate (3.6%) is at its lowest level in around five decades, the labor-force participation rate (62.8%) also remains relatively low.

Owing to the persistence of low inflation, monetary policies have remained ultra-loose for an unusually long time, raising concerns that the US or Europe may succumb to “Japanification” as consumers postpone purchases and companies reduce investment outlays. So far, that risk has led to protractedly low or negative (in the case of the European Central Bank) policy rates and bloated central-bank balance sheets, despite the potentially deleterious effects of such policies on the integrity of the financial system.

In fact, some economic observers favor the ECB not just maintaining negative interest rates, but also restarting asset purchases under its quantitative-easing (QE) program. Likewise, there are those who want the US Federal Reserve to implement an “insurance cut,” despite indicators suggesting that this will be another year of solid economic growth and job creation. Meanwhile, central banks have begun to look beyond their existing toolkits (traditional and unconventional) for new ways to spur economy-wide price increases, such as by raising the inflation target, either directly or by pursuing an average and allowing for deviations over time.

But today’s surprisingly low inflation also appears to be linked to larger structural forces, which means that it’s not rooted only in insufficient aggregate demand. Technological innovations – particularly those related to artificial intelligence, big data, and mobility – have ushered in a more generalized breakdown of traditional economic relationships and an erosion of pricing power.

Taken together, I call these structural forces the Amazon/Google/Uber effect. While the Amazon model pushes down prices by allowing consumers to bypass more expensive intermediaries, Google undercuts companies’ pricing power by reducing search costs, and Uber brings existing assets into the marketplace, further eroding established firms’ pricing power.

The Amazon/Google/Uber effect has turbocharged a disinflationary process that began with the acceleration of globalization, bringing far more low-cost production online and reducing the power of organized labor in advanced economies (as has the gig economy more recently). But while these trends will most continue for now, they are likely to confront countervailing inflationary influences that have yet to reach critical mass: the slack in the labor market is diminishing every month, and increased industrial concentration is giving some companies, especially in the technology sector, far greater pricing power.

Now, consider those trends in the context of today’s changing political landscape. Fueled by understandable anger over inequality (of income, wealth, and opportunity), more politicians are embracing populism, with promises of more active fiscal management and measures to curb the power of capital in favor of labor. At the same time, there is growing political pressure on central banks to bypass the asset channel (that is, QE bond purchases) and inject liquidity directly into the economy.

Economic anxieties are also driving anti-globalization politics. The weaponization of economic-policy tools such as tariffs and other trade measures is risking a fragmentation of global economic and financial relationships, favoring higher prices, and compelling a greater degree of more costly self-insurance by companies and consumers. At the same time, as expectations of continued low inflation become more entrenched, an upward price shock could expose vulnerabilities and increase the risk of policy mistakes and market accidents.

Considering how these competing forces are likely to play out over time, policymakers and investors should not rule out a return of inflation over time. Looking ahead, we will likely continue experiencing an initial stage in which the Amazon/Google/Uber effect remains dominant. But that may well be followed by a second stage in which tight labor markets, populist nationalism, and industry concentration begin to offset the one-time structural effects of new technologies being widely adopted. And in a third stage, the possible onset of higher inflation may catch policymakers and investors by surprise, producing excessive reactions that make a bad situation worse.

As with most paradigm shifts, there can be little certainty regarding the timing of this scenario. But, either way, policymakers in advanced economies must recognize that their inflation outlook is subject to a wider range of dynamic possibilities than they have considered so far. Focusing too much on the cyclical, rather than the structural, could pose serious risks to future economic wellbeing and financial stability. The longer we wait to broaden the prevailing mindset, the more likely we are to advance to the next stages of an inflationary process in which the impact of an exciting one-and-done technological event gives way to some old and more familiar tendencies.

Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers in 2009, 2010, 2011, and 2012. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.

Can the Belt and Road Become a Trap for China?

Through its Belt and Road Initiative, China is building ties to some of the world’s most authoritarian, financially opaque, and economically backward countries. Rather than exposing itself to massive political, economic, and default risks, Chinese policymakers should instead seek to repair relations with the West.

Yasheng Huang


CAMBRIDGE – Critics often claim that China is using its massive “Belt and Road Initiative” as a form of coercive “debt-trap diplomacy” to exert control over the countries that join its transnational infrastructure investment scheme. This risk, as Deborah Brautigam of John Hopkins University recently noted, is often exaggerated by the media. In fact, the BRI may hold a different kind of risk – for China itself.

At the recent BRI summit in Beijing, Chinese President Xi Jinping seemed to acknowledge the “debt-trap” criticism. In his address, Xi said that “building high-quality, sustainable, risk-resistant, reasonably priced, and inclusive infrastructure will help countries to utilize fully their resource endowments.”

This is an encouraging signal, as it shows that China has become more aware of the debt implications of BRI. A study by the Center for Global Development concluded that eight of the 63 countries participating in the BRI are at risk of “debt distress.”

But as John Maynard Keynes memorably put it, “If you owe your bank a hundred pounds, you have a problem. But if you owe your bank a million pounds, it has.” In the context of the BRI, China may turn out to be the banker who is owed a million pounds.

In particular, China may fall victim to the “obsolescing bargain model,” which states that a foreign investor loses bargaining power as it invests more in a host country. Infrastructure projects like those under the BRI are a classic example, because they are bulky, bolted to the ground, and have zero economic value if left incomplete.

Unsurprisingly, some BRI partner countries are now demanding to renegotiate terms, and typically after the projects have started. China may be forced to offer ever more favorable concessions in order to keep the projects on track. In mid-April, for example, Malaysia announced that a major BRI rail project, put on hold by the government after last year’s election, would now go ahead “after renegotiation.” According to media reports, the costs of construction were reduced by as much as one-third. Other BRI countries will probably also ask for debt forgiveness and write-offs, the costs of which will ultimately be borne by Chinese savers.

The BRI may well have additional hidden costs for China down the road. For starters, it is extraordinarily difficult to make money on infrastructure projects. There is a widespread belief that infrastructure investment powers economic growth, but the evidence for this is weak. In fact, China itself built much of its current infrastructure after its growth had taken off. In the 1980s and 1990s, for example, China grew much faster than India despite having a shorter railway network. According to the World Bank, in 1996 China had 56,678 kilometers (35,218 miles) of rail lines, and India had 62,915 kilometers. Chinese growth was not jump-started by infrastructure, but by reforms and human capital investments. If growth fails to materialize in BRI countries, Chinese companies may end up bearing the costs.

Furthermore, many of China’s BRI partner countries are risky – including Pakistan, a major recipient of investments under the scheme. In addition to its high political, economic, and default risks, the country also scores poorly on education indicators. According to one report, Pakistan ranked 180th among 221 countries in literacy. This is a potential red flag for Chinese investments in Pakistan, because research suggests that investments in physical infrastructure promote growth only in countries with high levels of human capital. China itself benefited from its infrastructural investments because it had also invested heavily in education.

Nor should the BRI be compared to the Marshall Plan, the US aid program to help rebuild Western Europe after World War II, as an example of how large-scale investment projects can boost growth. The Marshall Plan was so successful – and at a fraction of the BRI’s cost – because it helped generally well-governed countries that had been temporarily disrupted by war. Aid acted as a stimulus that triggered growth. Several of the BRI countries, by contrast, are plagued by economic and governance problems and lack basic requirements for growth. Simply building up their infrastructure will not be enough.

Finally, the BRI will probably further strengthen China’s state sector, thereby increasing one of the long-term threats to its economy. According to a study by the American Enterprise Institute, private firms accounted for only 28% of BRI investments in the first half of 2018 (the latest data available), down by 12 percentage points from the same period of 2017.

The BRI’s massive scale, coupled with the lack of profitability of China’s state sector, means that projects under the scheme may need substantial support from Chinese banks. BRI investments would then inevitably compete for funds – and increasingly precious foreign-exchange resources – with China’s domestic private sector, which is already facing a high tax burden and the strains of the trade war with the US.

Moreover, Western firms, an important component of China’s private sector, are retreating from the country. Several US companies, including Amazon, Oracle, Seagate, and Uber – as well as South Korea’s Samsung and SK Hynix, and Toshiba, Mitsubishi, and Sony from Japan – have either scaled down their China operations or decided to leave altogether. Partly as a result, US foreign direct investment in China in 2017 was $2.6 billion, compared to $5.4 billion in 2002.

This is a worrisome development. Through the BRI, China is building ties to some of the world’s most authoritarian, financially opaque, and economically backward countries. At the same time, a trade war, an ever-stronger state sector, and protectionism are distancing China from the West.

China has grown and developed the capacity to undertake BRI projects precisely because it opened its economy to globalization, and to Western technology and knowhow. Compared to its engagements with the West, the BRI may entail risks and uncertainties that could become problematic for the Chinese economy. As the Chinese economy slows down, and its export prospects are increasingly clouded by geopolitical factors, it is worth rethinking the pace, scope, and scale of the BRI.

Yasheng Huang is International Program Professor in Chinese Economy and Business and Professor of Global Economics and Management at the MIT Sloan School of Management.

Is Gold About To Get Whacked?

Gold has spent the past couple of weeks steamrolling technical barriers and reviving the spirits of long-suffering gold bugs.
But markets don’t move in a straight line. Bull runs (if that’s what this is) have stomach-churning corrections along the way – usually just as everyone concludes that the good times will roll on forever.
321gold’s Bob Moriarty, a consistent voice of reason in the precious metals space, explained this to his readers yesterday:
Gold bulls are coming out of hibernation with even billionaires talking about how much they like gold. That tends to happen just before a correction. The gold bulls get frothy around the mouth; speculators pour money into gold contracts just in time to get whacked once more so they can whine about how gold and silver are manipulated and no one saw it coming. 
I’ve written a number of times about the importance of understanding bullish sentiment.  
I find the DSI of Jake Bernstein the single most valuable indicator I use. On both Thursday and Friday last, the DSI for gold hit 94. That doesn’t suggest a major high marking a top for the next 200 years but it does say caution would be merited.  
Too many people turned bullish all of a sudden. 
The COTs agree. Gold sentiment is excessive.

Speaking of the COTs (which show the structure of the gold futures market), they are indeed excessive. The past few weeks have seen an epic buildup of speculator longs and commercial shorts:

Gold COT gold whacked

Here’s the same data in graphical form, with the speculators in gray and the commercials in red:

Gold COT chart gold whacked

Since the speculators are usually wrong at big turning points and the commercials are usually right, the paper market set-up is extremely bearish. As Moriarty says, this doesn’t mean an end to the bull market, but it might mean a several-week-long pause.

As for how to play this kind of squiggle, that’s easy. Keep doing what you should have been doing all along, which is dollar-cost-averaging into gold and silver bullion and well-chosen mining stocks. The fundamentals that will eventually drive precious metals and other real assets higher will continue their long march towards an era-ending financial crisis. And gold will track this evolution — with the occasional correction.

Ray Dalio Is Kinda, Sorta, Really Wrong, Part 3

By John Mauldin

Two weeks ago I started a mini-series in the form of an open letter responding to a series of essays by Ray Dalio, the founder of Bridgewater Associates. I wrote here and here that he was kinda, sorta wrong in Why and How Capitalism Needs to Be Reformed, Parts 1 and 2 but really, really wrong in It’s Time to Look More Carefully at ‘Monetary Policy 3 (MP3)’ and ‘Modern Monetary Theory,’ in which he basically endorsed MMT. Today I continue my response.

If reader feedback is any indication, you are also passionate about this conversation. Last week’s letter generated many long, thoughtful reader comments. Clearly, it is not just Ray and I who are worried about the country’s future direction. I find that encouraging. A national conversation is precisely what we need in these serious times.

As noted, Ray has done us all a service by pointing out some rarely mentioned elephants in the room (some tinged with pink). We discuss various parts but seldom the entire creature. By that, I mean the rapidly growing potential for “progressive” control of both Congress and the White House. This stems from differences between haves and have-nots, between the protected and unprotected, combined with a desire to have government solve our society’s perceived ills.

So let’s pick up where we left off last week.

Dear Ray

In Part 1 of this letter I mostly agreed with you about the significant wealth and income disparities in the US today. And then in looking for your hope of a bipartisan commission that can deal with the problems, I simply pointed out that such commissions have rarely worked in the past and would be even more unworkable given today’s partisan, ideological divide.

Now I want to review two of your suggested solutions. Since this is an open letter and others will be reading it, let me quote directly from that section:

1. Leadership from the top. I have a principle that you will not effect change unless you affect the people who have their hands on the levers of power so that they move them to change things the way you want them to change. So there need to be powerful forces from the top of the country that proclaim the income/wealth/opportunity gap to be a national emergency and take on the responsibility for reengineering the system so that it works better.

4. Redistribution of resources that will improve both the well-beings and the productivities of the vast majority of people. As an economic engineer, naturally I think about how money might be obtained from taxes, borrowing, businesses, and philanthropy, and how it would flow to affect prices and economies. For example, I think about how a change in personal tax rates might occur and how changes in them relative to corporate tax rates would affect how money would flow, and how changes in tax rates in one location relative to another location would drive flows and outcomes in them. I also think a lot about how the money raised will be spent—e.g., how much will be spent on programs that will improve both social and economic outcomes, and how much will be redistributive. Such decisions would of course be up to the people on the bipartisan commission and the leadership to decide and are way too complicated an engineering exercise for me to opine on here. I can, however, give my big picture inclinations. Above all else, I’d want to achieve good double bottom line results. To do that I’d:

b. Raise money in ways that both improve conditions and improve the economy’s productivity by taking into consideration the all-in costs for the society (e.g., I’d tax pollution and various causes of bad health that have sizable economic costs for the society).

c. Raise more from the top via taxes that would be engineered to not have disruptive effects on productivity and that would be earmarked to help those in the middle and the bottom primarily in ways that also improve the economy’s overall level of productivity, so that the spending on these programs is largely paid for by the cost savings and income improvements that they create. Having said that, I also believe that the society has to establish minimum standards of healthcare and education that are provided to those who are unable to take care of themselves.

A National Emergency?

Let me highlight in particular one sentence from the above with my own bolded emphasis.

So there need to be powerful forces from the top of the country that proclaim the income/wealth/opportunity gap to be a national emergency and take on the responsibility for reengineering the system so that it works better.

First, let’s ignore the fact that many would not agree that the income and wealth gaps rise to the level of “national emergency.” Let’s for the moment assume the levers of power you mention would pass to a majority who would in fact see it that way and want to do something about it.

Using suppositions and hypotheticals, this is not all that far-fetched. It is entirely possible next year’s elections will deliver a Democratic Congress and White House that would consider these gaps a national emergency. A recession in early 2020 would raise those odds. And if not in 2020 then by 2024 it might even be more plausible.

That said, let’s look at what your proposals to raise taxes and redistribute income might actually look like.

First, the on-budget national deficit for this year will be in the $1 trillion range and when you add in the off-budget deficits total debt could easily rise by $1.3 trillion or more. That’s just in 2019 and it won’t get much better in 2020.

Total US government debt is now $22.4 trillion. We could easily see the national debt at $25 trillion before the next inauguration. That doesn’t include the $3 trillion+ state and local governments owe, nor some $100 trillion of unfunded federal liabilities or $6.7 trillion of unfunded state and local government pensions (data from The US Debt Clock.)

Even a garden-variety recession will blow those deficit numbers out of the water. If revenue falls and expenses rise as they did in the last two recessions, a $2-trillion deficit is more than likely. The national debt would almost certainly reach $30 trillion within a few years.

Interest on the national debt is budgeted at $389 billion for fiscal 2019. Assuming similar interest rates in the future, that cost will rise to almost $550 billion on a $30-trillion national debt—almost as much as the defense budget.

Essentially, we would need to raise taxes by $1 trillion along with some considerable budget cutting just to balance the budget before we get into any redistribution of income. But let’s set aside that for the moment and talk about raising taxes enough to fund the income redistribution programs you would like to see.

In your words, you want to increase taxes “from the top” and earmark those increases to help those in the bottom and middle, somehow “engineering” those taxes to have no effect on productivity. Let’s look at some real-world numbers of what the top income earners pay in taxes, courtesy of the Tax Foundation.

Some 68% of all income tax revenue comes from the top 10% of income earners.
That’s fair enough, I suppose. Interestingly, the top 1/10 of 1% of income tax payers pay more than the bottom 50% combined.  

Source: Bloomberg

Here’s a chart from that same Bloomberg article that breaks it down by the different percentiles and the percentage of total income taxes they paid. The top 1% paid a greater share of individual income taxes (37.3%) than the bottom 90% combined (30.5%).

Source: Bloomberg

Now, let’s go back to the Tax Foundation data. This is part of a larger and more detailed analysis at the website.

Note the top 10% of income tax payers paid approximately $1 trillion in income taxes. When you say that you want to “raise more from the top via taxes” let’s see what that means. Giving $3,000 to each of the 70 million tax filers in the bottom half would require $210 billion. You would also need the government to have the systems and people to do this which would require at least another $20 billion or so, and that may be giving a lot of credit to government efficiency.

So, getting an additional $230 billion from the top 10% of income earners would mean giving that group a roughly 23% across-the-board tax increase. That’s before we do anything about the national deficit.

Note also, to do this you wouldn’t be taxing only millionaires and the rich. To get in the top 10% of income payers you merely need to be making ~$140,000 a year. The cut-off for the top 5% is approximately $200,000.

So, let’s say we ask only the top 5% of income earners to fund this new spending. To get that same $230 billion you would need to raise their taxes by approximately 30%, give or take.

Want to do it just from the top 1%? You would need to raise their tax rates by 50%. Again, that is before we even begin to reduce the deficit.

And when you say that you want to engineer these taxes not to affect productivity, I am scratching my head trying to figure out precisely how to do that. The marginal tax rate for incomes over $500,000 is 37%. So if you wanted to get that $230 billion from the wealthiest taxpayers, their top marginal tax rate would rise to approximately 56%. Add state income tax and the rates could easily get to 60% or more in some states.

And do we really want to raise taxes either during or just after recession? Seriously? Not exactly a prescription to boost the economy and productivity.

Adding a little more complexity, there is a difference between the top 10% of earners and the top 10% of taxpayers. To be a top-10% earner, you merely have to make $118,000. In October of 2018, the Economic Policy Institute published a study showing that the top 1% reached the highest wages ever in 2017. But when you read all those stories about the 1%—or even the top 5% or 10%—how much money do you need to pull in to be in one of those groups?

Source: Investopedia

We already have a system where somewhere between 40–47% of taxpayers literally pay no income tax. (They do, of course, pay Social Security and Medicare taxes on their wage incomes.) How much more progressivity do we need in order to be “fair,” whatever that is?

It is one thing to simply state that you want to engineer taxes in order to redistribute income to the lower half and doing that while not hurting productivity. But it is another thing entirely to lay out exactly how much money is needed to be able to make the system more equitable.

Is $3,000 per family enough? Do you need twice that much? Where does the money come from and how much would taxes have to be raised? It is one thing to say that we should tax pollution (if it would help bring down pollution, I might even find myself in favor of that—pollution has a social cost) but it is another thing to say what constitutes pollution and how much. Automobile emissions? Do you raise taxes on the bottom 50% for their cars? It gets complicated real quick.

Louisiana Sen. Russell Long (Senate finance committee chair from 1966 to 1981) is credited with saying, “Most people have the same philosophy about taxes. Don’t tax you, don’t tax me, tax that fellow behind the tree.” If the top 10% are the “fellow behind the tree” then you must raise their taxes substantially in order to collect any meaningful amount of money. Or else move down the scale and raise taxes on many more people.

The real emergency? Trillion-dollar deficits that will grow to $2-trillion deficits during the next recession. You could literally double taxes for the top 10% and barely balance the budget today, before any recession. That is how far out of balance our system has gotten.

And all this is before we have paid for climate change or free college or any of the progressive left’s other proposals, along with income redistribution. And to be fair, Republicans are no longer concerned about multi-trillion-dollar deficits, either. They just have different spending priorities.

You want bipartisanship, Ray? It seems to me that deficit spending pretty much gets everyone’s support. Not exactly the kind of bipartisan cooperation that I find helpful.
A Little Coordination, Please

Finally, you call for coordinated monetary and fiscal policies. Quoting:

5. Coordination of monetary and fiscal policies. Because money is clogged at the top and because the capacity of central banks to ease enough to reverse the next economic downturn is limited, fiscal policy will have to be more coordinated with monetary policy, which can happen while maintaining the Federal Reserve’s independence. If done well, this will both stimulate economic growth and reduce the effects that quantitative easing has on increasing the wealth gap by shifting money and credit into the hands of those who have a higher propensity to spend from those who have a higher propensity to save and from those who need it less to those who need it more.

Here and elsewhere, you acknowledge that quantitative easing did in fact make the income and wealth gap worse. So you call for fiscal policy to do the income redistribution that you feel necessary.

When I read Parts 1 and 2, I came to this section and left a little bit mystified. If you didn’t want to use quantitative easing, and the realities of our national debt and growing deficits being what they are, how much would taxes have to be raised?

And then you answered that question when you wrote It’s Time to Look More Carefully at ‘Monetary Policy 3 (MP3)’ and ‘Modern Monetary Theory’. And it is at this point that you went from being kinda, sorta wrong to being really, really, really wrong.
[To be continued…]

Next week we will look at various scenarios for the future (going out about 10 years), what their various outcomes and costs might be, and how we can deal with the massive debt and deficits, not to mention new spending programs. I am actually going to propose my own solution that I think will put us back on track.

Unfortunately, paraphrasing Winston Churchill, the US will likely try everything else before we finally do the right thing.

Boston, New York, and Puerto Rico

I am enjoying the beautiful weather here in Puerto Rico. Later this month I’ll be visiting Boston and New York, then on July 4 I fly back to Puerto Rico working on what will likely be Part 5 of this series. It may or may not be the final part. I’ll just see how far I get.

Shane has developed an interesting new hobby. One of our guest bedrooms has an open outdoor alcove. There was really nothing in it but weeds when we moved in. She has cleared it out and made a nice little garden. The interesting thing is that she planted something that to me looks like a weed but monarch butterfly caterpillars evidently consider those weeds to be ambrosia. So now Shane is growing cocoons and raising monarch butterflies. It is really pretty cool to watch them emerge from the cocoon. And theoretically, they’ll migrate back next year, since they supposedly return where they were born to start the process all over again. We’ll see how that theory works next year. But right now, it’s just a lot of fun.

And with that I will hit the send button. I feel like there’s more to be said on taxes. I know that Elizabeth Warren is talking about a wealth tax. I’m not quite certain how that would work on illiquid assets. It would certainly raise a lot of money but imagine the chaos.

On that cheerful thought, let me wish you a great week!

Your thinking about taxes in the future analyst,

John Mauldin
Chairman, Mauldin Economics

Deeper in the red

As growth slows, the spectre of local-government debt looms once more

The central government urges spending, but regions are burdened by debt

A STATUE OF a golden bull, poised to charge, stands outside the headquarters of Xiangtan Jiuhua, a government-owned company that funds much of Xiangtan’s infrastructure investment. It has seen better days: the gold paint is flaking and the torso is cracked. That makes it a fitting symbol for public finances in the sprawling prefecture of 3m people in central China, and scores of similar cities across the country, where the ambitions of local officials have collided with heavy debt loads.

Concerns about local balance-sheets in China have recurred over the past decade. Recently they have come into sharp focus again. Attempts to clean up local debts have not worked. And borrowing looks set to rise as the trade war rumbles on: China wants its provinces and cities to prop up growth by building roads and railways.

At just 38% of GDP, less than half the average in advanced economies, government debt in China might seem under control. But that misses much of what is happening. Local governments have long relied on off-balance-sheet debt to solve a perennial policy quandary.

They are responsible for about 85% of public expenditures, yet command only 50% of revenues. Moreover, central authorities make it hard for them to borrow formally, hoping to limit their profligacy. So they have created entities such as Xiangtan Jiuhua, referred to as “local-government financing vehicles” (LGFVs). These are registered as companies. But creditors know—or, rather, assume—that the state stands behind them.

At last count China had 11,566 LGFVs. According to the IMF, when they are factored in, government debt rises to about 70% of GDP. This is worrying for three reasons. The first is the trajectory, with LGFV debts more than tripling over the past decade. The second is their opacity. Banks and bond investors think they must be safe, but even government auditors struggle to get a full picture of what is owed and where the money is going. Third, it is China’s poorer inland provinces that are most reliant on LGFVs. China International Capital Corp (CICC), a big domestic brokerage, has referred to them as a “grey rhino”: a risk that, unlike a “black-swan” event, is obvious but easily ignored.

The government, to be fair, does not have its eyes closed. It has been trying to limit LGFV borrowing since 2010. Regulators have also sought to ease financial constraints on local governments, most notably through a giant debt swap in which local governments exchanged trillions of yuan in LGFV bonds for official bonds charging lower interest.

But big risks remain. LGFVs are becoming less able to pay back their debts. Their operating incomes cover only about 40% of their obligations due within one year, according to CICC. For a normal company, that would spell trouble. Moreover, local governments remain addicted to them. Stripping out the bond swap, LGFV borrowing rose at 20% annually over the past five years, far outpacing overall debt growth.

Last year China seemed to be getting serious about crimping off-balance-sheet borrowing. It wielded its most potent weapon: permitting defaults. On 15 occasions LGFVs failed to repay loans on schedule, according to Fitch, a ratings agency. That spooked markets. LGFVs’ interest rates went up, and their bond sales slowed.

The impact was palpable. Local governments had less cash to spend, and Xiangtan was one of the casualties. It was forced to halt work on a highway around the city, which now stops abruptly at hoardings plastered in yellowing propaganda posters. A dirt track takes the place of an on-ramp. Zhou Juzhen, a retiree, has planted a small garden of chili peppers and green beans at its edge. “I wish the construction would resume,” she says. “It would be much more convenient living next to a big road.”

The slowdown in building has played out on a national level. Infrastructure investment was just 1.6% higher in May than a year earlier, a big comedown from the previous double-digit norm.

Worried about slowing GDP growth, on June 10th the central government opened the door for provinces and cities to increase spending. It urged them to issue special bonds for big projects such as modernising power grids. Many think local governments will again turn to a familiar friend. “Faith in LGFVs is seemingly on the rise again!” exclaimed analysts with ICBC, a major Chinese bank.

But the government may find that last year’s stringent debt-control campaign has made provinces and cities more reluctant to open their wallets. Local officials know that once growth stabilises, they are likely to face pressure to deleverage again, says Houze Song of the Paulson Institute, a think-tank in Chicago. There is a more radical option: the central government could in effect fund LGFVs directly. China Development Bank, a giant state-owned lender, has started to offer long-term loans to LGFVs to replace their short-term debts. This is similar to the bond swap, but allows LGFVs to get cheaper funding without testing the market.

Yet there are obvious drawbacks. For one thing, it puts the central government on the hook for LGFV liabilities. And if the programme is rolled out nationwide, efforts to get them to operate more responsibly would come to naught. So far the government has reportedly tested swaps in a few places. Xiangtan is one, not least because the prefecture includes the birthplace of Mao Zedong. China’s leaders do not want to see defaults here, of all places.

At a river that bisects Xiangtan, giant pilings have been sunk to support a bridge. But the site has been abandoned, another victim of the local cash crunch. Fu Weijun, who works in a nearby steel mill, walks along its banks before his shift begins. It is just a matter of time before the bridge is completed, he says. “Western countries change too often. We can stick to the same path, no matter what.” That confidence might be shaken in the coming years.

The rich world is enjoying an unprecedented jobs boom

Capitalism’s critics are yet to notice

EVERYONE SAYS work is miserable. Today’s workers, if they are lucky enough to escape the gig economy and have a real job, have lost control over their lives. They are underpaid and exploited by unscrupulous bosses. And they face a precarious future, as machines threaten to make them unemployable.

There is just one problem with this bleak picture: it is at odds with reality. As we report this week, most of the rich world is enjoying a jobs boom of unprecedented scope. Not only is work plentiful, but it is also, on average, getting better. Capitalism is improving workers’ lot faster than it has in years, as tight labour markets enhance their bargaining power. The zeitgeist has lost touch with the data.

Just the job

In America the unemployment rate is only 3.6%, the lowest in half a century. Less appreciated is the abundance of jobs across most of the rich world. Two-thirds of the members of the OECD, a club of mostly rich countries, enjoy record-high employment among 15- to 64-year-olds. In Japan 77% of this group has a job, up six percentage points in six years. This year Britons will work a record 350bn hours a month. Germany is enjoying a bonanza of tax revenue following a surge in the size of its labour force. Even in France, Spain and Italy, where joblessness is still relatively high, working-age employment is close to or exceeds 2005 levels.

The rich-world jobs boom is partly cyclical—the result of a decade of economic stimulus and recovery since the great recession. But it also reflects structural shifts. Populations are becoming more educated. Websites are efficient at matching vacancies and qualified applicants.

And ever more women work. In fact women account for almost all the growth in the rich-world
employment rate since 2007. That has something to do with pro-family policies in Europe, but since 2015 the trend is found in America, too. Last, reforms to welfare programmes, both to make them less generous and to toughen eligibility tests, seem to have encouraged people to seek work.

Thanks to the jobs boom, unemployment, once the central issue of political economy, has all but disappeared from the political landscape in many countries. It has been replaced by a series of complaints about the quality and direction of work. These are less tangible and harder to judge than employment statistics. The most important are that automation is destroying opportunities and that work, though plentiful, is low-quality and precarious. “Our jobs market is being turned into a sea of insecurity,” says Jeremy Corbyn, leader of Britain’s Labour Party.

Again, reality begs to differ. In manufacturing, machines have replaced workers over a period of decades. This seems to have contributed to a pocket of persistent joblessness among American men. But across the OECD as a whole, a jobs apocalypse carried out by machines and algorithms, much feared in Silicon Valley, is nowhere to be seen. A greater share of people with only a secondary education or less is in work now than in 2000.

It is also true that middle-skilled jobs are becoming harder to find as the structure of the economy changes, and as the service sector—including the gig economy—expands. By 2026 America will have more at-home carers than secretaries, according to official projections. Yet as labour markets hollow out, more high-skilled jobs are being created than menial ones.

Meanwhile, low-end work is becoming better paid, in part because of higher minimum wages.

Across the rich world, wages below two-thirds of the national median are becoming rarer, not more common.

As for precariousness, in America traditional full-time jobs made up the same proportion of employment in 2017 as they did in 2005. The gig economy accounts for only around 1% of jobs there. In France, despite recent reforms to make labour markets more flexible, the share of new hires given permanent contracts recently hit an all-time high. The truly precarious work is found in southern European countries like Italy, and neither exploitative employers nor modern technology is to blame. The culprit is old-fashioned law that stitches up labour markets, locking out young workers in order to keep insiders in cushy jobs.

Elsewhere, the knock-on benefits of abundant work are becoming clear. As firms compete for workers rather than workers for jobs, average wage growth is rising, pushing up workers’ share of the pie—albeit not as fast as the extent of the boom might have suggested. Tight labour markets lead firms to fish for employees in neglected pools, including among ex-convicts, and to boost training amid skills shortages. American wonks fretted for years about how to shrink disability-benefit rolls. Now the hot labour market is doing it for them. Indeed, one attraction of the jobs boom is its potential to help solve social ills without governments having to do or spend very much.

Nonetheless, policymakers do have lessons to learn. Economists have again been humbled. They have consistently underestimated potential employment, leading to hesitant fiscal and monetary policy. Just as their sanguine outlook on finance in the 2000s contributed to the bust, so their mistaken pessimism about the potential for jobs growth in the 2010s has needlessly slowed the recovery.

The left needs to accept that many of the criticisms it levels at capitalism do not fit the facts.

Life at the bottom of the labour market is not joyous—far from it. However, the lot of workers is improving and entry-level jobs are a much better launch pad to something better than joblessness is. A failure to acknowledge this will lead to government intervention that is at best unnecessary and at worst jeopardises recent progress. The jobs boom seems to be partly down to welfare reforms that the likes of Mr Corbyn have vociferously opposed.

The right should acknowledge that jobs have boomed without the bonfire of regulations that typically forms its labour-market policy. In fact, labour-market rules are proliferating. And although the jury is out on whether rising minimum wages are harming some groups, such as the young, they are not doing damage that is large enough to show up in aggregate.

The jobs boom will not last for ever. Eventually, a recession will kill it off. Meanwhile, it deserves a little appreciation.

Technology platforms are losing control

The land grab for assets across media and food delivery shows their power is under threat

John Gapper

Everything Amazon does has an impact and by leading a $575m funding round for the British food delivery company Deliveroo, it hurt shares in the latter’s rivals. The deal gives Amazon a stake in both delivery and preparation through “dark kitchens” in which some Deliveroo meals are made.

It is an arresting move — who knew that a company that started by selling books online would end up as the part owner of kitchens? — but it is characteristic of Amazon’s roaming instinct. It has moved from online retailing to running warehouses, publishing books, and making films and television shows for its Prime streaming service.

More surprising is the degree to which other technology groups are following Amazon in becoming vertically integrated. Instead of sticking to the business of running platforms, they are creating their own content and buying assets to bolster themselves.

Netflix is close to a 10-year deal with Pinewood to lease studio facilities in the UK, while WeWork is raising $2.9bn for a property fund to buy offices that it will lease. Apple is spending hundreds of millions on video game development for its Arcade service, pushing Microsoft and Sony to form a tentative alliance to defend their games franchises.

Integration is also developing in the other direction, with brands trying to find a path to sell directly to consumers, rather than through retailers. Edgewell Personal Care, owner of the Wilkinson Sword and Schick men’s razor brands, this month acquired Harry’s, the razor subscription business, for $1.4bn. Investors took fright and Edgewell shares dropped to a 10-year low.

A sudden move to integrate by buying a supplier or distributor suggests vulnerability — why take the risk of doing it unless you fear being shut out? Controlling the supply chain from parts to production, marketing and distribution secures autonomy. But it also requires capital investment and is a challenge for any company to manage.

So far, technology companies have not been punished by shareholders for pursuing integration. Amazon is trusted to handle acquisitions, such as that of Whole Foods, the US supermarket chain, and Netflix’s huge investment in original production has not alienated investors. Their critics instead wonder whether they are acquiring too much power over markets.

Lina Khan, a fellow at Columbia Law School, has attacked Amazon for exploiting the gaps in US competition law, arguing that it has “marched toward monopoly by singing the tune of contemporary antitrust”. Ms Khan singles out its vertical integration, which is treated leniently by US authorities.

Amazon has expanded across its supply chain, into retailing and other services, and controls production and distribution assets, now including a stake in Deliveroo. This enables it to offer its own goods and services to Prime subscribers, as well as boosting its bargaining strength with other suppliers.

This contrasts with the original approach of platforms such as Google and Facebook, which focused on building networks while relying on others for content. Uber and Lyft have a similar strategy — creating ride services by linking drivers to customers, rather than by owning and operating taxis.

But as platforms mature, vertical integration is growing. The meal delivery industry is one example, moving from a traditional platform approach to one in which companies such as Deliveroo and UberEats run kitchens. Deliveroo is a pioneer with its Editions kitchen hubs, where meals are prepared by restaurants and caterers.

The threat is that someone else builds such facilities, limiting the power of any platform: Travis Kalanick, Uber’s co-founder, last year acquired a $150m controlling stake in the parent of CloudKitchens, which does so. Restaurants at its facilities in Los Angeles cook meals that are delivered by platforms including Uber Eats and GrubHub.

A similar battle is occurring in video games, with both Apple and Google setting up new streaming services. The ideal for these companies would be to have games developers flock to their platforms and pay them fees, but competition is such that they cannot rely on that. Apple is taking the same path as Netflix — investing in production to secure exclusive rights.

This makes technology companies more like media businesses that own distribution and content. Vertical integration was limited in the 1970s and 1980s by rules barring US television networks from controlling too much production but has grown. Mergers such as Comcast’s acquisition of NBC Universal have been approved by regulators.

The shift to integration by technology companies requires close scrutiny by competition authorities, as Ms Khan suggests. But it is also an expression of weakness — platforms that used to be able to dictate terms to providers of content and services now feel the need to secure assets, rather than risk being shut out by others.

If so, investors may be treating the land grab across retailing, media and other industries too complacently. They are accustomed to Amazon and others being able to dominate, but this burst of dealmaking tells a story of technology platforms losing control.