Digging a Hole to China

By John Mauldin



Good news: The trade war is over. No, it’s getting worse. Or maybe it is ending but it could start again tomorrow.

Confused? All of the above were true at various points in the last few weeks. Markets bounced around in reaction. And we are still no closer to knowing how it will all end.

Needless to say (but I’ll say it anyway) this uncertainty has a chilling effect on business investment. If you are considering whether to spend billions on new manufacturing capacity, opening stores, or hiring new employees, you need to know your costs and have reliable supply chains. That is all but impossible with tariff rates going up, down, or sideways depending on the day.

The saddest part is that the world trading system does, indeed, have serious problems, many of which emanate from China. We need to fix them. I fully support that goal. I am glad we have an administration that takes Chinese behavior seriously. But the tariff strategy is making the situation worse, not better, and the focus on trade deficits is entirely misplaced.

This will be a potentially incendiary letter, but sometimes things just need to be said. But first, I want to call attention to one of our gifted young writers at Mauldin Economics, Jared Dillian, and give you a chance to read him for free. That’s because, like the old potato chip commercial, I bet you can’t eat just one.

Jared writes a daily newsletter called The Daily Dirtnap. When I first heard the letter name, I thought, “Really?” But that was me not getting Jared’s Gen X humor. When I first started reading him, I appreciated the insights he was giving me. My dad would say, “Jared’s about half a bubble off dead center.” He just sees things differently. Then I realized that’s not entirely true. He’s a full generation different than me with a gift for writing and explanation and a wicked, brilliant instinct for the markets.

I urge you to try The Daily Dirtnap. For those of us of an older generation (ahem), you might need to have Google handy, as there will be some phrases and acronyms you’ve never heard of. That’s part of the fun and the learning process. It's just three pages a day—you’re through it in well under 10 minutes, but you’ll be thinking about what you’ve read throughout the day. Click here to learn more.
 

China and Intellectual Property

I’m going to start with a story that might fit better in the middle of the letter, but I suspect some readers will not get there. They will read my rather strong free trade biases and feel that I don’t recognize the problem China represents. Nothing could be further from the truth. While I am not happy with the way that Trump is conducting the “trade war,” I’m glad he is doing something about it.

There is a drug produced in China that works well on strokes and numerous other less devastating medical issues. It is derived from pig pancreases or human urine. It isn’t approved in the US due to justifiable regulatory issues, but it is used in Europe as well as China. It is quite expensive, both to produce and buy.

A small biotechnological firm in the US has the technology to synthesize this drug without using pancreases or urine. This would be safer and lower-cost. The Chinese company agreed to pay the US company $4.5 million upon the meeting of certain guidelines and then to purchase the drug from the company at a fraction of its Chinese production cost. For the US company, having the main distributor buy their drug without having to set up the distribution process was a good deal.

The US company spent a great deal of money and met their guidelines, providing the Chinese company with everything required under the contract. The Chinese company then said, basically, “We need to see the actual process and cell lines in order to verify the process.”

That means, in essence, “Give us your intellectual property.” With that knowledge, the Chinese company would no longer have needed the US company. When the US company had to tell shareholders that the deal fell through because they (correctly) told the Chinese company to go pound sand, their stock value plummeted. The Chinese company knew that would happen and had bet the Americans would fold. In this case, they didn’t.

This happens many times every year with Chinese companies on a hundred different fronts. Standard practice. It is why the US and other countries push back against the theft of intellectual property by Chinese companies.

Let me go just a little bit further. This is not just some widget or a better way to make a phone. This is a drug that, if it were introduced into the United States and the developed world, would allow far quicker treatment for stroke victims and save thousands if not tens of thousands of lives every year.

This is just a small part of the cost of Chinese intellectual property theft.

Binary Thinking

I have long said that protectionism is the single biggest threat to global prosperity. As we were approaching the 2001 recession, there were calls for trade protectionism. I wrote at the time that the single most destructive economic force that can be unleashed on the United States would be serious trade protectionism.

Unfortunately, I have to keep saying that because politicians keep trying it.
 
What Trump is doing right now is not new. I wrote this back in 2007.

That is the growing mood in Congress for passing trade protection legislation that could start a series of retaliatory actions around the world that could result in a trade war, a la Smoot-Hawley in the 1930s.

Stephen Roach, chief economist at Morgan Stanley, writes a rather chilling description of his recent testimony before the Senate Finance Committee. He noted that as he entered the room, he looked up and saw a picture of Senator Reed Smoot on the walls, as Smoot was a former chair of the committee and the co-sponsor of the Smoot-Hawley Tariff Act of 1930, largely responsible for the Great Depression.

At the hearing, it was clear that a bi-partisan effort is getting ready to pass legislation that would punish China for the large trade deficit we have with that nation.
 

As I recall, it was Democratic Sen. Chuck Schumer and Republican Sen. Lindsey Graham who led the way worrying about trade deficits, proving mainly that neither of them knew anything about trade deficits. As we will see in a bit, trade deficits are not the issue. Fortunately, that effort fizzled, though I suspect it helped set up the 2008 fireworks.

Politicians of all parties love free trade in theory. Its benefits are clear, but they are also unevenly distributed. Which I admit is a problem.

As long as we have sovereign national governments, goods will face obstacles and delays getting across borders. We can’t have truly “free trade” unless we eliminate borders, which of course creates other problems. (Think of the US as a free trade zone. Would we be nearly as prosperous if we had to negotiate every little trade deal between various states?)

Countries that trade with each other need fair and reasonable rules governing it, and both sides must enforce the rules. Obviously, this is complicated in a modern economy. That’s one reason trade agreements take so long to negotiate. And of course, there will always be squabbles and disputes. But generally open trade is possible, as we see in blocs like the European Union and NAFTA. It works because all sides are committed to making it work.

Problems occur when a country flouts the rules or enforces them selectively, as China does. I’ve often talked about China’s rapid entry into the advanced world’s economy. In less than a few generations it went from subsistence farming to modern industry. This happened because the US and others agreed to let their domestic businesses trade with China on favorable terms.

China was supposed to reciprocate with similar terms of its own. It pretended to, but hasn’t been thorough or consistent. This is most evident in intellectual property. The Chinese government routinely extracts (or steals) trade secrets from foreign businesses that wish to operate in China. Software code, drug formulas, and other information then finds its way to Chinese companies that shamelessly copy it.

Again, this is nothing new. The same thing happened years ago when Chinese merchants pirated all manner of Western consumer goods. More recently they’ve done the same for intangible technology and sent it into overdrive. And the Chinese government does nothing to stop it.

Talks to resolve these and other problems have been fruitless. Beijing agrees to changes then fails to implement them, and gets away with it because the US and other Western democracies have these inconvenient things called “elections.” China’s rulers know they can just wait out the clock until we get a new leader with different priorities.

The Trade Deficit Is Not a Scorecard

 
Give Trump credit for at least recognizing the problem and trying to do something about it. Unfortunately, he has some odd ideas about what “winning” looks like. Furthermore, he gets bad advice from so-called “economists” like Peter Navarro.
 
I deleted half this letter which was basically an exposé on Peter Navarro who I think is the most dangerous man in the Trump administration, if not the country. I know he has a Harvard PhD, but I think William Buckley had it largely right when he said better to be ruled by 2,000 random names from the phone book than by professors from Harvard.

We see this in the president’s trade deficit obsession. He seems to believe it is some kind of scorecard. If the US buys more from China than China buys from the US, the US is losing. That is not what it means at all. Both sides get what they want. China (or other exporters) gets cash, we get useful goods at fair prices (or we would stop buying them).

Better yet, since we own the reserve currency, we get to pay for these goods in dollars, which then return here as the Chinese or foreign recipients invest in US assets, namely our Treasury debt. That’s good for Americans. In fact, it’s critical. Our interest rates would be sharply higher, and our currency much lower, if not for the trade deficit, because US savers would have to cover the entire government debt. We don’t save nearly enough to do that.

And that is a very critical point. If other nations don’t want your currency, you can’t run trade deficits without severe economic problems. Valéry Giscard d'Estaing was right: The US has an exorbitant privilege as owner of the world’s reserve currency.

In fact, if you have the reserve currency, it is your obligation to run deficits so that the world has enough currency to conduct trade. No country south of the Rio Grande has that privilege. The Europeans kind of, sort of do. And the Japanese. The Chinese are working diligently to make the yuan a reserve currency, though they are not there yet.

If the US fails to run a real trade deficit, we will cease to have the reserve currency. It is that simple.

Bilateral Trade Balances—Whack-A-Mole?

Eliminating the trade deficit is not as easy as it may sound. Paul Kasriel sent out a note this week that I found compelling. Let me quote:

President Trump has imposed higher tariffs on US imports from Mainland China, in part, to narrow the bilateral trade deficit that the US runs with China. The president’s tariff policy appears to be working.
 
As shown in Chart 1, the 12-month cumulative US trade deficit in goods with Mainland China (the blue bars) is narrowing. For example, after a reaching a record goods deficit of $419.5 billion in the 12 months ended December 2018, the US goods deficit with Mainland China narrowed to $400.7 billion in the 12 months ended June 2019.


 
So far, so good for President Trump’s desire to see the US bilateral trade deficit with China narrow. But, I think it is fair to say that the president believes that it is in the best interest of the US to not only reduce our bilateral trade deficit with China but our trade deficit with the rest of the world as well.
 
And here, things are not moving in President Trump’s desired direction. Also shown in Chart 1 is the 12-month cumulative US trade deficit in goods with the world (the red line). Although the US bilateral goods trade deficit with China has been narrowing in recent months, the US goods trade deficit with the world widened to a record $886.0 billion in the 12 months ended June 2019.
 
This seems like a game of Whack-A-Mole. President Trump hikes tariffs on imports from one country in order to reduce the bilateral trade deficit with that country, and our trade deficits with other countries widen.

 
Again, the trade deficit is not a problem. But even if you assume it is a problem, tariffs won’t solve it so long as the government continues to run huge and growing deficits. No one in either party has any intent of even moving toward a balanced budget. Therefore, the trade deficit is going to grow—with other countries even if not China.

The US is using the wrong weapon to solve the wrong problem and harming our own economy in the process. What would work better? I believe that Trump’s choice (which candidate Clinton said she would do as well) to cancel US participation in the Trans-Pacific Partnership was a mistake. That agreement would have set up a giant free-trade zone as a counter to China, and I think at a minimum would have forced Beijing to negotiate more sincerely. TPP had more than a few problems, but they could have been fixed. But best case, it would’ve made it much easier for companies in the US to skip over China for their supply chains.

As it stands, the other TPP nations went forward without the US and are now trading with each other on more favorable terms. Thanks to TPP, Japan increasingly imports food products from Canada instead of the US.

Navarro appears not to care, and Trump appears to agree with him. And to be fair, Trump had protectionist leanings long before he met Navarro. Some of this might be happening anyway. But the combination of Trump and Navarro is proving economically catastrophic.

There has been a series of articles for the last five months pointing out that the Trump tax cuts averaged around $900 per taxpayer. Tariffs have already eaten about $800 of that tax break, essentially nullifying the benefits of the tax cuts. JPMorgan said it again this week.

We have spent two years digging a hole to China. Will we spend at least that many years refilling it? Trade wars are not easy to win.

Should we be dealing aggressively with China on its theft of intellectual property, its lack of a fair playing field, its mercantilist policies and government subsidies of companies? Absolutely. And you can insert a few expletives deleted after that absolutely.

We can start dealing one-on-one with companies that are clearly violating intellectual property and other WTO rules. Simply ban them from doing business in the US, or take away their banking privileges. WTO should classify China as a developed market in WTO, not an emerging one. Just look at pictures of Beijing and Shanghai and dozens of other cities to recognize China has emerged.

Tariffs are hurting US consumers. China is not paying those tariffs, we are, and any economist worth their salt (other than Navarro) knows it.

Get tough with China? Damn Skippy. But don’t make Americans pay for it. If you’re going to fight a trade war then don’t point the gun at yourself.

I Need a Vacation from My Vacation


I know it’s kind of a cliché, but sometimes you really do need another vacation after your vacation. Maine, Montana, and New York were absolutely fabulous. Then I came back to Puerto Rico with 400+ emails in my inbox, despite trying to deal with it while on vacation, and an extra 10 pounds. I will get my emails under control before I lose those 10 pounds but I’m working at it, or actually Shane will, as she will be feeding me fish pretty much every night.

The good news is I had a really productive time thinking about the future, not only writing but about the new things we can do for you as a reader. I think you will see some changes in the next 60 to 90 days.

And with that, I’m going to hit the send button. You have a great week and enjoy the waning days of summer…

Your starting the rest of his life/diet analyst,


 
John Mauldin
Chairman, Mauldin Economics


Trade War Escalation and Bombs

Doug Nolan


August 23 – Reuters (Se Young Lee and Judy Hua): “China said on Friday it will impose retaliatory tariffs against about $75 billion worth of U.S. goods, putting as much as an extra 10% on top of existing rates in the dispute between the world’s top two economies. The latest salvo from China comes after the United States unveiled tariffs on an additional $300 billion worth of Chinese goods… scheduled to go into effect in two stages on Sept. 1 and Dec. 15. China will impose additional tariffs of 5% or 10% on a total of 5,078 products originating from the United States including agricultural products such as soybeans, crude oil and small aircraft. China is also reinstituting tariffs on cars and auto parts originating from the United States. ‘China’s decision to implement additional tariffs was forced by the U.S.’s unilateralism and protectionism,’ China’s Commerce Ministry said…”

S&P500 futures were trading up about 0.3% in early Friday overseas trading, boosted by a somewhat stronger-than-expected PBOC renminbi “fix.” The first “Bomb” hit at 8:02 am eastern: “China to Levy Retaliatory Tariffs on Another $75B of U.S. Goods.” 8:04: “China to Resume 25% Tariffs on U.S. Autos From Dec. 15.” 8:17: “China to Impose Extra 5% Tariff on Soy Beans From Sept. 1.” 8:24: “China: Imposes 5% Tariff on U.S. Crude Oil Imports From Sept. 1.”

S&P500 futures dropped as much as 26 points (0.9%) on Chinese retaliation, news that hit two hours before Chairman Powell’s widely anticipated 10:00 am speech to open the Fed’s Jackson Hole Economic Policy Symposium. Powell’s talk was generally considered “balanced” to somewhat more dovish than expected. Markets were relieved to see no reference to “mid-cycle adjustment,” with more attention to trade and global risks. By 10:37 am, the S&P500 was back in positive territory, having fully recovered earlier (China retaliation) losses.

Presidential Bomb drops at 10:57: “As usual, the Fed did NOTHING! It is incredible that they can ‘speak’ without knowing or asking what I am doing, which will be announced shortly. We have a very strong dollar and a very weak Fed. I will work ‘brilliantly’ with both, and the U.S. will do great...”

Followed up with a precision bunker buster: “...My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?”

Cluster Bomb inbound at 10:59: “Our Country has lost, stupidly, Trillions of Dollars with China over many years. They have stolen our Intellectual Property at a rate of Hundreds of Billions of Dollars a year, & they want to continue. I won’t let that happen! We don’t need China and, frankly, would be far....”

“....better off without them. The vast amounts of money made and stolen by China from the United States, year after year, for decades, will and must STOP. Our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing..”

“....your companies HOME and making your products in the USA. I will be responding to China’s Tariffs this afternoon. This is a GREAT opportunity for the United States. Also, I am ordering all carriers, including Fed Ex, Amazon, UPS and the Post Office, to SEARCH FOR & REFUSE,....”

“....all deliveries of Fentanyl from China (or anywhere else!). Fentanyl kills 100,000 Americans a year. President Xi said this would stop - it didn’t. Our Economy, because of our gains in the last 2 1/2 years, is MUCH larger than that of China. We will keep it that way!”

Trading at 2,926 at 10:59 am, the S&P500 was down 1.8% to 2,874 just 11 minutes later (ending the session down 2.6% at 2,847). The tech-heavy Nasdaq100 dropped 2.6% in an hour.

After trading at 1.66% in early overseas trading, 10-year Treasury yields were down to 1.52% by noon eastern (almost matching the low yield since 2016). The implied yield on December Fed fund futures dropped a quick eight bps to 1.55%.

Gold was trading below $1,500 before the Bombs started falling. The shiny metal surged to $1,529 on Trump’s Cluster… (Bomb). Crude (WTI July contract) traded as high as $55.60 in pre-U.S. Friday trading, only to sink as low as $53.24. The yen rallied almost 1% to near the strongest level vs. the dollar since 2016. China’s offshore renminbi dropped 0.5% versus the dollar. The onshore renminbi traded to 7.0955, the low versus the dollar since March 2008.

Beyond the obvious major ramifications of an escalating China/U.S. trade war, expect intensifying debate regarding the mental stability of our Commander and Chief. The President’s, “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?” is especially alarming. Any suggestion that Chairman Powell is an enemy of the people crosses the line.

Having a disagreement with Federal Reserve monetary management is one thing. The President villainizing the head of the Federal Reserve in the current environment only further undermines a critical institution at a time of troubling market, economic, social and geopolitical instability. And doing so right after Powell delivered a Jackson Hole speech widely viewed as balanced and positively received by the markets does not instill confidence in the President’s rationality. That Friday’s tweets followed by a couple days the bizarre exchange over Greenland and the cancellation of the President’s state visit to Denmark is further disconcerting. And it’s worth recalling that the President threatened China with new tariffs back on August 1st over the objections of his advisors.

And so much for “good friend.” I’ll assume affixing the “enemy” label to Xi Jinping denotes serious trade war escalation. The “We don’t need China and, frankly, would be far better off without them” is frighteningly delusional. Along with the majority of Americans, I’ve believed a tougher stance with China was overdue. Yet I’ve also voiced serious concerns that the President’s abrasive and condescending approach with Beijing stood a low probability of success – with not insignificant odds of dangerous fallout. A Friday afternoon Bloomberg headline resonated: “Much Tougher to Walk Back: Investors on Trump-Tweet Stock Rout.”

As promised, Friday evening the President retaliated against China’s retaliation:

August 23 – Bloomberg (Joshua Gallu): “President Donald Trump said he’s raising tariffs further on Chinese imports in response to Beijing’s retaliation earlier in the day, deepening the impasse over the two nations’ trade policies. Duties on $250 billion of imports already in effect will rise to 30% from 25% on Oct. 1, Trump said in a series of tweets Friday after U.S. markets closed. He also said that the remaining $300 billion in Chinese imports will be taxed at 15% instead of 10% starting Sept. 1. Friday’s events marked a dramatic escalation in tensions between the U.S. and China after months of failed talks to resolve their trade dispute. It’s unclear whether negotiators will follow through with a plan to meet in Washington next month as relations have continued to sour. “China should not have put new Tariffs on 75 BILLION DOLLARS of United States product (politically motivated!),” Trump said on Twitter.”

Friday’s caustic tone and sudden escalation brought into focus the possibility that this trade war has the clear potential to spiral precariously out of control. Will President Trump move forward with measures that would force U.S. companies to retreat from China? Might the Department of Treasury intervene in the currency markets? Could the U.S. further ratchet up sanctions on Chinese companies? What impact will this latest escalation have on already shaky Chinese financial stability? How much closer is China to using its huge trove of U.S. Treasuries to make a point?

And if the day hadn’t already generated bountiful historical subject matter… With an escalating trade war, talk of currency wars and intensifying geopolitical strife, it was an ominously befitting backdrop for Bank of England governor Mark Carney’s Jackson Hole speech, “The growing challenges for monetary policy in the current international monetary and financial system.”

August 23 – Bloomberg (Brian Swint): “Mark Carney laid out a radical proposal for an overhaul of the global financial system that would eventually replace the dollar as a reserve currency with a Libra-like virtual one. Just a few months before he steps down as Bank of England governor, Carney offered his vision for the international economy at a time of sweeping change. Trade wars and the threat of currency wars are hurting growth and upending multilateral cooperation, while central banks are trapped in a low interest-rate world as they struggle to revive inflation… His most striking point was that the dollar’s position as the world’s reserve currency must end, and that some form of global digital currency -- similar to Facebook Inc’s proposed Libra -- would be a better option. That would be preferable to allowing the dollar’s reserve status to be replaced by another national currency such as China’s renminbi.”

The hastened formation of an international non-dollar block of economies will surely be one of the momentous consequences of the U.S. China trade war. Countries including Russia, China, Turkey, Iran, Venezuela, North Korea and many others will eventually operate outside of the existing U.S.-dominated structure of trade arrangements, financial relations and payment systems, and sanction regimes. Not only do I expect the unfolding crisis to be of an international scope much beyond 2008. Today’s hostile environment is in stark contrast to the cooperation and coordination that previously ensured a concerted global crisis response. There are today incredibly high stakes tottering on the perception that a unified global central bank community retains the capacity to hold crisis dynamics at bay.

August 22 – Bloomberg (Craig Torres): “Harvard University economist Lawrence Summers warned central bankers that they are staring at ‘black hole monetary economics’ where small changes in interest rates and even more aggressive strategies do little to solve demand shortfalls. ‘Interest rates stuck at zero with no real prospect of escape -- is now the confident market expectation in Europe and Japan, with essentially zero or negative yields over a generation,’ Summers wrote on in a series of tweets… ‘The United States is only one recession away from joining them.’”

Federal Reserve policy is at a critical juncture. The efficacy of global monetary stimulus is at a critical juncture, as are the world’s financial, economic and geopolitical backdrops. The Fed’s Jackson Hole symposium has spurred a most important debate. Several regional Federal Reserve Bank Presidents provided comments notable both for insight and candor. For posterity, I’ve included excerpts from timely interviews conducted from Jackson Hole.

Esther George, President of the Federal Reserve Bank of Kansas City: “As I look at where the economy is, it’s not yet time – I’m not ready to begin to provide more accommodation to the economy without seeing an outlook that suggests the economy is getting weaker here.”

Bloomberg’s Michael McKee: “If you’re not ready to cut rates, are you happy with where rates are given that inflation is lower than anticipated? And would you be happy to leave them at this level for quite some time?”

George: “So I think that’s going to be a process of judging how the economy unfolds. I think where rates are right now – relative to the unemployment rate and inflation - suggests we’re at a sort of equilibrium right now. And I’d be happy to leave rates here – absent seeing some weakness or some strengthening or some kind of upside risk that would make me think rates should be somewhere else.”

McKee “Where would you put the neutral rate right now relative to where you are – are you tight? Are you loose? Accommodative? How do you see it?”

George: “I would judge policy to be at neutral or even accommodative with this last rate cut. If you think about where real interest rates are relative to the rate of inflation and where the Fed funds rate is, we’re operating close to zero with real rates. I can’t believe that that is tight in any sense for the economy right now.”

Eric Rosengren, President of the Federal Reserve Bank of Boston: “My own view [dissenting from the July 31st rate cut decision] was that we have to be careful not to ease too much when we don’t have significant problems. So the focus is not to do something that affects the exchange rate or something that necessarily takes care of the world economy. We’re supposed to focus on unemployment and inflation in the United States. So I think we’re at a pretty good spot right now. And there are costs to easing in times when you don’t need to ease.”

Bloomberg’s Kathleen Hays: “What’s the cost?”

Rosengren: “There are several costs. One is, one of the ways monetary policy works is that you cause people to buy houses and cars earlier than they otherwise would – “inter-temporal substitution”. You choose to make an investment now because interest rates, you think, are going to be temporarily low. And so you make expenditures you might not otherwise make. A second is, that when we lower interest rates we make the cost of debt lower. That means that both households and firms are more likely to be leveraged. And if they get leveraged right before we have more significant problems, they are actually in much worse shape. So we have to think about the financial stability characteristics, and by that it’s thinking of how much do we want households and firms to be leveraged going into whenever we actually do have a significant downturn.”

Rosengren: “What I think has people really focused on whether we’re going to have a recession is a combination of volatility in the stock market: we obviously had a very big movement a week ago when we lost 800 points on the Dow – but in subsequent days we moved back up. And if you look at the long bond [yield], it is very low. It’s around 1.60%. One of the reasons for that is the global weakness. But the cure for global weakness is for countries around the world to expand with either fiscal or monetary policies in their own countries rather than just the United States to be doing the easing.”

CNBC’s Steve Liesman: “Let’s talk about where we are in terms of the economy. What is your outlook for the economy? What is your view of growth right now? Is it too slow?”

Patrick Harker, President of the Federal Reserve Bank of Philadelphia: “No. I think it’s exactly what we had anticipated – a year ago and even two years ago. We are going back to trend growth, roughly 2% growth.”

Liesman: “Where would you say policy is relative to that trend growth?”

Harker: “In December, I was not supportive of the increase. I was supportive of the decrease somewhat reluctantly this time around to get us back to where I think policy should be. We’re roughly where neutral is. It’s hard to know exactly where neutral is – but I think we’re roughly where neutral is right now. I think we should stay here for a while and see how things play out.”

Liesman: “You don’t see a case for further stimulus to the economy?”

Harker: “No. Not right now.”

Liesman: “Why not?”

Harker: “Because you look at the labor markets are strong, inflation is moving up slowly, the last CPI print was a good print. We’ll see how PCE comes in. There are negative headwinds to the economy. But right now I don’t think they call for any drastic action. I think we can take some time and see how things play out.”

Liesman: “Isn’t there an argument to take out an “insurance” cut for the type of potential negative effects?”

Harker: “I’ve heard that argument, but I’m not very sympathetic to the argument. Right now, given the volatility even of the policy itself, we don’t need to make that move right now. Nothing is moving dramatically in a negative direction. There is potential for it to do so. I think we need to keep our powder dry so that when that happens we have the policy space to move.”

Liesman: “How much concern do you have if rates remain too low for too long for the financial stability side of things?”

Harker: “That is the other factor that I have to weigh. I didn’t think the cut was appropriate necessarily, but I went along with it to get back to neutral. But I’m on hold right now. My forecast is just to hold where we are for one of the reasons is that. We run the risk of creating too much leverage in the economy.”

Staring into the abyss

Chinese troops must stay off the streets of Hong Kong

Deploying the army would have dangerous repercussions for China and the rest of the world




IT IS SUMMER, and the heat is oppressive. Thousands of students have been protesting for weeks, demanding freedoms that the authorities are not prepared to countenance. Officials have warned them to go home, and they have paid no attention. Among the working population, going about its business, irritation combines with sympathy. Everybody is nervous about how this is going to end, but few expect an outcome as brutal as the massacre of hundreds and maybe thousands of citizens.

Today, 30 years on, nobody knows how many were killed in and around Tiananmen Square, in that bloody culmination of student protests in Beijing on June 4th 1989. The Chinese regime’s blackout of information about that darkest of days is tacit admission of how momentous an event it was. But everybody knows that Tiananmen shaped the Chinese regime’s relations with the country and the world. Even a far less bloody intervention in Hong Kong would reverberate as widely.

What began as a movement against an extradition bill, which would have let criminal suspects in Hong Kong be handed over for trial by party-controlled courts in mainland China, has evolved into the biggest challenge from dissenters since Tiananmen. Activists are renewing demands for greater democracy in the territory. Some even want Hong Kong’s independence from China. Still more striking is the sheer size and persistence of the mass of ordinary people.

A general strike called for August 5th disrupted the city’s airport and mass-transit network.

Tens of thousands of civil servants defied their bosses to stage a peaceful public protest saying that they serve the people, not the current leadership. A very large number of mainstream Hong Kongers are signalling that they have no confidence in their rulers.

As the protests have escalated, so has the rhetoric of China and the Hong Kong government. On August 5th Carrie Lam, the territory’s crippled leader, said that the territory was “on the verge of a very dangerous situation”. On August 6th an official from the Chinese government’s Hong Kong office felt the need to flesh out the implications. “We would like to make it clear to the very small group of unscrupulous and violent criminals and the dirty forces behind them: those who play with fire will perish by it.” Anybody wondering what this could mean should watch a video released by the Chinese army’s garrison in Hong Kong. It shows a soldier shouting “All consequences are at your own risk!” at rioters retreating before a phalanx of troops.

The rhetoric is designed to scare the protesters off the streets. And yet the oppressive nature of Xi Jinping’s regime, the Communist Party’s ancient terror of unrest in the provinces and its historical willingness to use force, all point to the danger of something worse. If China were to send in the army, once an unthinkable idea, the risks would be not only to the demonstrators.

Such an intervention would enrage Hong Kongers as much as the declaration of martial law in 1989 aroused the fury of Beijing’s residents. But the story would play out differently. The regime had more control over Beijing then than it does over Hong Kong now. In Beijing the party had cells in every workplace, with the power to terrorise those who had not been scared enough by the tanks. Its control over Hong Kong, where people have access to uncensored news, is much shakier. Some of the territory’s citizens would resist, directly or in a campaign of civil disobedience. The army could even end up using lethal force, even if that was not the original plan.

With or without bloodshed, an intervention would undermine business confidence in Hong Kong and with it the fortunes of the many Chinese companies that rely on its stockmarket to raise capital. Hong Kong’s robust legal system, based on British common law, still makes it immensely valuable to a country that lacks credible courts of its own. The territory may account for a much smaller share of China’s GDP than when Britain handed it back to China in 1997, but it is still hugely important to the mainland. Cross-border bank lending booked in Hong Kong, much of it to Chinese companies, has more than doubled over the past two decades, and the number of multinational firms whose regional headquarters are in Hong Kong has risen by two-thirds. The sight of the army on the city’s streets would threaten to put an end to all that, as companies up sticks to calmer Asian bases.

The intervention of the People’s Liberation Army would also change how the world sees Hong Kong. It would drive out many of the foreigners who have made Hong Kong their home, as well as Hong Kongers who, anticipating such an eventuality, have acquired emergency passports and boltholes elsewhere. And it would have a corrosive effect on China’s relations with the world.

Hong Kong has already become a factor in the cold war that is developing between China and America. China is enraged by the high-level reception given in recent weeks to leading members of Hong Kong’s pro-democracy camp during visits to Washington. Their meetings with senior officials and members of Congress have been cited by China as evidence that America is a “black hand” behind the unrest, using it to pile pressure on the party as it battles with America over trade (a conflict that escalated this week, when China let its currency weaken.

Were the Chinese army to go so far as to shed protesters’ blood, relations would deteriorate further. American politicians would clamour for more sanctions, including suspension of the act that says Hong Kong should be treated as separate from the mainland, upon which its prosperity depends. China would hit back. Sino-American relations could go back to the dark days after Tiananmen, when the two countries struggled to remain on speaking terms and business ties slumped. Only this time, China is a great deal more powerful, and the tensions would be commensurately more alarming.

None of this is inevitable. China has matured since 1989. It is more powerful, more confident and has an understanding of the role that prosperity plays in its stability—and of the role that Hong Kong plays in its prosperity. Certainly, the party remains as determined to retain power as it was 30 years ago. But Hong Kong is not Tiananmen Square, and 2019 is not 1989. Putting these protests down with the army would not reinforce China’s stability and prosperity. It would jeopardise them.

Trump’s Deficit Economy

Economists have repeatedly tried to explain to Donald Trump that trade agreements may affect which countries the US buys from and sells to, but not the magnitude of the overall deficit. But, as usual, Trump believes what he wants to believes, leaving those who can least afford it to pay the Price.

Joseph E. Stiglitz

stiglitz261_Drew AngererGetty Images_trump jerome powell


NEW YORK – In the new world wrought by US President Donald Trump, where one shock follows another, there is never time to think through fully the implications of the events with which we are bombarded. In late July, the Federal Reserve Board reversed its policy of returning interest rates to more normal levels, after a decade of ultra-low rates in the wake of the Great Recession. Then, the United States had another two mass gun killings in under 24 hours, bringing the total for the year to 255 – more than one a day. And a trade war with China, which Trump had tweeted would be “good, and easy to win,” entered a new, more dangerous phase, rattling markets and posing the threat of a new cold war.

At one level, the Fed move was of little import: a 25-basis-point change will have little consequence. The idea that the Fed could fine-tune the economy by carefully timed changes in interest rates should by now have long been discredited – even if it provides entertainment for Fed watchers and employment for financial journalists. If lowering the interest rate from 5.25% to essentially zero had little impact on the economy in 2008-09, why should we think that lowering rates by 0.25% will have any observable effect? Large corporations are still sitting on hoards of cash: it’s not a lack of liquidity that’s stopping them from investing.

Long ago, John Maynard Keynes recognized that while a sudden tightening of monetary policy, restricting the availability of credit, could slow the economy, the effects of loosening policy when the economy is weak can be minimal. Even employing new instruments such as quantitative easing can have little effect, as Europe has learned. In fact, the negative interest rates being tried by several countries may, perversely, weaken the economy as a result of unfavorable effects on bank balance sheets and thus lending.

The lower interest rates do lead to a lower exchange rate. Indeed, this may be the principal channel through which Fed policy works today. But isn’t that nothing more than “competitive devaluation,” for which the Trump administration roundly criticizes China? And that, predictably, has been followed by other countries lowering their exchange rate, implying that any benefit to the US economy through the exchange-rate effect will be short-lived. More ironic is the fact that the recent decline in China’s exchange rate came about because of the new round of American protectionism and because China stopped interfering with the exchange rate – that is, stopped supporting it.

But, at another level, the Fed action spoke volumes. The US economy was supposed to be “great.” Its 3.7% unemployment rate and first-quarter growth of 3.1% should have been the envy of the advanced countries. But scratch a little bit beneath the surface, and there was plenty to worry about. Second-quarter growth plummeted to 2.1%. Average hours worked in manufacturing in July sank to the lowest level since 2011. Real wages are only slightly above their level a decade ago, before the Great Recession. Real investment as a percentage of GDP is well below levels in the late 1990s, despite a tax cut allegedly intended to spur business spending, but which was used mainly to finance share buybacks instead.

America should be in a boom, with three enormous fiscal-stimulus measures in the past three years. The 2017 tax cut, which mainly benefited billionaires and corporations, added some $1.5-2 trillion to the ten-year deficit. An almost $300 billion increase in expenditures over two years averted a government shutdown in 2018. And at the end of July, a new agreement to avoid another shutdown added another $320 billion of spending. If it takes trillion-dollar annual deficits to keep the US economy going in good times, what will it take when things are not so Rosy?

The US economy has not been working for most Americans, whose incomes have been stagnating – or worse – for decades. These adverse trends are reflected in declining life expectancy. The Trump tax bill made matters worse by compounding the problem of decaying infrastructure, weakening the ability of the more progressive states to support education, depriving millions more people of health insurance, and, when fully implemented, leading to an increase in taxes for middle-income Americans, worsening their plight.

Redistribution from the bottom to the top – the hallmark not only of Trump’s presidency, but also of preceding Republican administrations – reduces aggregate demand, because those at the top spend a smaller fraction of their income than those below. This weakens the economy in a way that cannot be offset even by a massive giveaway to corporations and billionaires. And the enormous Trump fiscal deficits have led to huge trade deficits, far larger than under Obama, as the US has had to import capital to finance the gap between domestic savings and investment.

Trump promised to get the trade deficit down, but his profound lack of understanding of economics has led to it increasing, just as most economists predicted it would. Despite Trump’s bad economic management and his attempt to talk the dollar down, and the Fed’s lowering of interest rates, his policies have resulted in the US dollar remaining strong, thereby discouraging exports and encouraging imports. Economists have repeatedly tried to explain to him that trade agreements may affect which countries the US buys from and sells to, but not the magnitude of the overall deficit.

In this as in so many other areas, from exchange rates to gun control, Trump believes what he wants to believe, leaving those who can least afford it to pay the Price.


Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University and Chief Economist at the Roosevelt Institute. He is the author, most recently, of People, Power, and Profits: Progressive Capitalism for an Age of Discontent (W.W. Norton and Allen Lane).


Deutsche Bank and UBS Explored European Banking Alliance

Deal talks in June never coalesced but show how far European lenders are willing to go to address a punishing banking environment

By Jenny Strasburg


UBS CEO Sergio Ermotti and Chairman Axel Weber at the company's shareholder meeting in May. Photo: arnd wiegmann/Reuters


Deutsche Bank AG DB -2.79%▲ and UBS UBS -1.41%▲ Group AG this year explored ways to combine their businesses, including talks as recently as mid-June to form an unusual alliance of investment-banking operations, according to people familiar with the discussions.

The talks between Germany and Switzerland’s biggest lenders show how far European lenders are willing to go to address a punishing banking environment. Hammered by negative interest rates and slowing economic growth, European banks are struggling to compete globally and fend off encroachments from bigger U.S. rivals on their home turf.



A deal never coalesced, as the two sides failed to sort out thorny issues, including how to structure and allocate capital to any joint operations, the people said. Deutsche Bank and UBS for years have contemplated exploring a merger, the people said. One person who has been involved in multiple deliberations said the talks have been on and off but never fully off the table.

Inside Deutsche Bank, a tie-up was seen as a way to save Germany’s biggest bank from the painful cuts now in motion, the people said. The banks discussed a full-blown merger earlier in the year, a move that would have created a European banking behemoth more able to compete with Wall Street’s most dominant players, such as JPMorgan Chase& Co. and Goldman Sachs Group Inc. Bloomberg reported in May that the two banks briefly explored a merger. The June talks haven’t been previously reported.

UBS has suffered from volatile performance in its investment bank, and shares currently trade near their lowest point since it restructured its business in 2012. Deutsche Bank’s shares trade just above their all-time low hit this month.

The mid-June discussions, held near Milan, included the finance chiefs of both banks, senior investment-banking executives and advisers, some of the people said. The executives discussed ways to swap some operations and intertwine parts of their investment banks but keep the parent companies separate, according to the people familiar with the talks.

The people said a concept behind an alliance was to play to the strengths of both lenders, as Deutsche Bank, which remains a big player in its fixed-income trading and structuring business, would get referrals from UBS, which pulled back from some of those business lines several years ago. Deutsche Bank would feed business into UBS’s more successful equities franchise, the people said. UBS was interested in some of Deutsche Bank’s deal-advisory teams in the U.S., a person briefed on the discussions said.

Such a venture was seen by some involved as a possible test case, some of the people familiar with the talks said. It might have allowed the German and Swiss banks—and regulators, governments and investors—to gauge whether a merger might make sense, without committing to a new headquarters, regulatory regime or full restructuring, the people said.

Deutsche Bank’s then-investment-banking chief Garth Ritchie was at the meeting in Italy, along with Alexander von zur Muehlen, who is Chief Executive Christian Sewing’s top internal adviser on strategy. So was UBS’s Robert Karofsky, co-president of the investment bank, people familiar with the meeting said.


Deutsche Bank CEO Christian Sewing, right, speaks with Chairman Paul Achleitner at the bank’s annual meeting in May. Photo: Alex Kraus/Bloomberg News


UBS Finance Chief Kirt Gardner attended, and Deutsche Bank’s CFO,James von Moltke, dialed in, people familiar with the talks said. Tadhg Flood, a partner with deal advisory firm Centerview Partners, was advising the German bank, the people said. He previously served inside Deutsche Bank and remains a confidant of Mr. Sewing. On the UBS side was Jonathan Wills, the people said, another Deutsche Bank alum who worked this year for consulting firm Oliver Wyman. In June, Mr. Wills joined UBS as head of investment-bank strategy.

Earlier in the year, when Deutsche Bank was in talks to merge with crosstown rival Commerzbank AG, Deutsche Bank had parallel discussions with UBS to combine their asset management arms, The Wall Street Journal and others reported in April.

UBS Chairman Axel Weber earlier this year discussed with German officials the potential merits of a UBS-Deutsche Bank deal, and UBS Chief Executive Sergio Ermottiwas also open to exploring the idea, some of the people said.



The full merger talks went on for weeks, but by May they bogged down over regulation of the investment bank and the location of a combined bank’s headquarters—Zurich, Frankfurt, a third location where neither bank is located, or some combination of the three, according to people familiar with the talks.

By June, Deutsche Bank was running out of time. While talking with UBS, the German bank was planning cuts and discussing with other banks selling off stock-trading technology and pieces of its prime-brokerage franchise, which serves hedge funds. French bank BNP Paribas eventually struck a deal for some of those businesses.

The alliance discussions with UBS were short-lived; UBS walked away after the Milan meeting, some people familiar with the negotiations said. Deep cooperation short of a merger is rare in the banking world. People involved in the talks said the two sides decided they couldn’t quickly sort out how to structure the operation or share capital between the entities. One of the people said the idea was a long shot.

On June 21, Mr. Sewing emailed business heads demanding additional details for executives preparing the “equity story” for a major restructuring, people familiar with the internal communications said.

Some inside the bank said the crunch of hurried decision-making left executives little time to finalize senior management and cost-cutting decisions. They say the impact is still felt, with confusion about what services the bank will keep and how much capital those businesses need.

On the first Sunday in July, Messrs. Sewing and von Moltke laid out a reorganization that included the departure of three management-board members, including Mr. Ritchie, and 18,000 job cuts. There will also be a major pullback from the bank’s Wall Street presence, with an exit from most of its equities business and more investment in its strongest fixed-income and advisory businesses.