Trump and Xi’s Narcissism of Small Differences

The presidents of the United States and China are destined to clash, precisely because their economic worldviews are so similar.

By Christopher Balding

U.S. President Donald Trump and Chinese President Xi Jinping in the Great Hall of the People, Beijing on Nov. 9. (Jim Watson/AFP/Getty Images)
U.S. President Donald Trump and Chinese President Xi Jinping in the Great Hall of the People, Beijing on Nov. 9. (Jim Watson/AFP/Getty Images)

President Donald Trump is returning home from an Asian trip during which the United States and China announced agreements worth over $250 billion. This allows Trump, who built much of his political identity on his supposed negotiating prowess and willingness to stand up to China, to return home triumphantly announcing his success at standing up to China.

Perhaps unsurprisingly, this supposed victory is entirely hollow. Most of the largesse comprises ongoing deals or ones unlikely to be executed; even if all of the $250 billion in deals is realized, it will have minimal impact on the structural United States trade deficit and does nothing to address the lack of market access facing foreign firms in China. Trump and Chinese President Xi Jinping carefully avoided any public discussion of more fundamental issues like market access to China by foreign firms.

Xi, who has staked his identity and regime upon projecting China as a great power on the same level as the United States and returning it to global prominence, had broader objectives in mind. In their joint press conference, Xi talked about “promoting coordination and cooperation among major countries” to demonstrate to his domestic audience he treated Trump as an equal.

But his talk about cooperation did little to obscure the underlying conflict between Trump and Xi — a conflict that stems from their fundamental similarities rather than their superficial differences. Trump the brash-talking reality TV star and real estate mogul and Xi the guarded, re-educated party leader seem to share little in common. But they have fundamentally similar geopolitical – and, more specifically, geo-economic — worldviews.

Trump and Xi are both strident nationalists. Trump’s infamous “Make America Great Again” catch phrase strikes the same chord as Xi’s sloganeering promotion “national rejuvenation” or the “Chinese dream.” Both romanticize historical eras when they their countries commanded more respect or power. Their visions of these periods may never have existed or censor out key historical details, but they both want to return to hazy replication of previous glories.

Nationalism informs their other agendas and how they pursue their goals. Flowing from their nationalist mindsets, Trump and Xi view the economic world in mercantilist terms. Trump prioritizes addressing the chronic U.S. trade deficit in the mistaken belief this is a sign of economic weakness and that surpluses equal strength. Xi prioritizes maintaining closed Chinese markets while prying open international markets to drive the trade surplus required by the capital accumulation model of economic growth.

Their latent nationalist mercantilism informs how and what objectives each pursues. Economic negotiations are seen as zero-sum games rather than attempts to expand the range and level of opportunities. Any agreement to open up markets implies a national weakness that may exacerbate the measure of national strength through the trade surplus. This approach narrows opportunity for agreement between countries.

Beyond how Xi and Trump negotiate, mercantilism decides what they will negotiate. Gone are the days of negotiating sweeping, fundamentally revolutionary agreements, with the leaders instead focusing on transactional bargaining that accomplishes no larger goal. In the spring, Trump and Xi announced a 10-point agreement on narrowly focused issues such as U.S. beef exports and Chinese bank investigations in the United States. Described as a “herculean” effort, this agreement contained no larger objectives remaining purely transactional. Market access issues were similarly absent from the recent package of deals. Even China’s announcement that it will allow foreigners to own Chinese banks seems like an attempt to persuade foreigners to bail out an increasingly shaky financial system rather than a principled shift in market access.

Negotiation between the two major global powers focuses on specific transactions rather than advancing broad principles.

This shift bears significant consequences for the state of the bilateral economic relationship.

Despite Trump’s focus on addressing the trade deficit with China, it is simply an impossibility to arrest a $350 billion deficit via individual transactions negotiated by the president. Absent a broader agreement, either on a bilateral basis or, preferably, a multilateral one, transactional negotiation will fail to prevent an expansion of the trade deficit worsening Chinese-U.S. economic relations.

It also further entrenches Chinese interests in an illiberal world order. For all the hand-wringing over Trump’s isolationist rhetoric, the world has feted Chairman Xi’s closing of Chinese markets and nationalist industrial policies. The longer Trump focuses on transactional negotiations rather than principles, the more entrenched illiberal Chinese market practices will take hold and dominate. Perversely, Trump attempting to reduce the U.S.-China trade deficit one transaction at a time is further entrenching the illiberal market practices China holds at home and projects abroad.

A US Recession: Will Economic Change Mean Political Change?

By Xander Snyder

Economic duress can be the harbinger of political change – and sometimes geopolitical change.

Think about the United States in the 1930s, or the Soviet Union in the 1980s, or the European Union any time in the past decade. In these instances and many others, leaders’ options for righting the economy were only as palatable as the political consequences they would incur.

A case in point is the United States today. Like so many other countries, the U.S. is still coping with the social and economic fallout wrought by the 2008 financial crisis. The crisis may not have created Washington’s economic problems, but neither did it resolve them. And as those wounds continue to fester, it appears as though the U.S. is headed for recession.

Evidence to that effect is the flattening of the yield curve for U.S. Treasuries – a curve that is the flattest it’s been in 10 years. Usually, long-term debt has a higher interest rate to compensate investors for tying their capital up for longer. Declining interest rates on long-term debt, or higher rates on short-term debt, result in a narrower spread in the yield curve.
(Visually, this looks like it is becoming flat.) The rare occurrence of an inverted yield curve – when short-term rates are higher than long-term rates – has on several occasions heralded a recession.

Yield vs. Security

A yield curve can flatten or become inverted in two ways: through higher short-term interest rates and through lower long-term ones. Both are now occurring at the same time. Since the 2008 recession, the Federal Reserve has maintained low interest rates, prompting investors to “search for yield.” In other words, they searched for higher returns in riskier investments.

Investors are now flocking to long-term treasuries to reduce risk, a sign that they believe the economy will fare poorly in the future. After 2008, when the Fed lowered interest rates, stocks and “junk bonds” – bonds with a low credit rating and higher interest rates – were purchased in greater numbers. Investors have since begun to sell stocks and junk bonds in exchange for more secure assets. CalPERS, the United States’ largest pension fund, which manages nearly $350 billion in assets, is reducing its exposure to stocks and overweighting high-rated debt. Similarly, capital from debt investment funds has begun to flow out of those in the high-risk category and into more secure ones.

The other way that a yield curve can flatten – higher short-term interest rates – is driven by monetary policy. The Fed has begun to raise rates, thanks in part to low unemployment, though inflation has remained below its target of 2 percent. The Fed typically adjusts its rates based on employment and inflation metrics. Too much inflation is dangerous because it lowers the value of money, but too little inflation is also dangerous because it can create unsustainably high levels of debt. Otherwise it can send an economy into a deflationary spiral, whereby prices constantly decrease and therefore discourage consumer spending. Rising interest rates in a low-inflation environment increase the risk of such a spiral.

Investors and the Fed are concerned that low inflation will play its part to suppress economic growth.

The causes of this peculiar brand of low inflation, however, tell us something deeper about the U.S. demography.

Adequate Wages

Inflation is simply a measurement of price increases. The Consumer Price Index is frequently cited to determine inflation. It stands to reason, then, that if inflation is low, consumer spending is also low.

This is in fact the case. Since the end of the 2008 recession, consumption expenditure growth – which tends to be a leading indicator of inflation, albeit a slight one – has generally stayed within a range of -1.5 percent to 2 percent. Consumer spending growth since 1980, on the other hand, rarely dipped below 0 percent and generally stayed between 2 percent and 4 percent.

Why is consumer spending – and therefore inflation – so low if the U.S. unemployment rate is likewise so low at roughly 4 percent? Shouldn’t employed people be spending money, and therefore driving higher inflation? The answer to that question lies both in the size of the labor force and the quality of the jobs that people are finding.

The unemployment rate, generically understood as the percentage of people without jobs, is a useful but sometimes misleading metric. It only calculates employed people as a percent of the labor force.

It excludes people not actively searching for jobs (as determined by a number of criteria). This means that the unemployment rate can fall even as people leave the labor force. Participation in the labor force declined over the past decade, from 66 percent to 62.7 percent, which some have attributed to the retirement of baby boomers. This is only partly true. The labor force participation rate for workers in their “prime” years – 25 to 54 years – declined from 83.3 percent in 2008 to 81.6 percent today. In fact, the participation rate for workers of all ages declined over the past decade except for those over 55 years of age.

While the increase in the participation rate for those over 55 may seem counterintuitive – given that they are the retiring baby boomers – participation rates for those over 55 and 65 are much lower than for younger workers. Further, retiring baby boomers make up a larger portion of the population than they did a decade ago, so you can actually have an increasing participation rate in older categories with fewer actual workers in the market. The result is a shrinking labor force, and slow growth in consumption expenditure.

The second factor has to do with the quality of employment. The U.S. personal savings rate, declining since 2012, is at a near-record low of 3.1 percent. Despite low and relatively steady consumer expenditure growth, people are still not able to save as much as they did before 2012. (In fairness, the lowest savings rate in the past 50 years came just before the 2008 crisis.)

Taken together, these two metrics suggest that people have jobs – just perhaps not ones that can cover their living expenses.

The flattening yield curve, therefore, illustrates what’s going on in the economy. Low inflation – the indicator that both debt investors and the Fed fixate on – stems from mild consumption growth, caused by a declining prime-age labor force and an inability of those in the labor force to secure adequate wages. Lower long-term interest rates, combined with the Fed increasing rates, are signs that the U.S. economy is heading for a recession. Though that recession may not be as bad as the 2008 recession, the inherent social divisions aggravated by the 2008 recession are still here. A recession that makes life more difficult for those who have suffered for the past decade – but not for the elite – is inherently political.

Bitcoin Tops $15,000 as Manic Rally Gains Even More Momentum

The virtual currency’s gains this year have accelerated recently, rising more than 40% in the past week alone

By Steven Russolillo

The price of bitcoin topped $15,000 for the first time on Thursday, in a fresh rally that is hitting new highs every day.

Bitcoin crossed the latest milestone Thursday morning just shy of 6 a.m. New York time. It hit a recent high of $15,058 a few minutes later, according to research site CoinDesk, coming only hours after it topped $14,000 for the first time. It recently traded at around $14,800.

Bitcoin’s gains this year have accelerated recently, rising more than 40% in the past week alone. The rally has attracted new investors around the world as excitement mounts about the potential for digital currencies.

“Bitcoin and cryptocurrencies are something exciting, something new, and people want to be part of the story,” said Cedric Jeanson, a former JPMorgan Chase & Co. trader who has since started BitSpread Ltd., a bitcoin-focused hedge fund. “You’re seeing everyone seize the opportunity” and that’s driving the price higher, he said.

The price of the digital currency has soared, but experts say you should be wary.

The latest surge comes despite the theft of nearly $70 million worth of bitcoin from a cryptocurrency-mining service called NiceHash following a security breach, causing the company to halt operations for at least 24 hours.

But even the hack didn’t do much to halt the rally’s momentum. Bitcoin crossed $13,000 on Wednesday, just hours after breaching $12,000 for the first time and a week after it first broke above $11,000.

Bitcoin has rallied more than 1,400% so far this year.

Bitcoin’s rise has attracted crowds of eager small-time investors who are piling in, a contrast from when the digital currency was created nearly decade ago and had originally been just a curiosity for techies.

Now, cryptocurrencies are expected to see more interest from institutional investors. Three exchanges in the U.S. are set to offer futures contracts on bitcoin, including CME Group and Cboe Global Markets, which are poised to launch futures contracts later this month. The launches are considered another step toward building a traditional market around the stateless digital currency.

US yield curve flattens at fastest pace since financial crisis

Short-term rates shoot up as Congress nears passage of sweeping tax bill

John Plender

US President Donald Trump meets with small businesses to discuss tax reform, which has contributed to recent yield curve steepening © EPA

The difference between short-dated and longer-dated US Treasury yields has narrowed at its fastest pace since 2008, as investors anticipate a quicker rate of policy tightening from the Federal Reserve next year.

The difference between two- and 10-year yields has fallen 33 basis points to just 52 basis points over the past 30 days, while the difference between five- and 30-year yields has fallen 34 basis points, surpassing declines prompted by the European sovereign debt crisis in 2011 and reaching a pace last seen during the financial crisis, according to analysts at Citi.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

But some investors and analysts say the driving forces for the current move are different. Heightened expectations for the passage of tax reform into law could offer a short-term boost to the economy, but were unlikely to trigger a long-term boost to inflation that would drive longer-dated yields higher, said Ian Lyngen, head of US interest rate strategy at BMO Capital Markets.

“It’s pretty straightforward. It will keep the Fed on path to keep normalising but it won’t trigger the kind of stimulus that might introduce more significant inflation,” he said.

The probability that the Fed will increase the target Fed funds rate when it meets in December have hit 98.3 per cent as implied by the markets, up from 87.5 per cent the day after the Fed last met at the beginning of November.

Increasing expectations of interest rate rises from the Fed have helped drive the more policy-sensitive two-year Treasury yield up 54 basis points since early September to 1.80 per cent this week. In contrast the 10-year note yield has remained stuck between 2.30 per cent and 2.46 per cent since mid-October and on Wednesday was around 2.33 per cent.

Mr Lyngen also pointed to the Senate’s inclusion of the alternative minimum tax — a baseline, parallel tax assessment that permits fewer deductions — as damping the stimulative effect of tax reform. It may still be removed as the House and Senate seek to align their proposals but analysts say its inclusion would provide a floor to the benefit received by companies, with effective tax rates already below the statutory 35 per cent.

Market gauges of investors’ inflation expectations have remained muted since the passage of the Senate’s tax proposal. The 10-year break-even inflation rate edged slightly lower on Tuesday to 1.88 per cent.

Analysts also point to strong demand for longer-dated bonds as another factor weighing on yields.

Foreign investors have been big buyers of Treasuries this year, attracted to the higher-yielding asset compared to high-quality government debt elsewhere across the globe. Domestically, traders say pension funds have been driving recent demand.

“That is going to continue to put pressure on the yield curve to flatten,” said Andrew Brenner at National Alliance.

A Hedge Fund That Has a University

Taxing endowments’ investment income would help higher ed.

By Thomas Gilbert and Christopher Hrdlicka

Rowers paddle along the Charles River past the Harvard College campus in Cambridge, Mass., March 7. Photo: Charles Krupa/Associated Press

Whatever you may hear, the Republican tax-reform proposal isn’t an assault on higher education. The House and Senate plans include a new 1.4% excise tax on the net investment income of university endowments, but the levy applies only to private colleges with at least 500 students and endowments of more than $250,000 a student. Schools like Harvard, Yale, Stanford and Princeton—which together hold over $100 billion—are predicting doom. Yet this long-overdue tax will benefit higher education in the end.

Over the past 30 years universities have chased higher returns on their endowments, leading them to take greater risks. Our research shows that more than 75% of the assets in university endowments are now in risky investments: equities, hedge funds and private equity. Think of Harvard as a tax-free hedge fund that happens to have a university.

The proposed levy on investment income—dividends, interest and capital gains—is fundamentally a tax on this risk-taking, not on the endowments themselves. By taxing risk-driven income, the GOP plan doesn’t target higher education. It goes after hedge funds masquerading as university endowments.

When an endowment is invested in safe assets such as bonds, it serves as a rainy-day fund to buffer the risks a university takes in its normal operations: admitting students on scholarship, launching new research laboratories and generally expanding its educational and research missions. Such a safe endowment generates almost no investment income, meaning there would be no tax liability under the GOP proposal.

Instead the tax would fall on large, risky and illiquid funds. Endowments that make such investment decisions cannot effectively protect their schools. During the financial crisis, Harvard’s endowment lost nearly 30% of its value. After failing to sell its private-equity portfolio, the university had to institute drastic hiring and budget freezes.

A large and risky endowment also reveals a university’s poor assessment of its internal investment opportunities, such as scholarships and research. If Harvard and Stanford have educational and research projects that could benefit from additional funds, why put their money at risk in the stock market? Perhaps the answer is that the opportunity to run a tax-free hedge fund is too attractive. In that case, why should taxpayers subsidize their activities?

In colleges’ defense, states have placed perverse restrictions on their ability to use endowments as rainy-day funds. The Uniform Prudent Management of Institutional Funds Act is a law in 49 states that limits the maximum endowment payout rate between 5% and 7% a year. Although well-intentioned, that and earlier restrictions prevent universities from tapping endowments to fill the kind of budget holes they experienced in 2008.

To have the best chance of improving incentives for endowments, the proposed investment tax should be accompanied by a repeal of these payout caps. But it’s a mistake to think that taxing risky investments by university endowments is an attack on academia. Discouraging superwealthy schools from pumping cash into stocks, hedge funds and private equity should lead to increased spending on education and research. Isn’t that the purpose of higher education?

Messrs. Gilbert and Hrdlicka are assistant professors of finance at the University of Washington.

Trump’s Financial 9/11

by Nick Giambruno

Ron Paul told me this would happen…

Dr. Paul first laid out his theory in 2006, in a little-known speech, during an otherwise dull session of Congress. I think it’s his most important speech ever.

During the speech, Paul traced the history of the US dollar within the international financial system.

Crucially, he pointed out the one thing that would precipitate the US dollar’s collapse. Now that one thing is about to happen.

Here’s the most important part:

The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros. The sooner the better.

In other words, we’ll know the dollar-centric monetary system is about to end when countries start trading oil for gold or its equivalent… not dollars.

Now—thanks to China—that’s about to happen in a very big way.

I discussed all of this with Ron Paul extensively at a past Casey Research conference. He told me he stands by his assessment.

China recently announced a mechanism that will make it possible to trade oil for gold on a large scale for the first time in many decades.

This mechanism could undermine the petrodollar system—the system that’s supported the US dollar as the top global currency since the 1970s.

I call it China’s “Golden Alternative” to the petrodollar.

Why the US Dollar Is So Special

The petrodollar system is the big reason the US dollar is so unique. Here’s how it works…
Oil is by far the largest and most strategic commodity market in the world. And, until recently, virtually anyone who wanted to import oil needed US dollars to pay for it.
Every country needs oil. And if foreign countries need US dollars to buy oil, they have a very compelling reason to hold large dollar reserves.
This creates a huge artificial market for US dollars. It also gives a tremendous boost to anyone who lives in the US or holds US dollars.
The petrodollar system is the reason foreign countries keep such large US dollar reserves.
Now China is set to hit the petrodollar with a mortal blow...
China’s Golden Alternative to the Petrodollar
Throughout history, every great power has had money that’s recognized around the world.

Usually, these currencies have been tied to gold and silver.
Ancient Greece had the silver drachma. Rome had the silver denarius. The Islamic Caliphates had the gold dinar and the silver dirham. Venice had the gold ducat. Great Britain had the gold sovereign.
The United States used silver in its coins until 1964. And the dollar was under a pseudo-gold standard until 1971.
Now it’s China’s turn.
It’s no secret that China has been stashing away as much gold as it can.
Today, China is the world’s largest producer and buyer of gold. According to informed observers, China now has official reserves of over 160 million ounces. It also has 400 million ounces in the ground that it could potentially mine.
(The US, by contrast, claims it has official reserves of around 260 million ounces.)
China’s Golden Alternative is the reason it’s been stashing so much gold.
The Golden Alternative will allow anyone in the world to trade oil for gold. It will totally bypass the US dollar and the US financial system.
For many, it will be much more attractive than the petrodollar system. 
The Golden Alternative is the beginning of the end of the international monetary system that has reigned since the early 1970s.
Here’s how it will work…
The Shanghai International Energy Exchange (INE) is about to launch a crude oil futures contract denominated in Chinese yuan. It will allow oil producers to sell their oil for yuan.

Of course, most oil producers don’t want a large reserve of yuan. China knows this.

That’s why China has explicitly linked the crude futures contract with the ability to convert yuan into physical gold through gold exchanges in Shanghai (the world’s largest physical gold market) and Hong Kong. The system won’t touch China’s official gold reserves.

Oil producers will have two ways to do this:

1. Immediately convert the yuan they receive from selling oil into physical gold at the spot price for immediate delivery.

2. Or, lock in the gold to be delivered at a future date for a fixed yuan price with a gold futures contract. This eliminates any uncertainty because of fluctuating prices.

Bottom line, it will allow oil producers to sell oil for gold. Producers will be able to completely bypass the petrodollar system and any restrictions/regulations/sanctions of the US financial system.

I recently spoke with the officials at the exchange. They told me they plan to go live with the INE crude contract before the end of the year.

China Wants Pricing Power

One of China’s key goals here is to reduce the dollar’s influence over oil pricing.

China is the world’s largest oil importer. Developing the new crude contract gives it some global pricing power.

Currently, most of the $1.7 trillion worth of oil traded each year is priced off of two US dollar-denominated crude benchmarks: West Texas Intermediate (WTI) and Brent.

Beijing thinks the yuan crude contract will reflect the market conditions in Asia better. It could become the most important oil benchmark in Asia.

The vice-chairman of the China Securities Regulatory Commission recently said:

The country will make crude oil futures the new starting point of opening up all futures markets…

And then, we will allow foreign players, whose enthusiasm is very high at present, to enter other futures markets, such as iron ore and PTA, when conditions are ripe.

In other words, oil is just the beginning.

Eventually, China plans to challenge the dollar’s dominance over all commodities.

Why Medium Sour Crude?

The INE crude futures will be priced in yuan per barrel and be for 1,000 barrels.

Brent and WTI futures contracts are for light, sweet crude. “Light” means it has relatively low density, and “sweet” means it has a low sulfur content.

The INE contract, on the other hand, will be for medium sour crude.
There are a handful of reasons for this:

• Medium sour crude is the main type of oil China and its neighboring countries import.

• Medium sour crude oil accounts for over 40% of global crude output, but there is currently no price benchmark for it.

• The supply/demand dynamics of medium sour are not the same as light sweet crude.

PetroChina and Sinopec, two giant Chinese oil companies, will provide liquidity to the new yuan crude futures.

But non-Chinese companies will be welcome, too. The crude yuan future will be China’s first commodities futures contract open to foreign investors.

JPMorgan and UBS have already gained approval to trade. So have over 6,000 individual traders. It’s just a matter of time before the other big global players join.

Remember the big idea here… the new yuan crude futures contracts will be a huge hit to the petrodollar.

And it’s going to make a lot of money flood into gold—money that would have otherwise gone into the US dollar and US Treasuries.

“We Don’t Have a Country”

The breakdown of the petrodollar will cause a financial crisis.

Here’s how things will unravel…

The petrodollar system is one of the most powerful forces driving the US bond market. Oil producing countries accumulate hundreds of billions of US dollars in oil profits, which they recycle back into US Treasuries.

This keeps interest rates lower than they would be otherwise. It allows the US government to finance enormous deficits with debt at an artificially low cost.

If the petrodollar system unravels, interest rates will soar. (Interest rates are currently near historic lows.)

Even a small rate increase is a lethal threat to the US budget.

The US government currently needs over $400 billion from taxpayers just to pay the interest on its debt. Tax receipts are just over $2 trillion.

If interest rates rise…

• 1%, the government would need over $600 billion to pay the interest on its debt.

• 2%, it would need over $800 billion.

• 3%, it would need $1 trillion.

• 4%, it would need over $1.2 trillion, or over half of what it currently snatches from taxpayers—again, just to pay the interest.

Clearly, none of this is sustainable.

Trump was correct last year when he noted: “What happens if that interest rate goes up 2, 3, 4 points? We don’t have a country.”

In many ways, this could turn into President Trump’s financial 9/11.

The petrodollar system has allowed the US government and many Americans to live way beyond their means for decades.

The US takes this unique position for granted. But it will disappear once the petrodollar system breaks down.

When that happens, inflation could be severe.

This will likely be the tipping point…

Afterward, the US government will be desperate enough to implement capital controls, people controls, nationalization of retirement savings, and other forms of wealth confiscation.

I urge you to prepare for the economic and sociopolitical fallout while you still can. Expect bigger government, less freedom, shrinking prosperity… and possibly worse.

It’s probably not going to happen tomorrow. But it’s clear where this trend is headed.

It is very possible that one day soon, Americans will wake up to a new reality.

Until next time,