$247 Trillion and (Rapidly) Counting

Doug Nolan

I chronicled mortgage finance Bubble excess on a weekly basis. Relevant data were right there in plain sight, much of it courtesy of the Federal Reserve. Yet only after the Bubble burst did it all suddenly become obvious. Flashing warning signs were masked by manic delusions of endless prosperity and faith in the almighty "inside the beltway". These days, data for the global government finance Bubble is not as easily-accessible, although there is ample evidence for which to draw conclusions. It will all be frustratingly obvious in hindsight.

The Institute of International Finance is out with their latest data that, unfortunately, is not made available in detail to the general public. Global debt ended the first quarter at a record $247 Trillion, or 318% of GDP. Even after a decade of historic Credit inflation, global debt continues to expand at ("Terminal Phase") double-digit rates (11.1% y-o-y).

Global debt growth accelerated during the first quarter to $8.0 Trillion - and surged $30 Trillion over just the past five quarters. In a single data point not to be disregarded, Global Debt Has Expanded (a difficult to fathom) $150 Trillion, or 150%, Over the Past Ten Years. Actually, the trajectory of Bubble-period Credit expansion may seem rather familiar. It's been, after all, a replay of the reckless U.S. mortgage Credit episode, only on a much grander global scale.

July 10 - Financial Times (Jonathan Wheatley): "The amount of debt in the world increased by nearly $25tn in the year to the end of March, piling more pressure on a global financial system already struggling to deal with rising US interest rates, widening spreads for borrowers and a strengthening US dollar. The Institute of International Finance… said total debts owed by households, governments and financial and non-financial corporations amounted to $247.2tn at the end of March, up from $222.6tn a year earlier and an increase of nearly $8tn in the first quarter alone. 'The increase in the level of debt, both in absolute terms and relative to GDP, against a backdrop of tightening financial conditions, is, of course, a cause for concern,' said Hung Tran, the IIF's executive managing director… The IIF said the debts of non-financial corporations in EMs rose $1.5tn in the first quarter to $31.5tn, the equivalent of 94.4% of GDP…"

A few notable quotes from press reports:

"With global growth losing some momentum and becoming more divergent, and U.S. rates rising steadily, worries about credit risk are returning to the fore - including in many mature economies," the IIF said.

"Non-financial borrowers in the corporate sector, in the household sector, in the government sector having very high debt levels, will find it very costly and difficult to refinance and borrow more in order to sustain investment and consumption going forward. That is really causing growth to falter, so what I term headwinds to growth." IIF Executive Managing Director Hung Tran.

"For many emerging markets, which rely heavily on bank financing, higher borrowing costs for banks could be passed through to the corporate and household sectors, so something of a hidden risk in terms of this floating rate borrowing," said IIF Senior Director Sonja Gibbs.

Bloomberg (Alexandre Tanzi): "Government debt has risen most sharply in Brazil, Saudi Arabia, Nigeria and Argentina, according to the report. Of the four, U.S. dollar refinancing risk is particularly high for Argentina and Nigeria, where over three-quarters of redemptions will be in dollars. About $900 billion is in U.S. dollar-dominated emerging bonds/syndicated loans that will mature by 2020…"

July 10 - Yahoo Finance (Dion Rabouin): "'The pace is indeed a cause for concern,' IIF's Executive Managing Director Hung Tran told Yahoo… 'The problem with the pace and speed is if you borrow or if you lend very quickly … the quality of the credit tends to suffer.' That means more governments, businesses and individuals have been borrowing that could have trouble paying the money back. 'The quality of creditworthiness has declined sharply,' Tran added… Sonja Gibbs, IIF's senior director of the global capital markets department, noted that there was an increased risk of sovereign debt crises in a select few developed markets as a result of the increase of debt and financing costs. 'Government debt is higher than it was prior to the crisis and corporate debt as well,' Gibbs said… Gibbs added that the United States' debt growth was particularly worrisome, given that it has now grown to more than 100% of GDP. With the increases in spending from President Donald Trump and Congress, the U.S. will now have funding needs of 25% of its GDP. 'The U.S. really stands out here because … a lot of that is the expanding budget deficit as well as maturing debt,' Gibbs said. 'That's a lot of financing need affecting the market.'"

U.S. government debt surpassed 100% of GDP during the quarter. Japanese government debt-to-GDP ended the quarter at 224%, the euro area at 101%, the UK up to 105% and the emerging markets to 48% of GDP.

To see non-productive U.S. government debt, the foundational "Core" of global finance, inflate so rapidly should be quite distressing. Worse yet, extreme Credit excess is systematic, as debt balloons also at the "Periphery". From my analytical perspective, we're witnessing catastrophic, all-encompassing "Terminal Phase" excess. The first quarter saw emerging market debt rise by $2.5 trillion, or about 18% annualized, to a record $58.5 trillion. EM Non-financial Corporate debt surged $1.5 Trillion, or about 25% annualized, to $31.5 TN - and now exceeds 94% of GDP. One big final blow-off setting the stage for crisis.

From the FT (Jonathan Wheatley): "'The emerging market bond market has grown tremendously over the past decade but trading volumes have not kept pace,' said Sonja Gibbs, senior director at the IIF. 'When you combine a rising rate environment, stronger dollar and low levels of liquidity, you have a recipe for volatility and the exacerbation of any periods of market strain.'"

My thesis holds that the global Bubble has been pierced at the "Periphery." Not atypically, this follows on the heels of remarkable "Terminal Phase Excess," including phenomenal Credit growth and massive "hot money" inflows. The "hot money" has now reversed; de-risking/de-leveraging dynamics are taking hold. Market complacency is at least partially explained by the sizable reserves the emerging markets have accumulated over recent years, resources the marketplace sees available for stabilizing currencies and Credit systems.

July 9 - Wall Street Journal (Chelsey Dulaney): "Emerging-market central banks are tapping a roughly $6 trillion stash of foreign-exchange reserves as they struggle to contain deepening currency declines. Policymakers across the developing world built up foreign reserve buffers over the past year, capitalizing on investor interest in higher-yielding emerging market assets as global growth remained sanguine. In the first five months of 2018, the central banks added $114 billion to their reserves, the fastest pace of accumulation since 2014…"

The problem, also noted by the WSJ: "Emerging-market central banks used roughly $57 billion in foreign reserves in June, which would rank as the largest monthly intervention since late 2016…" Brazil is said to have burned through $44 billion to support its faltering currency. EM reserve data will be monitored closely over the coming weeks and months. Dwindling reserves will incite a rush to the exits.

There's been considerable market focus on recent woes in Brazil, Turkey and Argentina. But from a more global systemic perspective, I would at this point focus on heavily indebted Asia. Interestingly, Asian currencies were down again this week. The Chinese renminbi declined 0.7%, the Japanese yen 1.7%, the South Korean won 0.7%, the Singapore dollar 0.6%, and the Thai baht 0.5%. Over the past month, the renminbi is down 4.4%, the won 4.1%, the baht 3.5%, the Indonesia rupiah 3.2% and the Singapore dollar 2.2%.

The unfolding trade war is indeed a major issue for EM, arriving at a most inopportune juncture. Financial conditions have already tightened meaningfully throughout Asian markets, though I would contend that the issue goes much beyond trade. Let's start with a China Credit Bubble update:

Total aggregate finance expanded $176 billion during June, up from May's $115 billion but 16% below estimates. Aggregate Finance grew $1.36 TN during the first-half, about 18% below comparable 2017. The growth in Bank Loans surged $274 billion in June, up from May's $175 billion and the strongest expansion since January. Meanwhile, key "shadow banking" components contracted. At $106 billion, growth in Household (chiefly mortgage) borrowings remained strong.

June's jump in Chinese bank lending surely emboldens those with the view that Beijing has everything in control - that Chinese officials will adeptly commandeer the financial system to ensure sufficient Credit growth and liquidity. It likely won't be that simple. Chinese banks and corporations have issued enormous quantities of marketable debt over recent years, a significant portion denominated in dollars. A massive bank lending campaign at this stage of the cycle will not be confidence inspiring.

It's also worth reminding readers than China's international reserve holdings have declined about $900 billion from 2014 highs to $3.112 TN. China now faces the dilemma that their maladjusted economic system will require several trillion ($) of annual Credit growth. Yes, Beijing can dictate lending from state-directed financial institutions. But aggressive reflationary measures risk spurring capital flight and currency turmoil. A disorderly devaluation would be highly problematic for those on the wrong side of dollar-denominated debt.

July 12 - Bloomberg (Lianting Tu and Finbarr Flynn): "A rout in China's dollar-denominated junk bonds is getting worse as mounting defaults send traders running for cover. Rising trade tensions are also adding to longer-existing difficulties created by the nation's push to cut excessive leverage. Junk bonds from China have been more volatile this year than such securities from all of Asia. The average yield for the nation's speculative-rated notes has surged to 10.5%, the highest since 2015, according to ICE BofAML indexes. Few expect a rebound anytime soon."

July 12 - Bloomberg (Andy Mukherjee): "Donald Trump has made Asian high-yield investors nervous wrecks. First, there are the obvious casualties of his trade war against China. Lenovo Group Ltd.'s bonds are down to 87.4 cents on the dollar from more than 100 cents at the start of the year. Then there's the collateral damage of his greenback-boosting, late-cycle fiscal stimulus, which is making investors worried about Asian currency weakness. Indonesian notes are swimming in a sea of red ink… Liquidity in Asian high yield is so bad that, after a little haggling, a bond quoted at 94 cents on the dollar can be had for 91 cents. Sellers are panicking."

After widening 120 bps in four weeks, Asian high-yield spreads on Wednesday were at the widest level since the Chinese mini-crisis back in Q1 2016. China CDS ended last Friday's trading at a 13-month high (73bps). As noted above, the rout over the past two months has left Chinese junk yields at the highs since early-2015.

"[US Treasury] Yield Curve at its Flattest Since August 2007," was a Friday evening Financial Times (Joe Rennison) headline. "The measure is an important signal for investors of when the Federal Reserve may curtail its policy tightening and is also seen as a warning of a coming recession if it turns negative, which last happened in 2006."

I viewed the flat yield curve back in 2007 as more of a warning of Bubble Fragility than an indicator of imminent recession. But with U.S. mortgage finance at the epicenter of the Bubble back then, the bursting Bubble coincided with an abrupt end to Credit expansion and economic growth. I view today's flat Treasury curve as again signaling Bubble Fragility. The big difference, however, is that global (as opposed to U.S.) finance is at today's Bubble epicenter. Heightened fragility in China, Asia and EM, more generally, risks global financial turmoil and economic vulnerability.

This is creating quite a dilemma for the Federal Reserve. Cracks in the Global Bubble's "Periphery" are putting downward pressure on Treasury yields, in the process loosening U.S. financial conditions in the face of cautious Fed rate increases. The booming U.S. economy at this point beckons for restrictive monetary conditions, yet a more hawkish Fed risks spurring a dollar melt-up and full-fledged EM financial crisis.

The GSCI commodities index sank 3.6% this week. Copper dropped another 1.7%, boosting y-t-d declines to 16%. Zinc fell 5.7% this week, lead 5.6%, Aluminum 2.4% and Platinum 2.1%. WTI Crude dropped 3.8%. In the agriculture commodities, Soybeans dropped 6.7%, Corn 4.9%, Wheat 3.5%, Sugar 4.8% and Coffee 3.8%.

From the currencies to market yields and yield curves to commodities, markets are signaling trouble ahead. The great irony is that Cracks at the Global Periphery now work to prolong "Terminal Phase Excess" at the "Periphery of the Core" - certainly including higher risk U.S. corporate Credit. And booming debt markets feed a highly speculative equities Bubble right along with an overheated U.S. Bubble Economy. After years of Easy Street, central banking has turned into quite a hard challenge.

July 10 - Bloomberg (Danielle DiMartino Booth): "Much has been made of the degradation of the $7.5 trillion U.S. corporate debt market. High yield offers too little, well, yield. And 'high grade' now requires air quotes to account for the growing dominance of bonds rated BBB, which is the lowest rung on the investment-grade ladder before dropping into 'junk' status. And then there's the massive market for leveraged loans, where covenants protecting investors have all but disappeared. How does that break down? Corporate bonds rated BBB now total $2.56 trillion, having surpassed in size the sum of higher-rated debentures, which total $2.55 trillion, according to Morgan Stanley. Put another way, BBB bonds outstanding exceed by 50% the size of the entire investment grade market at the peak of the last credit boom, in 2007… In 2000, when BBB bonds were a mere third of the market, net leverage (total debt minus cash and short term investments divided by earnings before interest, taxes, depreciation and amortization) was 1.7 times. By the end of last year, the ratio had ballooned to 2.9 times."

I'm Not The Bear You're Looking For

by: The Heisenberg

- In 2018, I've variously attempted to disabuse readers of the notion that I fall into the same category as other notable pessimists.

- Amusingly, that effort has coincided with the realization of a number of event risks that actually lend credence to the bear case.

- Nevertheless, I'm still going to try and present the most balanced macro take possible, even when the storm clouds are gathering.

- Here's an in-depth, cross-asset look at the environment as it stands right now.

You can't make an omelette without breaking a few eggs, and in my case, "you" can't make an omelette period, because breakfast is something that's always eluded my rudimentary cooking skills (long-time Heisenberg readers know I can cook a mean NY Strip, though).
The figurative omelette I set out to make in 2018 involved disabusing readers of the idea that my musings and various missives somehow belong in the same category as those emanating from a handful of big name pessimists and doomsayers.
Initially, I didn't mind being branded a pessimist, although I would have really preferred "cynic". But the mischaracterizations started to grate a bit as the "brand" grew. Some time late last year, folks started to make direct comparisons between me and other specific bearish commentators. At that juncture, I decided to make a concerted effort to recalibrate reader expectations, mostly because I didn't want my personal site to become a haven for geopolitical conspiracy theorists.
I'm a trained political scientist and I come from a family of academics that dedicated their entire lives to teaching liberal arts at the graduate and undergraduate level. My formal training in finance and economics was borne out of necessity when I decided to break with family precedent by not becoming a college teacher.
But the finance bent never diminished my passion for political science and long before I adopted the pseudonym, my raison d'être revolved around the notion that geopolitics and markets are inextricably bound up with one another and you can't properly understand the latter without studying the former.

Political science is obviously not a so-called "hard" science, and neither is economics, economists' protestations notwithstanding. But there's a fine line between, on one hand, acknowledging the inherent absurdity in using the word "science" to describe the study of politics and, on the other, making a mockery of the entire endeavor by pushing wild conspiracy theories. Long story short, I was getting a lot of the latter in the comments section of my own site and that started to beget similarly far-fetched theories about central bank conspiracies.
Invariably, that rather toxic combination manifests itself in predictions of 75% market crashes, calls for gold soaring to $30,000 and other various shenanigans. I have no patience for that. It flies in the face of my respect for academic rigor.
So, I started to infuse explicit caveats in my writing designed to make it clear that I'm not the bear you're looking for. Perhaps the most concise example of that effort can be found in "Albert Edwards Returns From Yosemite, Disagrees With Other Notable Bear When It Comes To Forest Fires", but on this platform, my shift in strategy has probably been most evident in my rather effusive praise for Mario Draghi and in my recent critiques of Jerome Powell's "plain English" approach to Fed communication.
Rekindling the metaphor I employed here at the outset, some eggs were indeed broken on the way to making my omelette. A few readers were seemingly disillusioned to learn that while I'm no fan of the post-crisis monetary policy regime and the distortions it's created across assets, I am a fan of the artistry involved in the maintenance of that policy regime. Similarly, I'm not a believer in the notion that central bankers set out to exacerbate wealth inequality (remember, enacting policies that you know will come with undesirable consequences is something entirely different from choosing those policies because they will bring about those consequences). Nor do I subscribe to the idea that creative destruction (i.e., some kind of "once and for all" purge of misallocated capital that involves a global depression) is something that's feasible, let alone desirable. In short: the "great reset" isn't coming. So if that's the rationale behind your wall-safe stuffed with physical gold coins, you might want to rethink that asset allocation decision.
I lost some followers on my site once folks figured out that I'm actually in the business of providing halfway serious analysis and, more amusingly, I left some Heisenberg Twitter critics flummoxed when I delivered critiques of the people they were comparing me to that were far harsher than anything they were prepared to say publicly.
The irony in all of this, is that 2018 turned out not to be a great year when it comes to making a concerted effort to shake the "permabear" label.
Part of me reveled in the collapse of the short VIX ETPs and the extent to which the subsequent systematic de-risking (which saw CTAs and risk parity mechanically unwind somewhere between $200 and $300 billion worth of equity exposure) validated my long-held "doom loop" warnings. But another part of me felt a little bit bad about it because when I went back and read my posts about those products for this platform, I realized that I should have been a bit more explicit about the fact that what I was predicting was a near certainty (as opposed to a worst case scenario).
As a reminder, I repeatedly warned readers here that the levered and inverse VIX ETPs were accumulating a massive amount of rebalance risk that, if triggered, would mechanically involve panic-buying VIX futures into a volatility spike. On February 5, that rebalancing flow was a 23-standard-deviation event (charts below show the VIX ETP rebalancing flow on February 5, left pane, and the estimated combined de-risking in CTAs and risk parity strategies that occurred on Friday, February 2 and the following Monday).
(SocGen on the left, BofAML on the right)
While markets recovered from the February VIX quake, the newsflow since then has been unrelenting in terms of telegraphing event risk, whether it's trade wars, emerging market fragility, Italian political turmoil, regulatory risk in tech or domestic political friction in the United States. As I've tried to make clear in a number of recent posts, U.S. equities (SPY) are an island, of sorts. They are one of the only things that's still working.

So when it comes to timing, I could have picked a better six months when it comes to trying to convince people that I'm not a hopeless pessimist. That is, if you had to pick two six-month periods since the European debt crisis when it made sense to be a pessimist, one would be the second half of 2015 (following the yuan devaluation) and the other would be now. But that's how these things go. Markets have a penchant for making folks look silly; it's almost as if they (markets) are somehow capable of having a sense of purpose, despite being inanimate capital allocation mechanisms.
Recent surveys of institutional investors conducted by some of the major banks betray a sense of angst with regard to the growth outlook. To the extent large allocators of capital are worried, that consternation stems primarily from the prospect of trade tensions leading to a synchronous downturn in global growth. That said, most people seem to think the drag will be minimal, if not entirely inconsequential.
In their quarterly global macro survey, Barclays found that (and I'm quoting them here) “for the first time in at least four years, more than half of respondents think a disappointment [in global growth] lies ahead.”
Similarly, in their latest rates and FX survey conducted on 06-11 July and representing the views of 58 fund managers responsible for $286 billion in AUM, BofAML found that 64% of respondents believe trade tensions are set to get “modestly worse” resulting in a drag on global growth.
For their part, Goldman raised the odds of a material escalation in trade tensions between the U.S. and China to 60% in a note out Friday.
Still, there's a demonstrable tendency for large investors (and analysts, for that matter) to doubt whether the trade tensions will ultimately morph into something that will be serious enough to catalyze a painful correction.
That relatively benign assessment is at odds with the consensus view on emerging markets (consensus is very cautious there) and the dour outlook for EM is part and parcel of the assumption that the Fed's near-term hawkishness will continue to exert pressure on developing market assets which have benefited in recent years from carry-inspired flows.
When it comes to the Fed, there's a sense that sooner or later, Jerome Powell will have to relent in the face of EM pressure and the prospect of trade tensions weighing on the growth outlook.
For instance, in the same BofAML survey cited above, nearly half of survey participants now expect the Fed’s balance sheet normalization push to conclude in 2019. In the Barclays poll, the bank notes that “despite [institutional investors'] apparent enthusiasm for all things American, survey respondents continue to question the Fed’s desire to tighten policy”. Here's the visual on that:
All of this isn't entirely consistent. That is, it's difficult to reconcile the contention that trade frictions don't pose a meaningful threat to global growth with the notion that the Fed will have to end normalization "early" (and "early" is of course a relative term in that context).

It's possible to couch the argument about an early end to Fed balance sheet normalization in technical terms. This week, Morgan Stanley was out with a great note in which they suggest that too much balance sheet normalization risks driving the effective federal funds rate above the rate paid on excess reserves, an outcome which increases the chances that EFFR rises above the target range. This is an in-depth, technical discussion (the note is a full 77 pages long), and if you want the longer treatment, you can find more here. But for our purposes, suffice to say that simply lowering IOER relative to the upper bound (as the Fed did this year) might not ultimately be sufficient to incentivize larger banks (where reserves are concentrated) to lend in the Fed funds market and so, if EFFR keeps bumping up against IOER after a theoretical second technical tweak, the Fed will ultimately be forced to end QT early in order to avoid a liquidity squeeze.
The "problem" (if that's what you want to call it) there is that depending on the mechanics, ending normalization early could end up inverting the curve. Here's an excerpt from the Morgan note:
The early end to balance sheet normalization means the Fed will begin rolling over more of its Treasury holdings sooner than we thought previously. We also think it means that the Fed will remove Treasury supply from the secondary market when it reinvests agency debt and MBS principal into the Treasury market instead of the agency MBS market. In turn, the US Treasury will have to issue fewer Treasuries to the public than what we thought before.
That means the burden on the private sector when it comes to absorbing the increased Treasury supply necessitated by Trump's deficit-funded fiscal stimulus will be lower. That, in turn, means less upward pressure on long-end yields and a flatter curve. The other implication there is that the Fed's balance sheet will actually begin to grow again in 2020. Here's a visual:
(Morgan Stanley)
The implications of this for risk assets are ambiguous. On one hand, an early end to balance sheet normalization and an effective resumption of QE in 2020 should be supportive, but in the meantime, it's a different story. For what it's worth, here's what Morgan Stanley says in the same note:
A larger Fed balance sheet may eventually be supportive for risky assets, but we expect the flow effects of normalization to hurt into 2019. We don’t think support will arrive until the balance sheet stops shrinking. We see the flow effects of balance sheet normalization, which should accelerate into 4Q18 and 1Q19, negatively affecting US corporate credit and equities (in a continuation of the rolling bear market). We think agency MBS should suffer from reduced demand into a bull flattener, but actual performance will depend on how agency MBS paydowns are reinvested. On a 12-month horizon, we suggest investors overweight US Treasuries, underweight US corporate credit, be neutral agency MBS versus Treasuries and overweight agency MBS relative to credit.
Try and stay with me here. The point of walking you through the Morgan Stanley projections is to underscore the extent to which investors and analysts doubt, for one reason or another, the Fed's ability to normalize policy. Those doubts, irrespective of what informs them, seem to be at odds with the relatively benign outlook for how severely the trade tension will affect global growth.
Trade tensions are hardly the only thing the Fed has to be concerned about. In a note out earlier this month, Credit Suisse suggested that rather than counting the number of months since the last downturn or trying to discern what patterns existed prior to previous post-War recessions, you might want to look at balance sheets, if it's canaries you seek. To wit, from the note (the reference to "this era" refers to post-1982 cycles):
This era has also seen rapid secular debt growth, an increase in market based financial intermediation, high derivatives use, and large capital flows. The era’s two biggest recessions – 2008 and 1991 – involved deleveraging, credit crises, and messy bankruptcies of financial and non-financial firms. In our view, the causal relationship between those balance sheet problems and recessions runs both ways, with those recessions intensifying when balance sheet dynamics weakened by a slowdown started to constrain behavior which then worsened activity further.
The bank's subsequent assessment of balance sheet health in the U.S. is, well, balanced (pardon the bad pun). On the bright side, they note that looking at gross leverage can be misleading (net debt is sitting near its three-decade average), maturity profiles have been extended (thanks in no small part to post-crisis monetary policy) and the stock of liquid assets on corporate balance sheets is now sufficient to cover more than half of short-term liabilities (if you're not up on such things, that is very high historically).
That said, there are problems. Notably, the desperate hunt for yield combined with the newfound threat of rising rates has catalyzed voracious demand for CLOs. That demand is at least in part responsible for a rather disconcerting trend in the market that's seen covenant-lite deals comprising a larger and larger share of new supply, which has in turn left three quarters of the leveraged loan market cov-lite.
(Credit Suisse)
That's all fine and good unless interest costs rise so far, so fast that issuers can't keep up, in which case things can get ugly very quick.
The Fed is surely aware of that scenario. While we're on this subject, do note that the Q1 dollar funding squeeze, which was precipitated by the knock-on effects of the tax cuts and the spending bill (e.g., repatriation effects and T-bill supply), breached the floors for floating rate borrowers.
(Credit Suisse)
This is where I get to refer you back to an all-time Heisenberg classic post called "'FRYBOR': Conversing With Drunk Albanians".
All in all, there seems to be a bit of cognitive dissonance within both the buyside and sellside communities when it comes to positing, on the one hand, a benign scenario wherein strong U.S. earnings, a robust U.S. economy and a reasonably favorable resolution to the trade tensions allow everything to proceed apace and, on the other, a Fed that won't ultimately be able to complete the normalization of policy due to a variety of concerns ranging from technical problems (see the above discussion from Morgan Stanley) to the possibility that the trade war mushrooms into something that represents a threat to global growth.
Generally speaking, I'm inclined to believe that the benign scenario is far-fetched at this point, if for no other reason than the fact that the "synchronous global growth" narrative that defined 2017 has morphed into a U.S.-centric story that implicitly assumes this expansion will end up being the longest in recorded history. I'm not sure that is a safe assumption.
When you throw in the fact that the Fed is effectively hamstrung in its ability to respond quickly by the necessity of guarding against a scenario where the combination of late-cycle fiscal stimulus and tariff-driven price increases spurs an acceleration in domestic inflation, you've got a less-than-ideal setup.
Coming full circle, I'm not keen on pushing an overtly bearish narrative just for the sake of being pessimistic. But I am keen on conducting a rigorous examination of the underlying dynamics at play both in markets and on the geopolitical scene. The above represents just such an examination.
In short, I'm not the bear you're looking for. But I'll be him today.

Toward a New Understanding of World Trade

Precise evaluations of current and future global trade patterns are more important tan ever.

The first rule of studying international trade is that no single rule, statistic or equation is capable of adequately explaining either current or future trade patterns. Trade is too intricate and too variable, its shape naturally adjusting to conflict, politics, disruptive technologies and so on. This makes reliable data difficult to collect, and the presentation of trade data, like any statistic, can be manipulated to support almost any argument. Anecdotal evidence can complete the picture, or even paint a different one, and thus is just as important as what the numbers say. Ultimately, even the most elegant system of trade-related econometrics must judge itself not on the cleverness of its equations but on whether it describes reality accurately.

Despite the inherent difficulties of this work, the ability to precisely evaluate current and future global trade patterns is more important than ever. Protectionism is back in the news. In truth, protectionism never went away, and lest we think this is only a U.S.-driven process, we need only remind ourselves that Canada and the U.K. intimated last week that they were considering certain protectionist measures unrelated to U.S. moves. The international trade system since 1945 has been deeply marked by a veneer of free trade, but no one would assert that the progression toward freer trade is linear, an inevitable end of economic history.

In recognition of the need to do this important work and to make our analysis more accessible and transparent, GPF is exploring new quantitative ways to analyze trade relationships. We are beginning with a fairly unambitious goal: We want to establish a way to quantify the relative dependency in a bilateral trade relationship over a single commodity. The basis of our approach comes from a 1991 analysis by GPF founder and chairman George Friedman in relation to Japan’s dependence on imports. This approach is by no means sacrosanct, nor do we think it is a perfect representation of trade dependency. We do, however, think it is a useful tool for starting a more holistic conversation about how trade works – a conversation sorely missing from the present media environment.



This approach depends on establishing a relationship between three variables. The first variable is the importance of the commodity or good to the importer. Take, for example, Canadian imports of U.S. steel. We need to know how much steel Canada imports from the U.S. and how much it imports from the world overall. Dividing the Canada-U.S. import relationship by Canada’s total imports gives a sense of Canadian reliance on the U.S. for that commodity. Note that this is measured by physical weight (or in the case of a finished good, number of units), because that is more important to the importer than price.

The second variable is the importance of the trade of the commodity or good to the exporter. For the exporter, the monetary value of the trade is more important than the quantity – after all, the goal of the exporter is to make money, while the goal of the importer is to acquire a commodity or good. The second step, therefore, is to measure the importer’s payment for the import in relation to the total amount the exporter derives from that commodity or good in general. To use the example above, that would mean determining the amount Canada paid the U.S. for steel, and then dividing that figure by total payments for all U.S. steel exports.

Once these two relationships are established, a final variable is determined: whether the importer could easily find another source for the commodity or good in question. For this, we return to weight or unit measurements, and we compare the exporter’s production of the commodity or good (in this example, steel) to the total production of said commodity or good in the world. This last step is in many ways the most crucial. If the total availability of the commodity or good indicates that it would be fairly easy to find alternative sources, what might have looked like a highly dependent relationship for the importer can become a highly dependent relationship for the exporter.

By dividing the ratios established in the first and second variables, and then multiplying that figure by the ratio established in the third variable, we are left with a figure that gives a relative sense of dependency. If the figure is greater than 1, the importer is vulnerable; if it is less than 1, the exporter is vulnerable. The further the figure gets from 1 in either direction, the greater the dependency. For example, the vulnerability coefficient for Japanese imports of Australian coal in 1991 was 13.7, indicating that Japan was extremely dependent on Australian coal. (The figure has since dropped to 3.69, suggesting a trend of decreasing, if stubborn, dependence.) Conversely, Japan’s vulnerability coefficient for oil from the United Arab Emirates was just 0.01 in 1991, suggesting that Japan, which is almost entirely dependent on imports for its oil, nevertheless had the upper hand in the oil trade relationship with the UAE.

This way of looking at dependence comes replete with flaws, as does any mathematical approach. It does not, for instance, account for the ability of the importer to produce for itself the commodity or good in question. It is also less valuable the broader the definition is of the commodity or good. Steel is a commodity, but there are many types of niche steel products. Canada may not exhibit a statistical dependency on U.S. steel imports overall, but perhaps it does depend on American coiled stainless steel wire, which would be very important in determining the direction of a trade negotiation. This means that to grasp the nuances of dependency requires highly focused analysis of specific commodities about which it will often be difficult or impossible to acquire the requisite data to make a calculation.

GPF has always defined itself as an organization whose research is based on both qualitative and quantitative methodologies. For those to whom data is a religious principle, this has at times provoked negative reactions. They believe “qualitative” is a dirty word for lacking rigor. But blind attachment to data is equally lacking in rigor. We have always tried to find a medium between these two poles, both trusting what we see while developing mathematically driven ways to simplify a complex issue like bilateral trade.

We will use the approach above increasingly in the coming months. Indeed, our first analysis on this issue will appear later this afternoon. As always, we welcome your feedback – especially from those who see solutions to the flaws inherent in this approach. One does not need an economics degree to engage in this kind of work; real-world observations can be just as valid as attempts to describe reality through equations. This is not a knock on economists but a testament to our readers, who have a great deal of both to offer. We invite you to join us in better understanding international trade as old patterns begin to transform.

Why Governments Should Invest in Sports

Luis Alberto Moreno

A member of the Satere Mawe tribe shoots at the goal

WASHINGTON, DC – As the World Cup unfolds, captivating soccer fans around the globe, the broad appeal of high-level sports is on full display. But the impact of sports extends far beyond major international events, as impressive they may be, to include far-reaching benefits for ordinary people.

Initiatives that encourage people to exercise regularly can help to reduce the incidence of strokes, cancer, and depression, resulting in higher productivity and lower health-care costs.

These are important goals for a region like Latin America and the Caribbean, where one in four adults is obese – a trend that has worsened over the last decade.

Sports can also strengthen social relationships, by bringing together people from different backgrounds and creating a sense of shared purpose and identity. Moreover, they can provide a productive outlet for young people, keeping them focused and engaged and boosting their self-esteem, thereby reducing their vulnerability to harmful social influences. And they can promote qualities like perseverance, teamwork, and leadership – the kinds of soft skills employers seek in job candidates – while even supporting gender equality.

In short, sports programs are good for individuals, communities, and countries. That is why, since 2004, the Inter-American Development Bank (IDB), of which I am president, has supported sports-for-development programs for at-risk youth in 18 countries. Such programs often combine the sport itself (namely, soccer) with vocational training and internships.

The results are promising, to say the least. Around 70% of participants complete the program; of those, more than 65% get formal jobs, return to school, or start a business within one year. A project carried out in El Alto, Bolivia, used soccer to enable more than 600 girls to learn leadership and other useful life skills. Though we have only limited data on their progress, we know from other research carried out in the United States that participation in sports can have long-term benefits for women, including higher educational attainment and job earnings.

Despite these benefits, Latin American and Caribbean countries spend a relatively modest 0.1% of GDP on sports programs with broad social goals – about one-third as much as their European counterparts. Does this mean that these countries should increase their investment in sport? It depends on the investment.

Not all sports programs are created equal. In Europe, researchers have found that youth recreation centers where activities are not structured sometimes become gathering places for kids involved in high-risk behavior such as gang activity.

Highly structured programs that build strong relationships between students and their coaches or other mentors are much more effective. For example, supervised sports programs for schoolchildren can be strengthened as part of efforts to extend the school day – an accelerating trend across Latin America and the Caribbean.

The IDB’s research and experience with sports-for-development programs supports these conclusions, indicating that the value of pubic investment depends on the specific strategy. But it is not yet clear precisely which strategies work best. Thus, to maximize the economic and social benefits of government investment in sports, policymakers need more information.

Specifically, there is a need for more experimentation, improved data collection, and careful evaluation, including reliable comparisons with competing approaches. At the IDB, we have found that the key is to test pilot projects and assess the data that are generated. Governments and other organizations, including development institutions like the IDB, can then work together to scale the programs that prove most effective, while applying the lessons of less effective interventions.

Much like scoring a goal, hitting a home run, or dunking a basketball, making sports-for-development programs work requires a lot of practice, not just to master the technique or approach, but also to be able to apply it to diverse circumstances. What happens on the playing field depends on everything that happened before – the failures as well as the successes.

If governments are not willing to put in the work, their investments will not be worthwhile. If, however, they commit to the experimentation, evidence collection, and evaluation that all smart public spending requires, sports-based investment can go a long way toward strengthening communities and enabling young people to live healthier, happier, and more productive lives.

Luis Alberto Moreno is President of the Inter-American Development Bank, and a member of the World Economic Forum’s Foundation Board.

Canada Gets Tough on Chinese Steel

Ottawa wants to avoid becoming dependent on Chinese suppliers.


As U.S. tariffs on steel hit markets around the world, Canada is considering ways to protect its own steel producers. The Canadian government is preparing to impose a combination of quotas and tariffs on steel imports from certain countries including China, according to a Bloomberg report last week that cited “people familiar with the plans.” This in addition to the Canadian tariffs on U.S. goods (including a number of steel products) worth 16.6 billion Canadian dollars ($12.6 billion) that went into effect on July 1.

According to the Bloomberg report, which remains unconfirmed, the new measures would be meant to prevent Chinese steel, in particular, from flooding the Canadian market to avoid duties imposed by the United States. That is only partly true. The broader issue is China’s steel dumping practices in general. With the U.S. attracting so much attention, Canada is now quietly considering imposing protectionist measures of its own that are not too different from those levied by its southern neighbor.

China’s dumping of steel on the global market has reduced steel prices and, in so doing, hurt the bottom line for Canadian steel companies, as well as companies from many other countries. It has also led to an increase in Canadian imports of Chinese steel. Though the U.S. is still by far the largest supplier to Canada – 55 percent of Canadian steel imports came from the U.S. last year, compared to just 7 percent from China in 2018 – China’s share is increasing while the United States’ is decreasing. And the sheer volume of Chinese production is an advantage for Beijing.


Right now, Canada isn’t overly reliant on China – it has access to cheap steel from elsewhere. But its reliance is increasing, and that could leave Canada in a vulnerable position in the future. Canadian imports of Chinese steel increased 26 percent in the first five months of 2018 compared with the same period in 2017. The only way for Canada not to become dependent on Chinese steel is to impose tariffs, quotas or other protectionist measures. After all, China has already shown it will not reduce production. (Whether that’s because of a lack of will or ability on China’s part is a key question, but we’ll leave that aside for now.) If Canada were to block Chinese steel imports, it would likely increase U.S. imports, but this wouldn’t make Canada dependent on U.S. steel. It would merely replace Chinese imports for U.S. imports – a better position for Canada even with the tough stance U.S. President Donald Trump has taken on trade. It’s also likely that once NAFTA talks are completed, the U.S. will grant Canada an exemption to steel tariffs – which the Trump administration has often used as leverage in the negotiations.
Another country on which Canada could consider imposing tariffs is Turkey. Turkish steel imports to Canada have increased a whopping 615 percent from roughly this time last year. Still, Turkey is far more dependent on Canada as a market than Canada is on Turkey as a supplier. Even if Canada blocked Chinese steel from entering the Canadian market, the trade relationship between Canada and Turkey would remain roughly the same, with Turkey more dependent on Canada because Canada would still have many other potential suppliers to fall back on. Even though Canada is not in danger of developing a dependency, the large increase in Canadian imports of Turkish steel looks bad politically, and for the purpose of boosting domestic production, Canada may decide to take aim at Turkish suppliers. Prime Minister Justin Trudeau is, after all, facing elections in 2019 and may be looking for a boost among certain constituencies in which he is currently unpopular. Moreover, a few tariffs, paltry when compared to those imposed by its southern neighbor, would likely go relatively unnoticed on the world stage.

For Canada, it comes down to a simple question: Is it preferable to have cheap steel and a potential trade dependency on China, or more expensive steel without any significant dependency on a single country? Ultimately, the latter is the better option. And if Canada no longer trusts the U.S. as a trade partner and wants to be self-sufficient when it comes to steel, it could achieve that as well: Canada can produce enough steel to meet its domestic demand, though this would require investing in the production of stainless steel, for which Canada currently relies on imports. But self-sufficiency is likely a bridge too far – especially for the present government, which has vehemently supported free trade. Tariffs on Chinese steel can be far more easily justified to Trudeau’s base than broader tariffs that would target a variety of countries. Most important, Canada is better served strategically by staying close to the United States. Given the choice then – and on steel imports, it looks like Canada is, for once, in the driver’s seat – we expect Canada to try to restrict Chinese steel imports while encouraging imports either from the U.S. or other countries with which it has closer ties.

 US Political Center Is Being Devoured From Both Right And Left 

President Trump will soon nominate his second Supreme Court justice. The first, Neil Gorsuch, has so perfectly replaced the late Antonin Scalia that it’s safe to assume retiring justice Anthony Kennedy’s successor will be in the same mold – which is to say formidable and unapologetically conservative. The result will be a solid conservative majority that’s more definite and less flexible on the issues where Kennedy was a swing vote.
And that’s if Notorious RBG manages to hang on through the Trump era. If she goes (and at 85 she’s likely to go soon one way or another) Trump will be one of those extremely rare presidents who gets to name THREE justices, thus extending his influence from four years to an entire generation.

Among the possible results of such a conservative judicial super-majority are the reversal of rulings that made abortion and gay marriage the laws of the land, making both state-level issues once again, where they’ll further polarize already-divided electorates.

Meanwhile, the Democrats are lurching waaayyy left. The implosion of the moderate Clinton wing of the party began during the past presidential election, when huge parts of the left openly supported socialist Bernie Sanders. This group now sees Elizabeth Warren – Bernie Sanders with a penchant for verbal street fighting – as the ideal candidate next time around. And despite a fairly consequential set of primary elections last Tuesday, pretty much all anyone is talking about is Alexandria Ocasio-Cortez, a latina “democratic socialist” who unseated a previously entrenched moderate incumbent and is now a lock to win a Bronx congressional seat in November – on a Sanders-esque platform of free everything for everyone and wide-open borders.
Each side is, as a result, finding it really easy to dehumanize the other. After Trump’s press secretary and family are evicted from a restaurant because the owner opposes Trump’s immigration policy, Democrat Senator Maxine Waters encourages liberals to make this a pattern by confronting White House officials in public whenever possible. Waters then gets death threats and responds “If you shoot at me, you better shoot straight.”

But wait, there’s more. This past Saturday:
More than 500 arrested as women rally in D.C. to protest Trump’s immigration policy
They came from all over, took planes and buses from 47 states, slept at friends’ homes or in churches and prepared to be arrested Thursday in Washington, D.C. Most of the participants were white women, stumbling over the syllables of Spanish-language chants. Many had never faced arrest before. But here they were. 
Capitol Police said 575 protesters were arrested and escorted out of the Hart Senate Office Building in a mass demonstration that called for the abolishment of the U.S. Immigration and Customs Enforcement agency, and an end to migrant family detentions and the Trump administration’s “zero tolerance” immigration policy. 
They were charged with unlawfully demonstrating, a misdemeanor. 
“I have two kids, and as a white mother, there is almost no circumstance that they would be taken away from me – ever,” said Victoria Farris, who slept Wednesday night in All Souls Church after participating in civil disobedience training. “I was awake one night because I couldn’t sleep thinking about all those [immigrant] mothers and terrified children. I realized I had to do something more than protest, more than make a sign and march.” 
Just after 3 p.m., protesters were rounded up in groups of a dozen or more and led out of the building. 
“Abolish ICE,” they shouted as more were moved out. “Shut it down.”

And Sunday:
Riot in Portland as far-right marchers clash with anti-fascists
A riot was declared in downtown Portland, Oregon on Saturday evening as the city exploded into its worst protest violence of the Trump era. 
More than 150 supporters of the far-right Patriot Prayer group fought pitched street battles with scores of anti-fascist protesters. In total, nine people were arrested. 
The far-right march had started near Schrunk Plaza in the city centre, where the rightwing group had held a rally, led by the Patriot Prayer founder and Republican US Senate candidate Joey Gibson. 
As soon as the group left the plaza, they clashed with anti-fascists who had been waiting across a heavily barricaded street nearby. 
As the two groups came to blows, Department of Homeland Security officers fired non-lethal ammunition towards the counter-protest.

What does all this late-1960s-esque turbulence mean and how does it tie into the populist wave that’s sweeping the rest of the world? The simple answer is that when a society borrows too much money it loses the ability to keep its people happy. The big systems stop working as pension plans and local governments run out of money, inequality becomes a chasm as the people with assets get richer while the people with debts sink into poverty, and disaffected voters lose faith in the establishment to address their needs. And they come to hate the people on the other side of major issues — even though those people are frequently also victims of the elites’ predation.

Each election becomes an adventure in which formerly fringe candidates do progressively better until they end up taking power. At which point the discredited center evaporates and everyone chooses one extreme or the other, losing any remaining shred of empathy for their political opponents.

And media accounts like this become the conventional wisdom:
Is America headed toward a civil war? Or is the civil war already starting?
White House press secretary Sarah Huckabee Sanders was even kicked out of the Red Hen restaurant in Lexington, Virginia, because the owner and employees disliked her politics. This seems like a small thing, but it would have been largely unthinkable a generation ago. 
And, in a somewhat less “soft” manifestation, Homeland Security Secretary Kirstjen Nielsen was bullied out of a restaurant by an angry anti-Trump mob, and a similar mob also showed up outside of her home. 
Will it get worse? Probably. To have a civil war, soft or otherwise, takes two sides. But as pseudonymous tweeter Thomas H. Crown notes, it’s childishly easy in these days to identify people in mobs, and then to dispatch similar mobs to their homes and workplaces. Eventually, he notes, it becomes “protesters all the way down, and if we haven’t yet figured out that can lead to political violence, we’re dumb.” 
Political contempt is the problem 
Marriage counselors say that when a couple view one another with contempt, it’s a top indicator that the relationship is likely to fail. Americans, who used to know how to disagree with one another without being mutually contemptuous, seem to be forgetting this. And the news media, which promote shrieking outrage in pursuit of ratings and page views, are making the problem worse.