Donald Trump’s war on the liberal world order

The president has broken with seven decades of US foreign policy

Martin Wolf

We have no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow.” Thus did Lord Palmerston, British prime minister from 1855 to 1858 and 1859 to 1865, describe his country’s foreign policy at the apogee of its global power.

Donald Trump is a Palmerstonian, as a former senior official at the US state department advised me last week. If any coherent doctrine underlies the president’s assault on the world order his own country created, that is it. But Mr Trump is no Palmerston and the early 21st century is not the middle of the 19th. Mr Trump’s narrowly transactional approach, driven by ignorance and resentment, risks disaster.

The US took a very different view in the aftermath of the second world war. The jockeying for position among mutually suspicious and nationalistic great powers had led to two shattering world wars. These had left Europe prostrate. No rationally founded idea of “interest” could justify this dire outcome. The world needed a much more enlightened vision of international relations than this one had been.

The new vision contained three essential elements. First, having been dragged out of its isolationism by two world wars, the US would become the stabilising power. Second, the US would form eternal alliances built on shared values. Finally, a set of international agreements, initially mostly economic, subsequently extended into areas such as climate, would provide a predictably liberal global economy and the capacity to tackle global challenges. All this, US policymakers believed, embodied a rational view of US interests. Its power was to be allied to beneficial ends by novel and intelligent means.

The US has made big mistakes: above all, trusting too much in the efficacy of interventions, especially military intervention, in other countries. Yet, overall, the Pax Americana has been a period of great success. The resurgence of world trade helped deliver an unparalleled era of global prosperity. The political and economic successes of the west gave victory over Soviet communism. Despite China’s rise, the US and its allies still enjoy preponderant economic and military power. (See charts.)

In the words of the King James Bible, “there arose up a new king over Egypt, which knew not Joseph”. That ignorant king is Mr Trump, who knows not those Americans who created the postwar order. He believes in transactions over alliances, bilateralism over multilateralism, unpredictability over consistency, power over rules and interests over ideals. He prefers authoritarians such as China’s Xi Jinping, Russia’s Vladimir Putin and even North Korea’s Kim Jong Un, to the leaders of his democratic allies. In his view, might makes right.

Striking features of Mr Trump’s behaviour are his fabrications, self-pity and bullying: others, including historic allies, are “laughing at us” over climate or “cheating” us over trade. The EU, he argues, “was put there to take advantage of the United States, OK? . . . Not any more . . . Those days are over.” These are absurd claims.

Armoured by ignorance and such attitudes, Mr Trump might do just about anything, particularly now, when he seems to be increasingly self-confident. The trade wars he is unleashing, under dubious justifications and for uncertain ends, lack clear outcomes. As Gavyn Davies notes, the cycles of retaliation might be prolonged. The costs of deglobalisation might be very high, especially if one includes the uncertainty it will create. Adam Posen, director of the Peterson Institute for International Economics, in Washington, notes the risk that these conflicts will “break down the separation between commerce and national security, raising the risk of significant escalation of conflict”. Mr Trump is deliberately confusing trade with national security. That has to make resolution far more difficult to achieve.

Mr Trump’s attitudes to China and Europe now look the most momentous. If the US dissolves its commitment to Nato or uses all its might to break up the EU, the stresses upon the latter — and the incentive for Russia (or China) to meddle in it — could be huge: Europe might come together, or it might break apart. Again, Mr Trump is determined to challenge China’s rise. While some progress on trade issues is indeed possible, this broader objective is not one China could conceivably accept. Growing friction now looks inevitable.

This, then, is an important historical moment. The foundations of the postwar economic and security order, not just of the “holiday from history” of the post-cold war era”, are now in doubt.

The question is whether one should view this as a temporary, albeit perilous, departure from the normal state of affairs, or a far more permanent shift. The argument for the former is that Mr Trump is an exceptional figure, who came from nowhere, in special circumstances. When he passes, so will this upheaval. This may be a delusion. Unless he blows up the world economy, Mr Trump has a good chance of re-election and so may last for six-and-a-half more years. He has identified a large and resentful part of the US body politic whose state is unlikely to get any better, while the gerrymandering of the US vote is likely to get even worse. Not least, a growing number of Americans agree that China is a cheat and a threat and Europeans are carping freeloaders.

Mr Trump will pass. Trumpism might not. The US could become far worse than soberly Palmerstonian. The rest of the world should take that possibility seriously — and think and act accordingly.

Bernanke warns against reading wrong yield curve signal

Distortions mean an inversion does not necessarily point to recession, says former Fed chief

Gillian Tett and Joe Rennison in New York

The last time the yield curve inverted was at the start of 2006, just as Ben Bernanke began leading the Fed © Bloomberg

It would be a mistake to think that the unexpected flattening of the US yield curve signals a looming recession, Ben Bernanke, the former chairman of the Federal Reserve has warned.

Mr Bernanke’s comments come as Fed officials under Jay Powell debate the significance of the narrowing gap between short- and long-term bond yields — a measure of the yield curve.

An inversion of the curve, where short-dated interest rates rise above longer-dated rates, is seen as a warning sign for recession, having preceded every economic downturn of the past 50 years — but some officials believe it has lost its signalling power because of market distortions caused by central banks.

“Historically the inversion of the yield curve has been a good [sign] of economic downturns [but] this time it may not,” because the normal market signals have been distorted by, “regulatory changes and quantitative easing in other jurisdictions”, he said, speaking with former treasury secretaries Hank Paulson and Timothy Geithner at an event to discuss lessons from the 2008 financial crisis.

“Everything we see in terms of the near-term outlook for the economy is quite strong,” he added.

Short-dated Treasury yields have been pushed higher as the Fed has raised interest rates. Meanwhile, longer-dated interest rates have not risen as quickly. Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said on Monday that the Fed should stop raising rates to avoid inverting the yield curve and risking economic turmoil, echoing some investors’ fears.

The last time the yield curve inverted was at the start of 2006, just as Mr Bernanke took office as Fed chair. The Fed continued raising interest rates until June that year. Rates were kept unchanged until September 2007, when it began to cut them again as economic conditions worsened.

But many now argue that the flat yield curve shows the system remains heavily distorted by the unprecedented central bank bond-buying programmes implemented after the financial crisis — meaning central bankers face a long path to return the system to normality.

Mr Bernanke himself did not comment on how badly distorted the financial system might currently be. However, he warned investors that they should not presume that the Fed’s balance sheet would shrink much further in the coming years.

Before the crisis the Fed held less than $1tn of assets, but this quadrupled during the crisis, before the Fed started recently cutting back. “We are not going anywhere close to $800bn again — I think the normal level of the Fed balance sheet is [going to be] closer to $3tn.”

Separately, Mr Bernanke, Mr Paulson and Mr Geithner declared that the US financial system was more robust than now than before the crisis, because of regulatory changes. But they expressed concern about the slow pace of action in Europe, which remains plagued by concerns about the health of some banks, ranging from small Italian lenders to large entities such as Deutsche Bank.

“[The Europeans] kidded themselves about how well capitalised their banks were for a long time,” Mr Paulson said. “I do believe that they have been slower to do the things they need to do.”

They also voiced fears that after the crisis Congress removed many of the statutory powers which Fed and Treasury officials had used in 2008 and 2009 to quell the financial panic.

“You have a more stable [financial] system today because the defences are better — but you have a weaker set of tools for dealing with an extreme crisis,” Mr Geithner said, noting that the 2008 crisis showed “how dangerous it is to not have tools”.

Mr Bernanke and Mr Paulson also pointed to the expansion of US government borrowing.

“This is the most predictable financial crisis in the world,” said Mr Paulson. “Do I think there will be a panic anytime soon? No. But the longer we wait [to deal with it] the more expensive it will be . . . when the economy is so strong is precisely the time the US government should be making an effort to deal with our fiscal issues.”

Defusing the US-China Trade Conflict

Wing Thye Woo

DAVIS – Every year since 2000, when then-presidential candidate George W. Bush called China a strategic “competitor” of the United States, I have welcomed the arrival of Christmas with a sigh of relief that a Sino-American trade war was averted for another 12 months.

But by January, my holiday cheer is usually replaced with dread because the tensions fueling Bush’s rhetoric – and the reasons he dismissed Bill Clinton’s preferred label of “partner” – have never adequately been addressed. And, as we are seeing now, the risks to the global economy have only grown more ominous in the years since.

The escalating US-China trade war is a response to three concerns that American leaders have long articulated: job losses, competition over technology, and a perceived Chinese threat to US national security.

The first concern – American job losses to China – is viewed as a byproduct of China’s trade surpluses, which the US has typically sought to remedy by advocating for renminbi revaluation. But this approach is misguided; the exchange rate is just one factor causing the trade imbalance, and any appreciation of the renminbi is unlikely to alter the status quo in a multipolar world. Consider, for example, what happened after implementation of the 1985 Plaza Accord, which drove up the value of the yen: the US bought less from Japan, but bought more from other countries, causing the overall US trade deficit to remain roughly unchanged.

The US-China trade imbalance stems from structural flaws. For China, those flaws include a weak social safety net, which has raised savings rates, and the backwardness of a state banking system that has lowered investments and sent excess savings abroad. For the US, on the other hand, soaring military expenditures and frequent tax cuts have created the economic conditions for trade deficits, and ineffective adjustment programs have only exacerbated the impact of trade on jobs. The US obsession with renminbi appreciation as the silver bullet for the bilateral trade imbalance has merely diverted attention from addressing its real causes.

The second issue pushing the US and China toward a trade war is competition over technology. For decades, and especially since the mid-1990s, China has made knowledge transfer via joint ventures with Chinese partners a condition for access to its large market. Many US business executives are finally opposing these policies, complaining of being “forced” to share their technology. This chorus of grievance is so loud that tech “theft” may be a bigger concern for Americans than the size of the US trade déficit.

And yet, given that the businesses involved are all willing participants, terms like “forced” and “theft” are red herrings. Moreover, the products that foreign-invested joint ventures produce usually enjoy monopoly prices in China, a benefit that weakens the American argument further.

Still, China’s leaders should not be tone deaf. In the absence of antitrust agreements, trade disputes involving a party possessing market dominance are typically settled only by the ability of the “victim” to mobilize retaliation. With the US government now taking action on behalf of US firms, China’s industrial policies will need to change accordingly, especially if European governments follow America’s lead, as some may.

There are many reasons why the current US government is acting so aggressively now, but two stand out: first, an increased sense of vulnerability proportionate to America’s declining global influence; and, second, the technologies China is now acquiring from foreign companies are frontier technologies. While China may never become a truly global hegemon (because its rise is coinciding with that of India), the US nonetheless feels threatened by China’s rapidly growing geostrategic presence.

And this brings us to the third US concern: national security. Underpinning the anger over technology transfer is a belief that American ingenuity will one day be used against American interests. But this, too, can be addressed. For example, the US could strengthen the review processes carried out by the Committee on Foreign Investment in the United States (CFIUS). With more CFIUS input on the types of foreign partnerships and deals that require federal approval, the US could reduce the risks of technological blowback.

As the international order moves from an era of US-led hegemony to one of multipolarity, overlapping spheres of influence will increase the chances of economic and political friction. Global prosperity requires that the multilateral free-trade system be maintained and strengthened, and this can be achieved only if the national security interests of regional powers are assured.

It is therefore important that leaders in both the US and China recognize the complexity of their relationship. On issues like nuclear non-proliferation, the two sides are strategic partners, as Clinton argued. But in other areas, such as research and development, Bush’s “competitor” label is more apt. To bridge this divide and reduce tensions, leaders must pursue confidence-building measures.

For China, this could mean ensuring more reciprocity in its trade and investment relations with the advanced economies, despite its World Trade Organization status as a developing country. It could also mean offering national treatment (the same registration process as for domestic enterprises) to more foreign firms and easing constraints on foreign acquisitions of Chinese firms, in a way that is consistent with national security.

As for the US, it should stop equating strategic competition (often a zero-sum game) with economic competition (which may be zero-sum in the short run, but creates win-win outcomes in the long run). National economic dynamism and resilience emerge from allowing international competition, not from insulating domestic high-tech firms permanently.

The current US-China trade conflict has been decades in the making; rolling it back will require both sides to acknowledge that old ways of thinking on trade have become counterproductive. Unless both sides start distinguishing between economic and strategic competition, the US-China trade war will not be over by Christmas.

Wing Thye Woo is a professor at the University of California, Davis, Sunway University in Kuala Lumpur, and the Chinese Academy of Social Sciences in Beijing.

Cash gains an edge over S&P 500 dividend yields

Three-month Treasury bill above 2% for first time in more than a decade

Peter Wells

The 2 per cent club has a new member. The yield on the three-month US Treasury bill crossed that milestone for the first time in just over a decade as the Federal Reserve remained on course to keep raising interest rates.

The yield on three-month bills is above 2 per cent for the first time since June 17 2008. The short-term market rate, viewed by investors as essentially a cash-like instrument and a very liquid haven in times of market turmoil, has doubled since the start of last September. The relentless rise in bill yields reflects a steady tightening of interest rate policy by the Fed, while the US Treasury has substantially boosted sales of short-term debt to help finance a worsening budget deficit.

The yield on the three-month T-bill has moved further above the trailing 12-month dividend yield of the S&P 500, in what probably signifies the dying moments of the Fed’s exceptional assistance to the stock market.

Since the 1960s, periods when three-month bill yields have been greater than the dividend yield of the S&P 500 have been relatively rare but have certainly not lasted for as long as the past decade. The most recent period stems from the Fed’s decision during the financial crisis to cut interest rates towards zero and conduct several rounds of bond purchases, known as quantitative easing.

A further climb in bill yields beckons as the central bank expects to deliver two more 25 basis point interest rate rises in 2018, while it has pencilled in three rate rises for 2019.

Why Mom and Pop Should Be Kept Away from Banks’ Bailout Bonds

Two new ETFs will let ordinary investors buy risky bank debt, which isn’t a good idea

By Paul J. Davies

Yield to maturity on an index of Cocos* 
Source: IHS Markit

Note: *iBoxx USD Contingent Convertible Liquid Developed Market AT1 index

Banks are hard enough to understand when it comes to owning their shares. But the complexity is doubled if you invest in their risky high-yield bonds, which are designed to pay for losses in times of trouble.

Mom-and-Pop investors in most countries have been blocked from owning these technically complex securities directly, which are often known as Cocos, an abbreviation of “contingent convertible.” However, now, retail investors can buy them in two exchange-traded funds. That might be a sign that this young market is growing up. Or perhaps it is a recipe for disaster. 
European and Asian banks have issued Cocos worth billions of dollars to help shore up their balance sheets since the 2008 crisis. They are cheaper to finance than equity, but still absorb losses in times of crisis and therefore make taxpayer bailouts less likely.

Deutsche Bank’s headquarters in Frankfurt. Photo: Michael Probst/Associated Press 

However, they have been criticized for being too complicated even for institutional investors and performance has been volatile. Prices plunged in early 2016 when fears around Deutsche Bank’s Co cos and misunderstandings about how they worked sparked panic in the sector. The collapse brought a spike in yields, which reached 10.7% for the iBoxx index of the most liquid, dollar-denominated Cocos in mid-February 2016, up from 7% at the start of January. 
This index is the basis for Invesco PowerShares’ new AT1 Capital Bond ETF, which was launched last week. WisdomTree launched a similar fund in May, based on a wider, multicurrency iBoxx Coco index. Neither fund is aimed at the retail market, but anyone can buy them.

Individual investors can access lots of assets through funds they couldn’t buy directly—corporate junk bonds or emerging-markets debt, for example. However, bank capital poses more problems than just complexity when held by retail investors.

In Italy, banks were allowed to keep selling similar bonds to individual investors. That has made fixing problem banks more difficult, because politicians were fearful of imposing losses on ordinary savers.

This is the essential problem with allowing nonprofessionals near these bonds: If the bonds can’t take losses, they don’t work as capital. One bond going bad in a fund should just mean a small loss, which is fine. However, if a lot of retail money is involved during a wider crisis, taxpayers’ money will be at risk again.

Why China Needs to Manage Expectations

Beijing has let the gap between the myth and the reality of its power grow too wide.

The Americans behold China’s military and technological achievements and are afraid. Japan is in awe, the Europeans are regretful. That’s the message in recent Chinese media headlines – and it’s wrong, according to the People’s Daily, a Communist Party of China mouthpiece. In the first story in a three-part series, the People’s Daily warns the Chinese public that “[a]rrogance won’t make a country powerful.” In a separate story on Monday, the official newspaper of the Chinese army printed an editorial that said the People’s Liberation Army had “peace disease” that could undermine its ability to wage war. Both stories were subsequently referenced in the English-language South China Morning Post, ensuring that they would reach the English-speaking world.
China, as all countries do, has been emphasizing its achievements and celebrating its future. These two articles break the pattern and thus need to be taken seriously. They are not the random musings of individuals; they are carefully considered messages from China’s leadership.
Why is China suddenly downplaying its military and technological capabilities for all the world, including its own citizens, to see? Part of the reason is that the image China has crafted – that of a dominant-power-in-waiting – has triggered reactions it was not prepared to cope with. The obvious example is U.S. trade protectionism, which is as much an attempt to curb China's rise as it is an attempt to defend U.S. industry. In Europe and elsewhere, the vision of China sweeping aside other powers has become standard, and the response has not always been friendly. There is a perception, for example, that China’s investments frequently benefit China but infrequently benefit the recipient country.
Similarly, the portrayal of China as a world-class military power has given the U.S. a greater sense of urgency to sustain its military edge. It created unease among China’s neighbors, such as Japan, which is capable of matching China’s military. Every time the U.S. parades one of its warships through South China Sea waters claimed by Beijing without any forceful Chinese response, it exposes the gap between what China says and what it can actually do.
During the 19th National Congress in October, Chinese President Xi Jinping said that China would leapfrog the world in technological development and would become a world-class military power by the middle of the century. He did not claim that China had yet accomplished either of these goals. China’s media played it differently. Facing substantial economic and financial difficulties from declines in exports and non-market allocation of capital, the media projected an image of a nation overcoming these problems and entering an even higher echelon. Both the Chinese public and foreign powers have seen this image and believed it – and the foreign powers are reacting against it.
China must now ready the public for the reality that its military will not soon be ranging the world, or even securing the South China Sea, after all. More important, it must prepare its people for the fact that the economy will be further buffeted by U.S. tariffs. It can punch back, but not with the same force as the United States. China depends on its exports more than the U.S. depends on Chinese imports, and thus China is more at risk.
Countries often overstate their own strength. Sometimes the world ignores them. Sometimes it believes them and is intimidated. And sometimes it believes them and responds, with unpleasant consequences. These two articles indicate that China feels it has exposed itself by letting the gap between its myth and its reality get too wide. The question now is at what point – should China’s public recalibration continue – this correction begins to undercut U.S. arguments that tariffs are an essential defense against a powerful and predatory China.