US trade hawks seize their chance to reset China relations

Latest tariffs look more like the start of a cold war than a trade war

Rana Foroohar

It would be easy to see the latest $200bn round of US tariffs against China, set to go into effect on Monday, as just another provocative shot fired off by an American president in need of overseas distractions at a time when the legal noose seems to be tightening around his own neck.

But that would be wrong. In fact, far from being an ill-advised and hasty policy decision emanating solely from Donald Trump’s White House, this latest tariff round represents something much more dangerous and lasting: a true reset of economic and political relations between the US and China, and the beginning of something that looks more like a cold war than a trade war.

This reset is supported by factions stretching well beyond Mr Trump, on both the left and the right. That is what makes it so serious. The president is indeed single-mindedly obsessed with the US-China trade deficit, but he’s also the sort of person who will cut a deal for personal gain, and it is hard to imagine that the Chinese could not come up with something that would make him flip to a more moderate position.

Not so the economic hawks within the administration, like Mr Trump’s trade adviser, Peter Navarro, and Robert Lighthizer, the US trade representative, who are playing an entirely different game. They believe it is in the long-term national interest for the US to decouple economically from China.

There are plenty of people in the Pentagon, as well as some in the labour faction of the progressive left, who agree. Many of these people will be in positions of power long after this president is gone. They have different agendas, but coalesce around the idea that the US and China are in a long-term strategic rivalry, and that, as a result, US trade policy and national security policy should no longer be separated.

That marks a fundamental shift for global business. The economic hawks have little sympathy for multinational chief executives who complain that the latest round of tariffs is broad and deep enough to create real inflationary pressure or force them to raise prices. Indeed, they see these companies as traitors who have naively sold out for short-term gain in a country that does not share fundamental western values, and will ultimately not allow them equal market access.

And in the current economic and political environment, they have taken control of the narrative. Hawks can cite Chinese intellectual property theft, human rights violations, and aggression in the South China Seas as proof of their position.

“You hear a lot of them talk about China as a ‘revisionist’ power, like the Soviet Union — a purveyor of a completely different system,” says Arthur Kroeber, managing director of Gavekal Dragonomics, a China-focused consultancy. That vision may be overblown, but it is an easier sell than defending status quo economic globalisation to an American public who are increasingly anxious about China or robots (or Chinese-made robots) taking their jobs.

The hawks have also been quite clever so far about crafting tariffs that will minimise the impact on consumer prices while also penalising companies that have shifted the most sensitive supply chains to China. Think of chipmaker Qualcomm (which has found itself on the wrong side of nationalism in both countries) or tech group Cisco, which lobbied unsuccessfully to have its routers and switches, which power smart cities in China as well as the US and Europe, left off the latest tariffs list.

A white paper recommending some US supply chain insourcing, prepared by the Department of Defense and likely to be released next month by the White House, may provide guidance on where the Trump administration will take its nascent attempt at industry policy. But it is clear that not all companies will suffer equally in a US-China cold war.

Traditional consumer businesses — Starbucks, say, or Walmart — will be able to maintain a Chinese market presence more easily than high-tech companies trafficking in sensitive data, or any business working in strategic areas such as mapping or autonomous vehicles. Apple, Facebook, Microsoft, Google and any number of other US multinationals doing business in China may have tough choices to make in the future if the trade war escalates into a cold war in which they can no longer turn a blind eye to the national concerns of the states where they operate.

The pain may be felt in China first, since the country is still much more export dependent than the US. But over the mid- to longer-term, US companies have more work to do in terms of insourcing supply chains.

It is both politically and logistically unfeasible to become Fortress America, insourcing everything, which means that the Trump administration must build alliances with trade partners in places including Europe if it wants to be able to execute an American industrial policy — not a strength of this president.

Business faces more existential challenges. What does it mean for a company like, for example, Google to launch a censored search engine in China, while its parent company, Alphabet, refuses to send its chief executive, Larry Page, to testify in the Senate on Russian meddling in US tech platforms? Can corporate leaders be above politics? They used to like to think so. Today, that seems like wishful thinking.

Resetting the Terms of North Korea Talks

The Pyongyang Declaration changes little but hints at a path forward.

By Phillip Orchard

Roughly thirteen years ago, in a joint statement released at the conclusion of the fourth round of six-party talks on North Korea’s budding nuclear program, Pyongyang pledged to “abandon all nuclear weapons and existing nuclear programs.” Less than a year later, the North tested its first nuclear device. In 2008, to revive the diplomatic process and ease Western sanctions pressure, the North Koreans blew up a cooling tower at the Yongbyon nuclear reactor complex under the watchful eye of international inspectors and provided the U.S. what they claimed was a full inventory of their nuclear activities. Since then, of course, the North has tested five additional nukes, each larger than the last, plus three intercontinental ballistic missiles (albeit with only partial success).

On Wednesday, in a joint statement following two days of landmark meetings with South Korean President Moon Jae-in in Pyongyang, North Korean leader Kim Jong Un again reiterated his oft-misinterpreted commitment to “turn the Korean peninsula into the land of peace without nuclear weapons or nuclear threats.” Notably, Kim also offered to dismantle the Yongbyon complex altogether (provided the U.S. takes certain reciprocal actions), as well as a key missile test site and launch pad. He even pledged to allow international inspectors in to verify that they did it. In response, U.S. Secretary of State Mike Pompeo said Wednesday that the U.S. was ready to restart talks with the North immediately and asserted that denuclearization of the North would be complete by 2021.

It’s natural to see the Pyongyang Declaration as merely another iteration of the North’s well-established pattern of duplicity. Skepticism is certainly warranted about any measures of good faith proffered by Pyongyang. But what’s different this time around is that the North is negotiating as, for all intents and purposes, a nuclear power. And when weighed against its broader geopolitical imperatives, the North’s behavior over the past year, not to mention Kim’s own rhetoric, has made Pyongyang’s intentions perfectly clear: It’s willing to talk about steps it can take to make it easier for the U.S. to stomach a nuclear North without violating Washington’s own imperatives on the matter. But absent dramatic moves that the U.S. is not ready to take, the North will remain nuclear. A core goal of last week’s declaration – for both Pyongyang and Seoul – was to reset the terms of the negotiation around this reality.

Fanciful Ambitions

As we’ve noted previously, the U.S. and North Korea mean different things when they talk about denuclearization. In the Trump administration’s view, denuclearization needs to be complete, verifiable and irreversible – CVID for short. In Pyongyang’s view, denuclearization means effectively the same thing as what the U.S. agreed to in 1968 when it signed the Nuclear Nonproliferation Treaty, which requires Washington and other nuclear states to pursue disarmament – someday. Kim’s lofty pledge in last week’s declaration to rid the peninsula of nuclear weapons and, crucially, nuclear threats was no different.

Pyongyang may get serious about denuclearization if U.S. forces leave the peninsula and Washington somehow convinces the North that South Korea and Japan no longer sit under the protection of the U.S. nuclear umbrella. That’s why “nuclear threats” (read: from the U.S.) was included in the Pyongyang Declaration. But Seoul and Tokyo are nowhere near ready for such a move, and certainly won’t be by 2021. Moreover, the North would still have ample reason to hold onto its nukes. The only country to give up an existing nuclear arsenal, South Africa, did so because it lost its strategic rationale for its nukes, rendering them more expensive than they’re worth. The North would still be living in a hostile neighborhood, with a long memory of being used as a pawn by stronger powers, and nuclear weapons would remain the ultimate deterrent against invasion. (Not to mention, the loss of the U.S. nuclear umbrella would make Japan and possibly South Korea more likely to go nuclear.)

The only other way the North would disarm is if the U.S. addressed the issue directly by going to war – or, at least, convincing Pyongyang that war is imminent – but the U.S. isn’t willing to do that.

Avoiding war is the most immediate goal of South Korea, Japan and China too. Sanctions were never going to be enough to force Pyongyang to capitulate, and the sanctions regime is now weakening anyway, perhaps irrevocably. Thus, what can realistically be negotiated falls far short of the denuclearization question. So long as the North refrains from proving the ability to strike the U.S. mainland with any degree of certainty – and its missile program is still not at the point where it can – the U.S. can live with a nuclear North, just as it has lived with a nuclear Pakistan. The North needs sanctions relief and security guarantees from the U.S. to stay the diplomatic course, and the U.S. has political interests at stake in how the process unfolds. But these are surmountable obstacles to a deal, even if it’s never more than a tacit one.

Concrete Measures

As could be expected, then, none of the moves outlined in the Pyongyang Declaration would amount to a major step toward complete disarmament. However, they do hint at a path forward for both sides.

The impact of dismantling nuclear facilities at Yongbyon would depend on what actually gets dismantled. Yongbyon is a large complex containing several key facilities, including a fuel enrichment plant, a 5-megawatt reactor, an experimental light water reactor, and a reprocessing facility used to extract uranium (and plutonium) from spent fuel rods. Destroying uranium enrichment facilities would make little practical difference. The U.S. believes the North has at least two other enrichment sites elsewhere. (Indeed, there’s some thought that the uranium enrichment facility at Yongbyon, which began operating in 2010, was built in part as a bargaining chip to be traded away in negotiations.) Destroying the reactors and the fuel reprocessing facility would be more tangible concessions, since doing so may limit the production of weapons-grade plutonium needed for thermonuclear bombs. (It’s unknown whether the North has another covert reactor elsewhere.) On the other hand, the 5-megawatt reactor at Yongbyon, which began operating in the 1960s, is believed to be nearing the end of its lifecycle anyway, so this too may not really be much of a concession.

The wording of the declaration is vague, to say the least, and open to interpretation about what’s actually on the table. In fact, there are reports that the line on Yongbyon was included at Moon’s urging, suggesting Pyongyang wasn’t exactly making a concrete proposal here. (Nor does the declaration elaborate on what “reciprocal actions” Pyongyang would expect in return.)

As always with these things, the devil is in the details. It’s also worth noting that the North hinted at a willingness to invite inspectors to witness destruction only of a missile launching site, not Yongbyon. In a tweet on Tuesday, U.S. President Donald Trump proclaimed otherwise, and it’s of course possible that Pyongyang has made such a pledge to the U.S. behind closed doors. But this is not what was announced in the Pyongyang Declaration. Whatever measures Pyongyang takes at the complex, international verification would be critical.

The offer to dismantle the Sohae missile launch site, which has been used to test both space launch and ICBM engines, is likewise less than meets the eye but not wholly insignificant.

Closing the site would do nothing to hamper the North’s ability to mass produce the types of long-range missiles it has already tested. The North has ample room for advances in missile engine technology, but the engines it has tested already are enough to give it a viable long-range deterrent; its problem is it has yet to prove mastery of re-entry technology, the most difficult part of missile development. Nor would it constrain the North’s ability to launch most types of missiles (whether as tests or in a conflict scenario). The last several test launches by the North were all conducted on road-mobile launchers, which are critical in sustaining the ability to retaliate following a strike by an outside power.

Disassembling the site (and giving inspectors access) would, however, hamper the North’s development of a space launch program to a degree. This is important, since there are concerns about the North potentially gaining the ability to put a nuke into space and conduct an electromagnetic pulse attack. Yet, this too would be only a limited concession, since the North has two other satellite launch sites, and launch sites are easy to rebuild anyway. Moreover, some smaller space launch vehicles (though perhaps not ones large enough to carry a nuclear payload) can be launched from mobile erectors.

In short, what the North is offering is low-hanging fruit, and mostly symbolic, but it’s a start.

These moves are intended to signal to the U.S. that there’s room to negotiate on the shape and size of its nuclear and ballistic missile programs. Nothing more, nothing less.

Do Spectacular Earnings Justify Spectacular US Stock Prices?

Robert J. Shiller  

stockbroker nyse

NEW HAVEN – The US stock market, as measured by the monthly real (inflation-adjusted) S&P Composite Index, or S&P 500, has increased 3.3-fold since its bottom in March 2009. This makes the US stock market the most expensive in the world, according to the cyclically adjusted price-to-earnings (CAPE) ratio that I have long advocated. Is the price increase justified, or are we witnessing a bubble?

One might think the increase is justified, given that real quarterly S&P 500 reported earnings per share rose 3.8-fold over essentially the same period, from the first quarter of 2009 to the second quarter of 2018. In fact, the price increase was a little less than equal to earnings.

Of course, 2008 was an unusual year. What if we measure earnings growth not from 2008, but from the beginning of the Trump administration, in January 2017?

Over that 20-month interval, real monthly US stock prices rose 24%. From the first quarter of 2017 to the second quarter of 2018, real earnings increased almost as much, by 20%.

With prices and earnings moving together on a nearly one-for-one basis, one might conclude that the US stock market is behaving sensibly, simply reflecting the US economy’s growing strength.

But it is important to bear in mind that earnings are highly volatile. Sudden sharp increases tend to be reversed within a few years. This has happened dramatically more than a dozen times in the US stock market’s history.

Earnings are different from most other economic variables, because they are defined essentially as the difference between two series: revenues and expenses. Rapid growth in earnings for a few years can thus easily be followed by a return to the long-term trend or even subpar levels. In fact, S&P 500 reported earnings per share were negative during the fourth quarter of 2008, partly owing to financial-crisis-induced write-offs. Of course, that episode didn’t last (and its significance has been questioned).

Market participants ought to know that they shouldn’t overreact to earnings growth, but they sometimes forget if popular narratives mislead. Consider an example from a century ago. Although real S&P Composite annual earnings rose 2.6-fold in just two years, from around trend in 1914 to a record high in 1916, stock prices rose only 16% from December 1914 to December 1916. Why didn’t the market respond as it has recently?

From newspaper reports at the time, one can glean some clues. Most important, people attributed the increase to sudden panicky demand for US goods from Europeans and others at the beginning of World War I. When the war ended, then, profits would return to normal. Moreover, widespread anger over high war profits while men were being conscripted to risk their lives led many people, not just Americans, to start advocating for “wealth conscription.” This forgotten term, which dropped out of usage following World War II, referred to heavy taxation on sudden increases in profits. Indeed, the US first imposed a punitive tax on corporate profits above prewar levels when it entered the war in April 1917.

But stock price movements haven’t always been as rational as they were in 1916. Market reaction to earnings increases was much more positive in the “roaring twenties.” After the end of the 1920-21 recession, real annual earnings, which had been depressed by the downturn, increased more than fivefold in the eight years to 1929, and real stock prices increased almost as much – more than fourfold.

What was different about the 1920s was the narrative. It wasn’t a foreign war story. It was a story of emergence from a “war to end all wars” that was safely in the past. It was a story of the liberating spirit of freedom and individualistic fulfillment. Unfortunately, that spirit did not end well, with both stock prices and corporate earnings crashing catastrophically at the end of the decade.

There was then a period, from 1982 to 2000, when real stock prices increased 7.5-fold while real annual earnings only doubled. The end of this period has been called the dot-com boom or Internet boom, but most of the price growth preceded the tech-driven “new economy” narrative, and declining inflation helped throughout. By 2003, however, both real earnings and real stock prices fell by almost half.

Then, from 2003 to 2007, during a period of gradual recovery following the 2001 recession, real corporate earnings per share almost tripled. But the real S&P 500 less than doubled, because investors apparently were unwilling to repeat their mistake in the years leading to 2000, when they overreacted to rapid earnings growth. Nonetheless, this period ended with the financial crisis and another collapse in earnings and stock prices.

That brings us to the current boom in earnings and prices. Apparently, investors believe that this boom is going to last, or at least that other investors think it should last, which is why they are bidding up stock prices in a dramatic response to the earnings increase.

The reason for this confidence is hard to pin down, but it must be rooted in the public’s loss of healthy skepticism about corporate earnings, together with an absence of popular narratives that tie the increase in earnings to transient factors. Talk of an expanding trade war and other possible actions by a volatile US president just does not seem strongly linked to talk of earnings forecasts – at least not yet.

A bear market could come without warning or apparent reason, or with the next recession, which would negatively affect corporate earnings. That outcome is hardly assured, but it would fit with a historical pattern of overreaction to earnings changes.

Robert J. Shiller, a 2013 Nobel laureate in economics, is Professor of Economics at Yale University and the co-creator of the Case-Shiller Index of US house prices. He is the author of Irrational Exuberance, the third edition of which was published in January 2015, and, most recently, Phishing for Phools: The Economics of Manipulation and Deception, co-authored with George Akerlof.

Elmer thud

A court ruling knocks another hole in Swiss banking secrecy

The country’s supreme court decides that overseas employees of Swiss banks can leak away

DURING his decade-long legal battle with the Swiss authorities, Rudolf Elmer, a bank whistleblower, endured 48 prosecutorial interrogations, spent six months in solitary confinement and faced 70 court rulings. None, though, was more important than the decision by Switzerland’s supreme court on October 10th, which set strict limits on the country’s famous bank-secrecy laws.

Mr Elmer had leaked data from Julius Bär after being sacked by the Cayman Islands affiliate of the Zurich-based bank. The court, dismissing an appeal by prosecutors, ruled that because he was employed by the Cayman outfit, not its parent, he was not bound by Swiss secrecy law when he handed data to WikiLeaks in 2008. The 3-2 ruling followed a rare public debate among the judges, held in only 0.3% of supreme-court cases, underlining the national importance of the issue.

The ruling matters because Swiss banks are among the world’s most international. They employ thousands of private bankers offshore, and many more in outsourcing operations in countries like India and Poland. Many foreign employees are involved in creating structures comprising overseas companies and trusts linked to a Swiss bank account. Thanks to the ruling, as long as their employment contract is local they can now leak information on suspected tax evasion or other shenanigans without fear of falling under Switzerland’s draconian secrecy law, which imposes jail terms of up to five years on whistleblowers.

The victory is bitter-sweet for Mr Elmer. He was found guilty of forging a letter and making a threat, and has been ordered to pay SFr320,000 ($325,000) towards costs, a princely sum for someone who has been campaigning unpaid for years. He believes the courts had no choice but to reject the extraterritorial reach of secrecy, and ordered costs as “revenge” for him causing trouble. He is mulling an appeal to the European Court of Human Rights.

The ruling is the latest in a series of assaults on Swiss financial secrecy. They have intensified since 2007, when America’s Congress was alerted to brazen tax-dodging through UBS, Switzerland’s largest bank. Dozens of banks have since been fined for aiding tax evaders. UBS, which paid America $780m, is on trial in Paris, with six current and former executives charged with tax fraud and money-laundering related to French clients. Prosecutors are seeking damages of €1.6bn ($1.9bn).

Under international pressure, Switzerland agreed systematically to swap information on account-holders with other countries, under an OECD-led anti-tax-evasion initiative, the Common Reporting Standard (CRS). It began doing so last month. For now, however, exchange is limited to the European Union and a handful of other countries. The Swiss refuse to swap data with several countries which are major sources of corrupt and tax-shy capital—including Russia, China and Pakistan—on data-safety grounds, even though the OECD considers those countries safe to exchange information with.

Moreover Switzerland, unlike the EU, has declined to adopt (non-binding) international rules to aid disclosure of schemes cooked up by banks and other intermediaries to circumvent the CRS. No wonder financial ne’er-do-wells are, as one tax adviser puts it, “still yodelling”.

Robots and AI Will Not Create Mass Unemployment

Patrick Cox

Because I make predictions for a living, people ask me what we’re going to do about all the people whose jobs are destroyed by artificial intelligence (AI) and automation.

The silver lining to that question is that it assumes we’re not going to be enslaved by Skynet.

I’ve worked with many accomplished scientists, but I’ve never met anybody who fears that electronic components and software can achieve anything resembling true sentience or self-determination. That’s probably because most of the scientists I know are biologists, so they realize how primitive modern computer technologies are compared to the incredible genetic and neurological complexity of human consciousness.

Fear of mass unemployment due to AI and robotics is, in my opinion, a variant of the same irrational fear.


People and Markets Are More Adjustable Than You Think

Even those who believe AI and robotics will wreck the economy admit that there have been predictions of massive and imminent technological unemployment since the Industrial Revolution, and probably before.

It’s true that new technologies have always made old jobs obsolete, but in free economies, they have never resulted in mass unemployment. Highly bureaucratic and regulated economies are another matter, but we won’t deal with that topic here.

What’s different today, say those who predict massive technological unemployment, is the pace of change. Technology is progressing so fast, they say, people won’t be able to find replacement jobs fast enough to keep up with the falling away of old jobs.

I think they underestimate the ability of people and markets to adjust, which has been greatly enhanced by information technologies. Moreover, markets themselves have built-in mechanisms that moderate the pace of change.

The most obvious impact is the effect job-destroying technologies would have on consumer spending. When unemployment rates grow, consumer spending, economic growth, and investment rates fall.

If unemployment insurance and welfare costs rise, the pressure to raise taxes increases.

Political opposition to the perceived job destroyer would also be a factor, making that industry a likely target.

That kind of environment doesn’t encourage major technological transitions.

Also, we never see an elimination of jobs without the creation of new ones.

Everything Balances Out in the End

Imagine emerging technologies that are so effective at cutting costs, they destroy 20% of all jobs. All other things remaining constant, it would be disastrous—a guaranteed depression.

In practice, cost-saving technologies always create a counterbalancing demand for labor. Somebody has to manufacture, sell, ship, and service these new cost-cutting, labor-saving technologies. Somebody will have to train workers to use the new devices.

There may be some net job loss due to technological innovation. But historically, the elimination of job categories has been due to cost-saving innovations that helped fund net job growth. We can imagine a scenario where more jobs are eliminated than created, but we’ve seen zero evidence that is beginning to happen.

The explosion in technological innovation over the last decade is unparalleled in human history, but we’re not seeing even marginal reductions in job creation due to innovation.

Japan, perhaps the most tech-friendly country in the world, is experiencing severe labor shortages.

Despite widespread adoption of new information technologies, the US is not seeing rapid job obsolescence.

In fact, we’re seeing just the opposite.

Source: ITIF

The Information Technology & Innovation Foundation published an extremely important report last year. The summary includes the following observation:

When we actually examine the last 165 years of American history, statistics show that the U.S. labor market is not experiencing particularly high levels of job churn (defined as new occupations being created while older occupations are destroyed). In fact, it’s the exact opposite: Levels of occupational churn in the United States are now at historic lows. The levels of churn in the last 20 years—a period of the dot-com crash, the financial crisis of 2007 to 2008, the subsequent Great Recession, and the emergence of new technologies that are purported to be more powerfully disruptive than anything in the past—have been just 38 percent of the levels from 1950 to 2000, and 42 percent of the levels from 1850 to 2000.

The summary then reiterates the main point, saying, “Contrary to popular perception, rather than increasing over time, the rate of occupational churn in recent decades is at the lowest level in American history—at least as far back as 1850.”

One reason for this new job stability is that it’s easier and cheaper to create and sell technologies that enhance the productivity of existing workers than to create technologies that destroy jobs. There is no reason to believe this will change in the future.

What will change, therefore, is that individual productivity will continue to improve. That, in turn, will continue to reduce the real cost of living.

Though it’s not reflected in the obsolete consumer price index (CPI) or long-term wage and salary growth, consumers get far more for their money in most categories of consumption than ever before. In general, technological innovation has improved things for many decades—reducing the cost of goods and services, and allowing people to work fewer hours.

This Trend Will Continue

Not that long ago, the consensus among economists was that we would never have a backward-bending supply curve for labor. In plain English, they scoffed at the idea that workers would ever choose to cut back on work hours.

Today, it’s reality. People work fewer hours and take longer vacations. This is possible only because innovation has reduced the real cost of living. We need to work fewer hours to buy the necessities. This phenomenon is even more evident in Europe.

If AI and robotics cut the number of jobs in half, it could happen only because they cut the real cost of living proportionately. Many people would choose to work less, so more jobs would be needed to do the same amount of work.

I’m not saying we won’t experience unexpected disruptions. We will. But in an era of sub-replacement fertility rates, you can stop worrying that automation will destroy all the jobs.

Instead, worry about how the shrinking workforce is going to pay for the healthcare costs of the silver tsunami.

In fact, we know how to fix that problem. Right now, scientists I personally know are working on breakthrough therapies that will rejuvenate the aged, allow them to avoid the diseases of aging, and stay productive much, much longer.

If you demand that politicians and regulators focus on getting those innovations to market, costs will be cut, jobs will be created, and lives will be saved.