A deal between Donald Trump and Xi Jinping will not last

Growing military tensions make the US-China trade dispute harder to settle

Gideon Rachman

Are you a Marxist, a realist or a believer in the accident theory of history? Each school of thought suggests a different way of analysing the crisis in US-Chinese relations.

A trade war is well under way between the world’s two largest economies, and talk of a new cold war is now common in both Washington and Beijing. The two countries have just had a frosty and unproductive encounter at the Asia Pacific Economic Co-operation meeting. But, at the end of this month, Donald Trump and Xi Jinping, the presidents of the US and China, will meet at the G20 summit in Argentina for crucial talks that could culminate in a new deal on trade — or a further rise in tensions.

A Marxist might expect that business interests will prevail, and that, as a result, there will soon be a truce in the trade war between the US and China. A follower of the “realist” theory of international relations would assume that an established power like the US and a rising power, such as China, are inevitably going to clash — and that therefore economic and strategic tensions will keep rising. And somebody who thinks that history is driven by accidents will tell you that no theory can explain how things will pan out since so much depends on unpredictable human beings.

One sign that several outcomes remain possible is the open infighting that has broken out between rival camps in the Trump administration, and the rather less open signs of tension in Beijing, as the Chinese government scrambles to find a way of appeasing Mr Trump.

There is a powerful camp of hawks in Washington who are actively pushing for a long-term confrontation with China. On the economic side, they include Peter Navarro, the White House trade adviser, and Robert Lighthizer, the US trade representative. On the strategic side, they include John Bolton, the president’s national security adviser, and Mike Pence, the vice-president, who recently gave an ultra-hawkish speech on China.

Set against them are the doves, led by Steven Mnuchin, the Treasury secretary, and Larry Kudlow, the White House’s chief economic adviser.

The doves want to see the current trade tensions swiftly resolved, while the hawks know that Mr Trump is both their biggest hope and their greatest potential weakness. He has already gone further than any other US president in confronting China, slapping tariffs on almost half of Chinese exports to the US and stepping up naval patrols through disputed waters in the Pacific.

But Mr Trump is also volatile and has a weakness for doing deals with autocrats. Some of his advisers are worried by the memory of June’s Singapore summit with Kim Jong Un, the North Korean dictator, when Mr Trump suddenly ended a year of dire threats and committed himself to dialogue. Since then, the US president has even tweeted about his “love” for Mr Kim.

Worryingly for the hawks, Mr Trump has long emphasised that he has the highest possible regard for Mr Xi. He has also shown a disconcerting tendency to claim imaginary breakthroughs. For example, the president recently claimed that China had abandoned its industrial policy, known as “Made in China 2025”, because he personally had found it “very insulting”. But there is no evidence of any such Chinese reversal.

The hawks’ anxiety was expressed by Mr Navarro in a recent speech in Washington, in which he accused “global billionaires” of acting as lobbyists for China. A few days later, he was directly contradicted by Mr Kudlow, his White House colleague, who said Mr Navarro’s comments were “way off base”.

Strategic tensions have increased, alongside the trade rivalry. American military strategists fear that China’s programme of building military bases in the South China Sea has changed the balance of power in the region. Admiral Phil Davidson, the head of America’s Indo-Pacific command, told Congress recently that “China is now capable of controlling the South China Sea in all scenarios short of war with the United States”.

To demonstrate that the US has not tacitly accepted Chinese dominance of these waters, the US has stepped up naval patrols, with ships from the two navies recently coming dangerously close to a collision. Some Washington hawks also want the US to persuade its allies — in particular Japan and South Korea — to allow America to deploy short-range nuclear missiles in the region. In theory, this would be to deter North Korea; in reality, the message would be directed at China.

These military tensions make the US-China trade dispute much harder to settle than the Trump administration’s trade arguments with Mexico and Canada, neither of which are strategic rivals to the US.

It is this geopolitical dispute — rather than the economics — that make me think that the “realist” assessment of US-China rivalry is most likely to be vindicated. So even if the G20 summit sees Mr Trump agreeing to defer his plans to increase tariffs on China, a trade truce may not last for long given this backdrop of growing superpower rivalry.

But the personality and impulses of the US president make all firm predictions dangerous. If there ever was a walking, talking embodiment of the “accident theory” of history, it is Mr Trump.

Ten-year hangover

What China talks about when it talks about stimulus

Excesses from its 2008 push limit options today

THE CAREER of China’s biggest property tycoon can be divided into two stages. Xu Jiayin started slowly, focusing on Guangzhou, a southern city. Then came the global financial crisis and the government’s response, a giant economic stimulus, launched a decade ago this month.

For Mr Xu it was a signal to become far bolder. His company, Evergrande, now has projects in 228 cities. Last year it completed enough floor space for 450,000 homes, up from 10,000 the year the stimulus began. It has bought a football club, built theme parks and entered the insurance business.

Yet expansion has come at a cost. Evergrande’s debt has soared to nearly $100bn. Short-sellers regularly target its stock. So far Mr Xu has defied the naysayers. But the market bears are taking another run at him. Evergrande’s stock is down by more than a third this year. Last month it struggled to sell new bonds, until Mr Xu bought $1bn worth with his own cash. As one of the richest people in China, a billionaire many times over, at least he can afford it.

For China as a whole, the government’s decision in 2008 to rev up investment was also a dividing line. Growth rebounded, while it sputtered elsewhere. Before the crisis China had a 6% share of global GDP; today it is closer to 16%. Yet there was a big downside. The economy became much more reliant on debt.

On the tenth anniversary of its big stimulus, China is again confronted by flagging growth, as Mr Xu can see from a recent slowdown in housing sales. The government has started dropping hints that a new stimulus is on the way. But the excesses from 2008 constrain it today. China knows it cannot afford another binge.

That caution reflects a change. Officials were almost uniformly positive in their initial verdict on the stimulus. Exports had plunged but growth was back to double digits within a year. In 2011 Wen Jiabao, the prime minister, said that not only had China been first in the world to recover from the crisis, but it had also laid a foundation for long-term growth. Now there is widespread recognition that the foundation was less solid than it appeared.

China’s steep rise in total debt, from 150% of GDP in 2008 to more than 250% today, is the most obvious problem. Such increases in other countries have often presaged trouble. Much of the debt was channelled through institutions outside the formal banking system, which are less transparent and more lightly regulated. Though some borrowers, such as Evergrande, profited from easy money, many others struggled. Dozens of industries, from solar power to steel, are grappling with overcapacity. Bai Chong’en, a former adviser to the Chinese central bank, has argued that one consequence has been a permanent decline in productivity.

As a result, stimulus has almost become a dirty word in policy circles. Li Keqiang, Mr Wen’s successor, has sworn off what he calls “flood-irrigation stimulus”, a reference to the farming practice of soaking all the soil, not just the crops. Over the past couple of years the government has tried to mop up the mess. It has aimed to slow the rise in debt, closing shadow banks and curtailing excess capacity.

But the resolve to tackle financial risks was easier to summon when growth was strong. In recent months it has sagged. With investment sluggish and the trade war rumbling on, headwinds are getting stronger. Many analysts think growth will dip towards 6% next year, which would be China’s weakest since 1990. For firms that had based their plans on sustained high-speed growth, even a mild slowdown hurts. Corporate-bond defaults in China have reached nearly $10bn this year, a record. Markets are braced for worse: borrowing rates for China’s high-yield issuers of dollar bonds have almost doubled, to 11%. Evergrande was forced to offer 13.75% on its bond in October.

It is against this jittery backdrop that investors are speculating about a new stimulus. The government, despite its vows to be prudent, has form: besides the massive stimulus in 2008, it also propped up the economy when growth softened in 2012 and 2015. As a first step officials appear to be relaxing their campaign to clean up the financial system. After a quarterly meeting on October 31st, the Politburo omitted a prior pledge to reduce debt.

Simply describing this as a shift to stimulus is too crude. Larry Hu, an economist with Macquarie Securities, separates China’s policy easing into three. First, fine-tuning, including doveish language. Second, more direct measures, such as interest-rate cuts. Third, all-out support, with infrastructure spending cranked up. Mr Hu reckons that China is now between the first and second, good for the stockmarket but not enough to stop the economy’s slide.

Can China find a way to shore up growth without falling back on debt-fuelled stimulus? It does have options, though they are likely to provide less of an immediate boost. The central bank could reduce benchmark interest rates, which have stayed unchanged since 2015. The finance ministry has scope to cut taxes more aggressively, especially for companies. Where borrowing is the only option, it is trying to make it safer. It is making it easier for officials to pay for infrastructure via bonds rather than shadow banks. Xi Jinping, the president, could also take long-delayed steps to lessen the clout of state-owned companies, giving private firms more leeway to invest in sectors such as energy and finance.

One thing China is likely to avoid is a significant change to its property policies, a crucial part of the stimulus in 2008. Mr Xi has repeatedly said that homes are for living in, not for speculating on. A thicket of restrictions has cooled the market, slowing purchases and choking off loans to developers. If Mr Xu of Evergrande is upset, he is not showing it. In a speech published this year he credited his firm’s success to government policies. Long a beneficiary, he has the sense not to turn critic.

Falling Corporate Earnings Will Fuel The Next Leg Of The Bear Market

If corporate earnings rise in 2019 like Wall Street analysts expect, stocks are a screaming buy at these bear-market levels. But earnings won’t rise and stocks are not a buy, says money manager Michael Pento:

Earnings Recession of 2019
President Trump’s plan to stimulate the economy, known as The Tax Cut and Jobs Act, was signed into law at the end of 2017. It ushered in a massive and permanent tax cut for corporations, along with a temporary reduction in rates for individuals.  
Consequently, earnings growth has soared this year when compared to the same period in the prior year. Companies in the S&P 500 grew their earnings by 25.6% in the third quarter of 2018 compared to the same period in 2017, according to FACTSET. And earnings growth is set to rise by 19% in the fourth quarter of 2018 y/y. 
But things aren’t looking nearly as good for next year’s comparisons. EPS growth for the S&P 500 in the first quarter of 2019 compared to 2018 is estimated be–by the, it’s always sunny outside crowd on Wall Street–to be 9.5%. But this guestimate might very well turn out to be extremely optimistic. 
During the second quarter of this year the economy grew at a 4.2% Q/Q SAAR. The third quarter growth in the U.S. saw the economy decelerate to 3.5%. And, according to Bloomberg, the estimate for fourth-quarter growth of this year will be 2.7%. Keeping with this trend in slowing growth, Q1 2019 is projected to post growth of just 2.4%–there is no doubt that the U.S. economy is in the process of decelerating. 
Given the strong headwinds hitting the global economy right now, and the fact that no economy exists on an island, it seems very likely that U.S. corporate profit growth could struggle just to remain in positive territory during 2019. Those headwinds include: The Fed continuing along its interest rate hiking path, while it also removes $600 billion from the financial system. Global central banks that have turned hawkish, causing the amount of QE to crash from $180 billion per month in recent years, to zero. Corporation are seeing profit margins shrinking from rising wages, much higher interest rates expenses and a stronger dollar. The end of trade war front running, which caused a huge inventory build and a temporary boost to growth. Emerging Markets turmoil is worsening. The U.S. is posting trillion dollar deficits and that amount of red ink is only getting bigger, and finally, the debt-disabled global economy is rolling over hard, causing stock market collapses and putting downward pressure on consumers worldwide. 
In addition to all those factors, corporate profits face extremely difficult comparisons due to the lapping of the repatriation of foreign earnings, along with the tax stimulus package. 
This year started off with an extreme level of investor optimism. Equity markets were supported by the outlook for a continuation of synchronized global growth.  
Nevertheless, the global economy is now weakening, as global monetary policies are tightening into record levels of debt. 
This is causing turmoil in currency, bond and equity markets across the globe. In this environment, it seems highly likely that S&P 500 earnings will struggle to grow at all.  
Indeed, the level of earnings for the S&P could find it difficult to remain at the $162.48 level that is projected by FactSet for calendar 2018. Therefore, investors need to reprice the rosy forecast of $177.90 for TTM 2019 that is currently hoped for by Wall Street. 
Not only is it the case that EPS growth will be far less than the 25% seen earlier this year; it is very likely that there will be an earnings recession next year. If this is indeed the case, the market will be forced to place a much lower multiple on that plunging growth rate of earnings. 
The current forward multiple on the S&P 500 EPS is 15.6. But this considers a robust growth rate that is near double digits. If the EPS number next year comes in closer to the same low $160’s EPS level seen in the trailing twelve months of this year, the multiple on those earnings should be closer to 14x…at best. Hence, if this assessment is anywhere near correct, the S&P 500 should trade around 2,240 at the end of next year. That would equate to a drop of nearly 20% from the current level. 
It is of paramount importance to note that those EPS figures are grossly overstated due to a decade’s worth of debt-fueled stock buybacks that have been prompted by near zero percent borrowing costs. Therefore, the fair value of the S&P 500 would only be achieved from a plunge much greater than 20%. 
The last earnings recession occurred during calendar year 2015; where EPS for the S&P 500 dropped by 0.3% over the year prior. During this timeframe the return on stocks was essentially flat. However, if earnings undergo another year over year decline next year, the market may not fare nearly as well. This is because global central banks were busy printing nearly a trillion dollars’ worth of QE during the last earnings recession in order to pump up asset prices. In sharp contrast, during 2019 the amount of money printing, on a net global basis, is projected to become negative. 
Such a dramatic plunge in asset prices should come as no surprise. What other possible outcome could be expected given that global central banks printed $14 trillion ex-nihilo in order to manipulate every major asset class into an unprecedented bubble.  
But, now inflation has forced them to reverse course on monetary policy, or risk having long-term interest rates spike out of control. Investors should already have their portfolios prepared for the third collapse of equity prices since the year 2000.

Why Central Bank Digital Currencies Will Destroy Cryptocurrencies

Leading economic policymakers are now considering whether central banks should issue their own digital currencies, to be made available to everyone, rather than just to licensed commercial banks. The idea deserves serious consideration, as it would replace an inherently crisis-prone banking system and close the door on crypto-scammers.

Nouriel Roubini

business digital code transfer

NEW YORK – The world’s central bankers have begun to discuss the idea of central bank digital currencies (CBDCs), and now even the International Monetary Fund and its managing director, Christine Lagarde, are talking openly about the pros and cons of the idea.

This conversation is past due. Cash is being used less and less, and has nearly disappeared in countries such as Sweden and China. At the same time, digital payment systems – PayPal, Venmo, and others in the West; Alipay and WeChat in China; M-Pesa in Kenya; Paytm in India – offer attractive alternatives to services once provided by traditional commercial banks.

Most of these fintech innovations are still connected to traditional banks, and none of them rely on cryptocurrencies or blockchain. Likewise, if CBDCs are ever issued, they will have nothing to do with these over-hyped blockchain technologies.

Nonetheless, starry-eyed crypto-fanatics have seized on policymakers’ consideration of CBDCs as proof that even central banks need blockchain or crypto to enter the digital-currency game. This is nonsense. If anything, CBDCs would likely replace all private digital payment systems, regardless of whether they are connected to traditional bank accounts or cryptocurrencies.

As matters currently stand, only commercial banks have access to central banks’ balance sheets; and central banks’ reserves are already held as digital currencies. That is why central banks are so efficient and cost-effective at mediating interbank payments and lending transactions. Because individuals, corporations, and non-bank financial institutions do not enjoy the same access, they must rely on licensed commercial banks to process their transactions. Bank deposits, then, are a form of private money that is used for transactions among non-bank private agents. As a result, not even fully digital systems such as Alipay or Venmo can operate apart from the banking system.

By allowing any individual to make transactions through the central bank, CBDCs would upend this arrangement, alleviating the need for cash, traditional bank accounts, and even digital payment services. Better yet, CBDCs would not have to rely on public “permission-less,” “trustless” distributed ledgers like those underpinning cryptocurrencies. After all, central banks already have a centralized permissioned private non-distributed ledger that allows for payments and transactions to be facilitated safely and seamlessly. No central banker in his or her right mind would ever swap out that sound system for one based on blockchain.

If a CBDC were to be issued, it would immediately displace cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized. Enthusiasts will argue that cryptocurrencies would remain attractive to those who wish to remain anonymous. But, like private bank deposits today, CBDC transactions could also be made anonymous, with access to account-holder information available, when necessary, only to law-enforcement authorities or regulators, as already happens with private banks. Besides, cryptocurrencies like Bitcoin are not actually anonymous, given that individuals and organizations using crypto-wallets still leave a digital footprint. And authorities that legitimately want to track criminals and terrorists will soon crack down on attempts to create crypto-currencies with complete privacy.

Insofar as CBDCs would crowd out worthless cryptocurrencies, they should be welcomed. Moreover, by transferring payments from private to central banks, a CBDC-based system would be a boon for financial inclusion. Millions of unbanked people would have access to a near-free, efficient payment system through their cell phones.

The main problem with CBDCs is that they would disrupt the current fractional-reserve system through which commercial banks create money by lending out more than they hold in liquid deposits. Banks need deposits in order to make loans and investment decisions. If all private bank deposits were to be moved into CBDCs, then traditional banks would need to become “loanable funds intermediaries,” borrowing long-term funds to finance long-term loans such as mortgages.

In other words, the fractional-reserve banking system would be replaced by a narrow-banking system administered mostly by the central bank. That would amount to a financial revolution – and one that would yield many benefits. Central banks would be in a much better position to control credit bubbles, stop bank runs, prevent maturity mismatches, and regulate risky credit/lending decisions by private banks.

So far, no country has decided to go this route, perhaps because it would entail a radical disintermediation of the private banking sector. One alternative would be for central banks to lend back to private banks the deposits that moved into CBDCs. But if the government was effectively banks’ only depositor and provider of funds, the risk of state interference in their lending decisions would be obvious.

Lagarde, for her part, has advocated a third solution: private-public partnerships between central banks and private banks. “Individuals could hold regular deposits with financial firms, but transactions would ultimately get settled in digital currency between firms,” she explained recently at the Singapore Fintech Festival. “Similar to what happens today, but in a split second.” The advantage of this arrangement is that payments “would be immediate, safe, cheap, and potentially semi-anonymous.” Moreover, “central banks would retain a sure footing in payments.”

This is a clever compromise, but some purists will argue that it would not solve the problems of the current fractional-reserve banking system. There would still be a risk of bank runs, maturity mismatches, and credit bubbles fueled by private-bank-created money. And there would still be a need for deposit insurance and lender-of-last-resort support, which itself creates a moral hazard. Such issues would need to be managed through regulation and bank supervision, and that wouldn’t necessarily be enough to prevent future banking crises.

In due time, CBDC-based narrow banking and loanable-funds intermediaries could ensure a better and more stable financial system. If the alternatives are a crisis-prone fractional-reserve system and a crypto-dystopia, then we should remain open to the idea.

Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House's Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.