Why China will resist dumping US Treasuries in retaliation

Ditching debt would unleash financial instability in Washington but likely backfire on Beijing

Michael Mackenzie

China is the largest foreign holder of US Treasury debt with $1.1tn worth of holdings © FT montage; AP/AFP/Getty

Occupying a prominent place in the bilateral trade and economic relationship between the US and China is the $16tn Treasury bond market. As the world’s two biggest economies escalate their rivalry, anxiety over whether China will abruptly use its $1.1tn holdings of US Treasuries as a trade war weapon is rippling through the bond market.

Rather like President Donald Trump’s numerous tweets extolling the benefits of tariffs for the US economy, the idea that China will undertake a major liquidation of its Treasury debt portfolio as a weapon does not stack up.

Liquidating its Treasury portfolio may appear a compelling threat on paper. China’s stake along with other foreign buyers, comprising 40 per cent of the market, has down the years helped contain US interest rates, enabling Washington to spend and push the federal deficit ever higher.

In practice, a draconian response from China runs the risk of unleashing a bout of financial instability that resonates globally. But the effect would be shortlived and wind up damaging China more than the US at a time when Beijing already faces the challenge of rebalancing a slowing and highly indebted economy.

That will not halt conjecture about China’s intentions. The latest official Treasury data released this week revealed further selling by the market’s largest foreign holder and during a time when a trade deal between Washington and Beijing appeared on track. While the drop in Treasury notes and bonds held by China in March was the largest in a year, half of the $20bn in sales was recycled back into short-dated bills.

This fits a pattern seen in recent years where China has been in maintenance mode with its Treasury portfolio as holdings peaked at $1.316tn in November 2013. China surpassed Japan as the largest foreign holder of Treasury debt in 2008, and has comfortably owned in excess of $1tn since 2010. Years of trade surpluses generated hefty foreign exchange reserves that peaked in 2014. In turn, this has helped manage the level of the renminbi, a currency that is weakening as the trade dispute intensifies.

Beijing is ready to sell Treasuries in order to moderate any decline in the currency given the often-stated desire for financial stability after a bruising 2015 devaluation of the renminbi. With more foreign investment funds buying mainland shares and bonds, a sudden drop in the currency would only impair China’s efforts to open up its markets to the rest of the world.

Supporting the renminbi in this way should not, however, be seen as an escalation by China towards actively liquidating its Treasury portfolio. Indeed, several factors limit Beijing from abruptly exiting the Treasury market.

There is a good reason why a chunk of China’s reserves sit in the world’s largest government bond market: it is deep, liquid and pays a positive yield. The two main rivals to Treasuries are Japanese government bonds and German Bunds. Both markets not only lack the depth and variety of Treasuries, they are also negative-yielding through to their respective 10-year benchmarks.

True, China’s central bank has been buying more gold lately, but as Marc Chandler at Bannockburn Global Forex points out, Beijing’s Treasury holdings are “worth around five years of gold production”.

Beyond trying to find an asset that can effectively replace US debt, there is the risk of China moving the Treasury market too sharply against it. Once any market senses a whale is selling, the cost of doing so rises sharply and China’s unsold holdings would devalue.

There are also reasonable grounds for thinking the bond market would recover from a temporary bout of indigestion that pushes yields sharply higher. In a $16tn market, China has some influence, but there are limits and for every seller there is a buyer.

This is particularly true given the current outlook flagged by the US bond market. Expectations for economic growth and inflation are the ultimate drivers of bonds. A two-year Treasury yield of 2.20 per cent sits below the Federal Reserve’s current overnight borrowing rate range. This late-cycle view of the US economy suggests Treasury prices will head higher over time. So it hardly makes sense for China to dump its holdings because it would only present a buying opportunity for others who hold a less reassuring macro view.

These are all aspects of Treasury trading that China understands. Despite the speculation over a dramatic exit trade, Beijing will stick to a long game. Treasury yields will trend lower as the economic cycle ebbs and the clamour among other investors for owning government bonds means China can exit near the top in price terms and smoothly pivot away from the US more broadly and focus on rebalancing its economy.

Germany’s economic model is not the problem

Political leadership in addressing regional inequality and social polarisation is lacking

Marcel Fratzscher

Cars under construction at the Porsche factory in Leipzig. Germany’s export companies are increasingly investing abroad and less at home, threatening the country’s attractiveness as an investment hub © Bloomberg

The German economic model has received some unusually harsh criticism of late, notably from French president Emmanuel Macron, who said in April that it “has perhaps run its course”. Yet the problem for Germany today is not its economic model, but rather inadequate economic policies and two deep-seated illusions.

The German economy has slowed sharply, its dependence on industry is high and its automotive sector is slow to embrace new technologies. Germany’s dependence on exports makes it vulnerable to a slowdown in global growth.

Yet the problem is not the country’s economic model, which has been key to its success since the end of the second world war. The openness of the German economy and high degree of geographic and sectoral diversification of German exports which helped it to prosper for decades will be even more important for income growth and stability as the population ages and emerging markets catch up.

Mr Macron’s criticism of the German model for not being compatible with his vision of a social Europe is misplaced. A particular strength of that model is the Mittelstand — midsized, often family-run companies, with hundreds of unsung champions. These are often flexible, highly innovative and specialised firms with solid balance sheets and stable global market shares.

Another traditional strength has been the social partnership between employers and unions and a strong social welfare state.

The real problem for Germany is that its political elite is in the grip of two dangerous illusions. The first is the widespread assumption that it is not Germany that needs to change, but other European countries who need to follow the virtuous German path. But Germany has implemented hardly any meaningful economic reforms during the past decade, despite mounting imbalances and vulnerabilities.

Low levels of public and private investment contribute to anaemic productivity in the non-tradable sectors and a current account surplus of 8 per cent of gross domestic product in 2017. Germany’s export companies are increasingly investing abroad and less at home, threatening the country’s attractiveness as an investment hub.

Low productivity and weakening social partnerships have contributed to the enormous expansion of the low-wage sector. Meanwhile, instead of implementing reforms — such as lowering labour taxes, simplifying the tax code, deregulating services, modernising an inefficient bureaucracy and raising public investment in infrastructure, education and innovation — the past three governments have tried to appease vested interests through misguided handouts.

Popular frustration with the political elite and the rise of the far-right Alternative for Germany party are not the result of economic weakness, the migrant crisis or an overreaching EU, but of a political failure to address some legitimate concerns about rising regional inequality and social polarisation. Germany failed to use the boom years to renew its economic model.

The second illusion is that Germany does not need Europe and that the EU and eurozone are effectively a transfer union with a German paymaster. This attitude explains why many Germans are deeply suspicious of Mr Macron’s proposals for reforming the eurozone. Ironically, however, Germany would be one of the greatest beneficiaries of some of the changes Mr Macron envisages: the completion of monetary union and the strengthening of European institutions. Yet for years, Berlin resisted such reforms. Worse, it is showing increasingly protectionist tendencies, with proposals for the state to intervene much more directly in the economy and pursue the creation of “national champions”.

Global trade tension and rising nationalism in the US and elsewhere mean the continued success of Germany’s economic and social model will hinge on its ability to help create a strong, united Europe. The extent of political support in Berlin for further EU integration will be crucial in determining whether Europe can be a third partner at the geopolitical table alongside the US and China.

So it is not Germany’s economic model, but the reluctance of its political elite to pursue economic and social reforms, domestically and in the EU, that is the main risk that Europe faces today. But it is not too late to change course — Germany’s economic and political strengths mean it still has a chance to bring about change together with its European partners.

The writer is president of DIW Berlin, a think-tank, and professor of macroeconomics and finance at Humboldt-University Berlin


American life is improving for the lowest paid

Come back capitalism, all is forgiven

BRAD HOOPER quit his previous job at a grocery in Madison because his boss was “a little crazy”. The manager threatened to sack him and other cashiers for refusing orders to work longer than their agreed hours. Not long ago, Mr Hooper’s decision to walk out might have looked foolhardy. A long-haired navy veteran, he suffers from recurrent ill-health, including insomnia. He has no education beyond high school. Early this decade he was jobless for a year and recalls how back then, there were “a thousand people applying for every McDonald’s job”.

This time he struck lucky, finding much better work. Today he sells tobacco and cigarettes in a chain store for 32 hours a week. That leaves plenty of time for his passion, reading science fiction. And after years of low earnings he collects $13.90 an hour, almost double the state’s minimum rate and better than the grocer’s pay. His new employer has already bumped up his wages twice in 18 months. “It’s pretty good,” he says with a grin. What’s really rare, he adds, is his annual week of paid holiday. The firm also offers help with health insurance.

His improving fortunes reflect recent gains for many of America’s lowest-paid. Handwritten “help wanted” signs adorn windows of many cafés and shops in Madison. A few steps on from the cigarette shop is the city’s job centre, where a manager with little else to do points to a screen that tallies 98,678 unfilled vacancies across Wisconsin. In five years, he says, he has never seen such demand for labour. He says some employers now recruit from a vocational training centre for the disabled. Others tour prisons, signing up inmates to work immediately on their release.

Unemployment in Wisconsin is below 3%, which is a record. Across America it was last this low, at 3.6%, half a century ago. A tight labour market has been pushing up median pay for some time. Fewer unauthorised immigrants arriving in America may contribute to the squeeze, though this is disputed. Official figures show average hourly earnings rising by 3.2% on an annual basis. “Right now, part time, it seems like everyone is hiring. Every American who wants a job right now can get a job,” says another shop worker in Merrillville, in northern Indiana.

In any economic upturn the last group of workers to prosper are typically the poorest earners, such as low-skilled shopstaff, food preparers, care-givers and temps. Their pay was walloped in the Great Recession a decade ago, and the recovery since has been unusually slow. Pay has leapt recently—with the lowest-paid enjoying faster gains than the better-off.

The benefits are not equally spread. In Wisconsin, as in much of the country, more jobs are being created in urban areas and in services. Laura Dresser, a labour economist, points to a “very big racial inequality among workers”. Wages have been rising fastest for African-Americans, but poorer blacks, especially those with felony convictions, are also likelier to have fallen out of the formal labour market, so are not counted in unemployment figures.

The wage recovery is not only about markets. Policy matters too. Some states, typically Republican-run, have been reluctant to lift minimum wages above the federal level of $7.25 an hour. In Merrillville, a worker in a petshop carries a Husky puppy to be inspected by a group of teenage girls. Staff are paid “a dollar or two above the minimum wage”, says his manager. Despite his 13 years’ employment, and over 40 hours’ toil each week, his pay and benefits amount to little. He calls occasional bonuses a “carrot at the end of the road”.

He could munch on bigger carrots in other states. Lawmakers in some states are more willing to lift minimum wages. Where they do, the incomes of the lowest-paid rise particularly fast. Thirteen states and the District of Columbia raised the minimum wage last year. (Some cities, like Chicago and New York, occasionally raise it too). Elise Gould of the Economic Policy Institute told Congress in March that, in states which put up minimum wages at least once in the five years to 2018, incomes for the poorest rose by an average of 13%. In the remaining states, by contrast, the poorest got a rise of 8.6% over the same period.

In neither case, however, do the increases amount to much better long-term prospects for the worst-off. By last year, the poorest 10% were still earning only a miserly 4.1% more per hour than they did (in real wages) 40 years ago. Median hourly pay for America’s workers was up a little more, by 14%.

One study in Wisconsin suggests that caretakers, for example, took home over $12 an hour by last year, so were only just getting back to their (real) average earnings achieved in 2010. Expansion at the bottom of the labour market “is finally pulling some wages up. But it’s certainly been much slower in this boom than any other,” argues Tim Smeeding, a poverty expert at the University of Wisconsin, in Madison. He describes “capital winning over labour” for several decades, and expects the trend to continue, given weak unions, more automation and other trends.

The poorest get some hard-to-measure benefits in addition to higher hourly pay. Mr Hooper is not alone in daring to walk away from an exploitative boss. More of the low-paid get a bit more say on how and when they toil. Many crave a reduction in the income volatility that afflicts them, since sudden swings in earnings are associated with poor mental health, high stress and worry over losing access to financial assistance or food stamps.

One study of 7,000 households, by Pew, found in 2015 that 92% of them would opt for lower average incomes, if earnings were predictable. Follow-up research late last year suggested the same trends are still present. Low- and middle-income households remain anxious about volatile earnings. Most have almost no savings. Many would struggle with a financial shock of just a few hundred dollars.

Lots of jobs that are being created are in or near flourishing cities like Madison, where low-paid workers are squeezed by high housing costs. Pew has estimated that 38% of all tenant households spend at least 30% of their income on rent. Living in more affordable places, such as Janesville, an hour south of Madison, may be an option for the lower-paid. But that means commuting to the city, or taking local jobs with less pay and fewer benefits. Few workers earning less than $12 an hour get health insurance from their employer, whereas most do so above that threshold.

Katherine Cramer, who studies the long-standing causes of simmering anger among poorer, rural Americans, says “resentment is worse than before”, despite the recent better wages.

Rural folk complain that “it’s been like this for decades”, she says. A year or two catching up has not yet been enough to change their minds.

ECB faces crucial test of credibility

Markets demand forceful action from central bank which has been failed by politicians

Frederik Ducrozet

Ever since Mario Draghi took office 8 years ago, he has dealt with the consequences of other policymakers’ mistakes, incompetence or inertia © Reuters

As markets seem prepared to call the European Central Bank’s bluff, we are left with fear and hope — that Mario Draghi and his successor will rise to the challenge.

Story of his life, as they say. Ever since the ECB president took office eight years ago, he has dealt with the consequences of other policymakers’ mistakes, incompetence or inertia. As he nears the end of his term in October, we have lost count of the number of times Mr Draghi has been under pressure to act, having already done the right thing.

On his first day in office in November 2011, Mr Draghi cut interest rates in response to his predecessor’s premature tightening of monetary policy. He then followed up with the first series of long-term refinancing operations (LTRO) for banks, which proved decisive in stemming the widening in sovereign debt spreads. When the euro’s existential crisis later led to a rapid rise in the so-called redenomination term premium (a measure of euro break-up risk), Mr Draghi responded with the three most powerful words a central banker has ever said: that he was ready to do “whatever it takes”, within his mandate, to preserve the single currency.

When front-loaded, synchronised fiscal austerity led to a double-dip recession, the ECB eased again, with forward guidance in July 2013 and negative rates in June 2014. When financial fragmentation threatened the transmission of monetary policy, the ECB doubled down on credit easing, including a “targeted” LTRO. Finally, when a global slowdown and a collapse in oil prices led to deflation fears, the answer was bond purchases — quantitative easing — culminating in over €2.5tn in asset purchases by the end of 2018.

It is not the failure of its monetary stimulus that has forced the ECB to ease again and again over the past eight years. Rather, national governments continued making promises they never delivered on, while failing to move beyond their differences to make the monetary union more resilient and efficient. It is the failure of politicians to take over that has left the ECB on the hook.

Faced with “pervasive uncertainty” and persistently low inflation, the ECB stands ready to act again today. Market-based inflation expectations are falling like a stone as ECB members meet for their annual conference in Sintra this week. Crucially, Mr Draghi has ruled out nothing for the June meeting, meaning rate cuts and new asset purchases are all on the table.

For markets, the devil will be in the details of any new stimulus. Cutting rates could be the path of least resistance, especially if aggressive monetary easing from the US leads to a stronger euro and an unwarranted tightening of financial conditions in Europe. In that case, the broader market reaction would largely depend on the implementation of mitigation measures for banks, as negative policy rates get closer to levels where their counterproductive effects outweigh the benefits. An even bolder move would include a cut in the ECB’s main refinancing rate, currently set at zero per cent.

Forward guidance is likely to be adjusted again, whether the ECB cuts rates or not. A proposal from Finnish central bank chief Olli Rehn to link the timing of the first rate rise to a sustained adjustment in (core) inflation using state-contingent forward guidance may be appealing to the Governing Council, eventually.

But, in a more adverse scenario, the ECB would have to resume bond purchases to address the risk of de-anchoring inflation expectations. It could do so by either adjusting limits on purchases to 33 per cent of member countries’ debt, or by tilting debt purchases toward corporates, supranational entities and/or the most indebted governments. In the former case, German Bund yields could fall even further into negative territory; in the latter, Bund yields could jump back above zero and the yield curve would steepen.

One option could be for the ECB to engineer a form of “insurance QE” in a similar spirit as potential insurance rate cuts from the Fed. That could take the form of a front-loaded programme with no predefined quantity of monthly purchases, but a total envelope to be spread over time with greater flexibility, depending on macro and market conditions.

The bigger picture boils down to the ECB’s credibility — its greatest asset under Mr Draghi’s presidency. If conditions deteriorate sharply, markets will demand another grand statement of intent. The hope could be to talk the QE talk without walking the walk, given all the institutional, political and technical hurdles embedded in a new QE programme. Inflation expectations, equity markets and the euro will rise if, and only if, the policy response proves credible.

Credibility inevitably raises the question of Mr Draghi’s successor. The biggest challenge he or she will face may not be to ease or to normalise monetary policy, but to maintain trust in the euro’s most important institution.

Frederik Ducrozet is a global strategist with Pictet Wealth Management, based in Geneva

When commodities get hooked on derivatives

The distortions will damage the welfare of market participants and society at large

Ruslan Kharlamov and Heiner Flassbeck

Pick up marketing materials of any commodity exchange and it’s all about “risk management”. 

For many bourses, however, a real business lies elsewhere. It needs no advertising and shuns public scrutiny. 

This is the business of making markets: a licence to set prices for raw materials. As these markets went global, so did the function of their pricing and benefits for those controlling this function.

Over the years, both commodity exchanges and derivatives traded on them came a long way from their original purpose. There were three forces behind this development.

First was the wave of mergers and buyouts in the 2000s, which turned western exchanges from not for profit utilities into large corporations. Today, CME Group and Intercontinental Exchange (ICE), the two bourses reining in energy and agricultural markets, are owned by institutional investors. In 2012, London Metal Exchange was acquired by Hong Kong Exchanges and Clearing for $2.2bn.

Exchange-traded derivatives (futures, options, swaps) were invented to help supply chains mitigate market risk through harvesting and economic cycles and were largely used for this purpose since the 19th century. The situation changed in the 1990s when investment funds noticed that commodity prices moved asymmetrically to financial markets and started trading raw materials as a store of value and a source of speculative income from price fluctuations. 

The derivatives enable such trading without physical possession. This was the second factor.

For exchanges and brokers that facilitate these transactions, it was a gold mine. Commodity risk management is limited by production, trade, and consumption; speculative trading is not. 

Since revenues depend on trading volumes and services, such as clearing, the more derivatives are traded, the more money flows to investors, exchanges and brokers, creating a whole new ecosystem. In this brave new world, nobody knows the size of derivative markets and understands the interplay with their physical cousins. 

Figure 1: Oil physical and derivative markets

Finally, China. As the world’s largest consumer and producer of many commodities, it wants a say in their pricing. But how to break into exchange “franchises” that had existed for decades? 

The answer is maximum liberalisation of domestic derivative markets to boost their size and impact, largely by dint of retail investors.

In the west, even though the business model of exchanges has changed, investors still assume that a commodity future should first be used for price hedging. 

Chinese futures were ostensibly launched with a financial community in mind irrespective of industrial needs and reception. The results are startling: last year eight of the top 10 metal and agricultural futures were traded on Chinese bourses. Energy is next in line.

These forces have fuelled an unprecedented surge of speculation in commodity markets. In a race for global dominance, derivatives turn into market-making instruments for investors and governments; laissez-faire meets co-ordinated policy; and risk management becomes a Trojan horse to justify financial intermediation and speculation. While regulators don’t keep up with the pace of change, commodities are overtaking equities to become the second-most traded derivative category (Figure 2).

Figure 2: Global futures and options trading (millions of contracts)

Once a commodity is hooked on derivatives, producers lose a right to set prices — and there’s no way back.

Derivative markets are not the efficient markets from economics textbooks. Centralisation and focus on trading expectations and interpretations rather than real things make them prone to behavioural biases and manipulation. Worse, they make commodities an integral part of financial markets.

The more commodities become investable assets, the more their pricing gets intertwined with financial market dynamics and phenomena unrelated to supply and demand. This is manifested by inverted correlations between commodity prices and financial markets, among other things (Figures 3 and 4). Quantifying these effects deserves a thorough scientific study based on meaningful data.

Markets so “financialised” fail in price discovery and the efficient allocation of economic resources. Such distortions may destabilise not only markets — consider, for example, renewable energy transition — but also entire commodity-dependent nations. They damage the long-term welfare of market participants and society at large.Figure 3: Crude oil financialization

<60-12-17-2201989-9399-66-48-67-331994-98233-39-27-41-111999-200331358 bank="" br="" imf="" lme="" world="">
<60-12-17-2201989-9399-66-48-67-331994-98233-39-27-41-111999-200331358 bank="" br="" imf="" lme="" world="">
To tackle commodities financialisation some policymakers think of curbing “excessive” speculation. This is hard to quantify and implement, especially in international markets. 

Innovation offers a better approach, shifting the onus from regulation to self-governance. By connecting suppliers, buyers and service providers directly, it will keep price formation in the real economy and enable risk management without financial intermediation.

As Milton Friedman observed: “One of the great mistakes is to judge policies by their intentions rather than results.” It’s time to follow his advice instead of financial marketing.

Ruslan Kharlamov is the chief executive of SteelHedge, and Heiner Flassbeck is an honorary professor at the University of Hamburg and a former chief economist of the United Nations Conference on Trade and Development

Is America Tired of Losing Yet?

In the two years since US President Donald Trump abandoned the Trans-Pacific Partnership, Japan and the other TPP signatories have forged ahead with new trade deals. As a result, US exporters are increasingly feeling the pinch – and probably wondering what happened to "the art of the deal."

Anne O. Krueger

krueger15_NICHOLASKAMMAFPGetty Images_trumphuggingflag

WASHINGTON, DC – Not content with its trade war against China, US President Donald Trump’s administration has also opened bilateral trade negotiations with Japan. Yet whatever Trump hopes to achieve with Japan, it will be far less than what he threw away when he abandoned the Trans-Pacific Partnership (TPP) in early 2017.

During the 2016 US presidential campaign, Trump promised Americans that he would negotiate so many great deals on their behalf that they would get “tired of winning.” Now that he has imposed heavy costs on US farmers, consumers, and the overall economy through tariffs on Chinese imports, Americans are probably growing quite tired indeed.

Trump’s withdrawal from the TPP is the canonical example of his trade-policy recklessness. Signed in 2016 by the United States and 11 other Pacific Rim countries, the treaty would have governed around 40% of all trade covered by World Trade Organization rules. It was a “twenty-first-century agreement” that included not just tariff reductions, but also provisions to liberalize retail, communications, entertainment, and financial services. It would have strengthened labor and environmental standards, established a new dispute-resolution mechanism, and created a framework for managing e-commerce, cyber security, intellectual-property rights, data mobility, and more.

When the US withdrew from the TPP, many assumed the agreement was dead. But the remaining signatories, led by Japanese Prime Minister Shinzo Abe, quickly agreed on a replacement, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which retains around 200 of the TPP’s 220-odd provisions. The 20 that were left out were those for which the US pushed, and can be reinstated should the country wish to join the pact at a later date.

Now that the CPTPP has entered into force, Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam enjoy preferential access to each other’s markets. As tariffs are phased out, US suppliers in those markets are finding themselves at a growing disadvantage. While the Japanese tariff on American beef imports has remained at 38.5%, the levy on beef from fellow CPTPP countries has fallen to 27.5% and eventually will reach just 9%. As a result, American beef (and wheat) entering Japan (or any other CPTPP country) now face a higher tariff than beef and wheat from Australia, Canada, or New Zealand.

Still, Abe has worked hard to maintain good relations with the US, taking much political heat at home for it. Japan was one of the few US trading partners not to retaliate when the Trump administration imposed tariffs on steel and aluminum. And while affirming Japan’s preference for regional and multilateral arrangements, Abe has nonetheless agreed to bilateral bargaining with the US.
With a Japanese parliamentary election coming this summer, bilateral talks aren’t likely to go anywhere until later in the year. When they do happen, Japan will benefit from having already entered into a free-trade agreement (FTA) with the European Union. As of this past February, more than 90% (soon to be 97%) of EU exports to Japan are duty-free; and, after a brief phase-out period, the same will apply to 85% of agri-food products. While wine from the US faces a 15% tariff, wine from the EU – as well as from CPTPP countries such as Chile – now enters Japan duty-free, as do European cars, which are subject to common safety standards. Not for nothing did Abe tout the EU deal as proof of “the unshaken political will of Japan and the EU to lead the world as the champions of free trade at a time when protectionism has spread.”

For its part, the Trump administration wants Japan to remove barriers to US agricultural and auto exports and reduce its bilateral trade surplus, which stood at $58 billion (in goods) in 2018. But while Trump often complains that US goods face trade discrimination in Japan, he has only himself to blame. It is only natural that US exporters would lose market share to their counterparts in Europe and the CPTPP countries. With Japan’s new FTAs in place, the US trade deficit with Japan is likely to grow even wider.

So much for Trump’s “art of the deal.” The supposedly brilliant negotiator has left US exporters at a severe disadvantage in markets spanning the Pacific Rim and Europe. Worse, China is now pushing for a mega-FTA among 16 countries under the Regional Comprehensive Economic Partnership (RCEP), negotiations for which are ongoing (although many China experts do not expect an agreement to be reached anytime soon).

Here, it is worth remembering that the TPP would have excluded China and locked in a US-led trade bloc in Asia for the long term. No deal that the Trump administration makes with Japan can possibly make up for what the US would have had under the TPP. At best, the US will salvage the TPP terms concerning Japan alone, rather than all 11 original signatories. Though Abe has declared his willingness to negotiate bilaterally with Trump, he cannot possibly grant the US better terms than those given to Japan’s CPTPP partners.

We’ve seen this movie before. With each Trumpian “negotiation,” the US issues its demands, offers little in return, and threatens “punishment” through tariffs if it doesn’t get its way. Like the thief who says “your money or your life,” there is no actual negotiation to speak of. By acting like an insecure bully, Trump has left the US increasingly isolated in the global economy. American producers and consumers are already paying the price. The only question is how much more “winning” they are willing to bear. 

Anne O. Krueger, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is Senior Research Professor of International Economics at the School of Advanced International Studies, Johns Hopkins University, and Senior Fellow at the Center for International Development, Stanford University.

Trump Is Turning Out To Be A Consequential President

The Donald’s personal failings make it hard to say nice things about his presidency.

Yet contrary to most inside-the-Beltway expectations, he’s having an impact.

Let’s start with abortion, something that divides the country in a visceral way, with one side seeing it as murder and the other side viewing its prohibition as the subjugation of poor women.

The Supreme Court’s 1973 Roe v Wade ruling — which legalized abortion from the top down – took the issue off the legislative agenda.

But early on, Trump got the chance to name two new Justices and picked relatively young, relatively conservative men who are seen as possible votes for overturning Roe v Wade. So abortion is back in play. From today’s Wall Street Journal:
States’ Abortion Curbs Put Supreme Court to the Test
Sweeping state-level abortion restrictions present a direct test of whether the newly constituted Supreme Court is willing to revisit Roe v. Wade, the landmark abortion-rights precedent that has spurred deep divisions for nearly 50 years. 
States with antiabortion legislative majorities have long been weighing how to prompt a Supreme Court review of the 1973 ruling, but generally have preferred a strategy aimed at reducing the procedure’s availability through incremental restrictions that hamper providers, or by forbidding late-term abortions. 
But following last year’s retirement of Justice Anthony Kennedy, the key fifth vote on a nine-member court for preserving Roe’s central guarantee, that attitude has shifted. Since President Trump took office, he has appointed Justices Neil Gorsuch and Brett Kavanaugh, and had vowed as part of his 2016 campaign to appoint jurists who would overturn the Roe decision, though neither of the new justices has committed to do so. 
During this state legislative season, lawmakers in several conservative-led states have proposed bills that are designed to challenge Roe in court, and governors have been more willing to sign them than ever before. The most dramatic example came this week in Alabama, which enacted a near-total ban on abortion, with an exception only when a woman faces a serious health risk; the Legislature rejected exceptions for victims of rape or incest. On Thursday, the Missouri Senate passed a ban on abortion after eight weeks of pregnancy. 
Several states—Georgia, Kentucky, Mississippi and Ohio—recently passed bans on abortion once a fetal heartbeat is detected, which can be as early as six weeks.

One or more of these cases will reach the Supreme Court before the 2020 presidential election, and it’s now at least conceivable that the Court will have something interesting to say.

And then there’s China. The developed world really, really wanted China’s billion people with their history of political instability and ideological insanity to morph into a peaceful quasi-capitalist country. So the US and Europe looked the other way as China developed at all costs – with those costs being born mostly by its trading partners.

Among the many ways China has been cheating are:

Extreme protectionism. China keeps foreign goods out with high tariffs and impenetrable regulations. And it subsidizes domestic industries with cheap energy, low-cost loans and lax environmental regulations.

Debt imperialism. It lends money to developing countries, then seizes collateral assets like mines and infrastructure when the loans aren’t repaid.
Forced technology transfer. If a foreign company wants to operate in China, Beijing requires it to take a majority local partner and transfer its technology to that partner – which then forwards it to the government.

Cyber- theft. The Chinese military runs an army of hackers who break into foreign networks and steal whatever business and military IP they find. This has allowed Chinese companies to produce copycat versions of major products, and its military to produce next-generation weapons, without all the expensive R&D.

This cheating — and the resulting hollowing out of American manufacturing — was just accepted as the price of having China inside rather than outside of the global trading system. Trump, as an obnoxious outsider himself, doesn’t seem to be constrained by this vision and is trying to force China to play by the same rules as Japan and France. He may or may not succeed, but he’s already shifted the debate, forcing mainstream pundits to preface their opinions with, “of course China cheats and of course we should do something about it…”

That’s pretty consequential right there.

Immigration. Pre-Trump, elites on both right and the left loved open borders, the former because of all the cheap labor that couldn’t complain about bad working conditions, and the latter because new arrivals tend to vote for Democrat.

But of course open borders are a disaster for pretty much the entire taxpaying mainstream, so Trump is finding fertile ground here and might just engineer an immigration system that controls the border and lets in only the most valuable immigrants. In any event, as with China, he’s changed the terms of debate by forcing opponents to begin with “of course border security is important…”

War. This is the ultimate in “consequential.” And there’s a lot of it going around. See ‘Potentially imminent threat’ from Iran grips Washington.

Most of the above (with the exception of war) would not even be discussed under President Hillary Clinton, illustrating the impact, for better or worse, that Trump is having. Much of it will endure long after he’s gone.

What Does It Take to Trigger a Stock-Market Selloff, Anyway?

By Ben Levisohn

Photograph by Mandel Ngan/AFP/Getty Images

Boy, that escalated quickly.

Investors ended the previous week hopeful for a quick resolution to the trade dispute between the U.S. and China. Those hopes were dashed after China said it would raise tariffs on U.S. goods and President Donald Trump signed an executive order banning telecommunications equipment built by “foreign adversaries.” Further talks between the U.S. and China seem to be off the table for now.

The stock market, however, didn’t seem to mind all that much. Yes, the S&P 500 index dropped 2.5% on Monday, as investors realized that the trade war would not end quietly, but it spent the rest of the week trying to make back its losses. It closed this past week down 0.8%, to 2859.53, while the Dow Jones Industrial Average declined 178.37 points, or 0.7%, to 25,764.00, and the Nasdaq Composite dropped 1.3%, to 7816.28.

The worst of the damage, perhaps unsurprisingly, was sustained by companies with the most overseas business. Goldman Sachs ’ sector-neutral basket of stocks with the most international exposure has dropped 5.5% in May, while a similar basket of domestically focused stocks has declined just 2%. (The S&P 500 has fallen 3% this month.) That’s a sure sign that investors have started paring back their exposure to companies that could be disproportionately affected by an escalating trade war.

That’s also how the situation played out in the fourth quarter of 2018. From Oct. 2 through Oct. 10, the stocks in the S&P 500 with the most overseas pretax income underperformed the ones with the least

That’s also how the situation played out in the fourth quarter of 2018. From Oct. 2 through Oct. 10, the stocks in the S&P 500 with the most overseas pretax income underperformed the ones with the least by about three percentage points. From Oct. 10 through the end of the year, the stocks with the most overseas exposure outperformed slightly as everything else played catch-up, observes Ed Clissold, chief U.S. strategist at Ned Davis Research.

“If the selling widens to other areas, it would be a sign that the pullback is taking on a life of its own,” he writes.

Still, the market drop has been rather muted, considering the risks. That China announced higher tariffs on U.S. goods was predictable—from the beginning, tariffs have been viewed as bargaining chips on the way to a trade deal between the two nations.

The decision to limit Huawei Technologies’ access to U.S. goods and markets, however, is something more, because it has the potential to disrupt China’s plans during a year when the People’s Republic is celebrating its 70th anniversary, says Carmel Wellso, director of research at Janus Henderson. “People don’t understand how important this is to the population of China,” she says. “We’re striking at something more fundamental.”

Some chalk up the market’s calm to investors’ ability to ignore what’s happening overseas. “In our view, the reason markets haven’t budged much on worsening China headlines is because America is happy right now and simply doesn’t get it yet,” explains Richard Farr, chief market strategist at Merion Capital Group.

The fact that the University of Michigan’s consumer sentiment index jumped to a 15-year high in May suggests as much, even if the survey was taken before the latest headlines.

Others suggest that a broader battle between the U.S. and China might not be that bad for stocks, at least in the short term. Higher tariffs will probably mean a slight pickup in inflation, while interest rates will almost certainly stay low. In fact, the futures market is predicting a 75% chance that the Federal Reserve will cut rates in 2019. “Low interest rates typically mean good stock markets,” says Janus Henderson’s Wellso.

But what if something has fundamentally changed in the market? Investors have become accustomed to central banks stepping in to bail out the market, as the Fed did in both February 2016 and this past January, explains Macquarie strategist Viktor Shvets, who notes that damage was quickly undone in both cases “as if by magic.”

There’s no reason to expect that to change, he says, and monetary policy could soon be joined by government spending of epic proportions to keep the economic cycle going. “Investors are complacent because they no longer believe in free markets, and expect any damage from trade wars or politics would be offset by fiscal or monetary tools,” Shvets writes.

The scary part is he might be right.