Trade truce

The ceasefire in the trade war between America and China is fragile

New American tariffs have been cancelled in a “phase one” trade deal

American trade deals typically stretch to thousands of pages. The new “phase one” trade deal between America and China takes up only 86. Wang Shouwen, the Chinese deputy representative of international trade negotiations, described a text with nine chapters, including ones on intellectual property, technology transfer, financial services and dispute settlement.

Robert Lighthizer, the United States Trade Representative (USTR) gave journalists a glimpse of it on December 13th, hours after it had been agreed. It is due to be signed by both sides in the new year.

Mr Lighthizer said that American tariffs on around $120bn of Chinese imports would be reduced from 15% to 7.5%.

Fresh tariffs due on December 15th were cancelled.

In return, he said, China would ramp up imports of American agricultural products, manufactured goods, energy products and services by $200bn over two years.

Negotiators had set targets for various categories of commodities, so that agricultural purchases would rise from a baseline of $24bn in 2017 to at least $40bn in 2020 and 2021.

The exact figures would be secret to avoid influencing markets.

These arrangements are sure to attract criticism.

It is hard to see how China will meet its targets while sticking to the World Trade Organisation’s principle of non-discrimination. Joe Glauber of the International Food Policy Research Institute, formerly chief economist of America’s Department of Agriculture, warns that other countries, in particular Australia, Brazil and Canada, may have objections.

He also questions the secrecy regarding the targets, asking “how else would producers get signals on what to plant?”

China, for its part, does not like the idea of becoming so reliant on America for imports of commodities such as soyabeans.

It had long insisted that it was unrealistic for President Donald Trump to demand that it double its purchases of agricultural products from America.

Intriguingly, after the new deal was announced it refrained from mentioning any numerical targets.

Whether that is because it is embarrassed about having been forced into such a concession, or because the purchase agreements are not as solid as American officials suggest, will become clear only when the text is eventually published.

The Chinese do, however, seem to have made some welcome promises.

Mr Lighthizer boasted of commitments on intellectual property similar to, albeit narrower than, those in the usmca, a recently agreed trade deal between America, Mexico and Canada.

He also said the Chinese authorities had agreed not to ask multinationals to hand over technology as part of the process of securing a licence to do business—an issue central to America’s first tariff action in the trade war.

Jake Parker of the us-China Business Council, a lobby group for American companies operating in China, notes that such tech transfer was the biggest concern for many of his group’s members.

The Chinese, for their part, insisted that their promises were in line with their broader economic strategy of opening up, and would improve the business environment. Indeed, cynics will note that many of the reforms being chalked up to the deal had already started, raising questions about whether the nearly two-year-long trade battle has made much difference.

Until the deal is signed, the threat of renewed trade hostilities remains.

And even then, the enforcement rules will cause anxiety. Mr Lighthizer, hardly an independent arbiter, will have the final say over whether China has broken its commitments. He will be able to consider anonymous complaints by American companies.

This fixes a real problem—fear of retaliation that leads executives to hold their tongues. But it also risks the Chinese feeling that they are being accused of misdeeds they can neither verify nor easily fix.

Both sides said that the success of the first phase of talks would determine success in the second, which would presumably unlock further tariff cuts.

Mr Lighthizer spoke of climbing a mountain a bit at a time.

But the summit is still distant.

Realpolitik for post-Brexit Britain

The UK needs a hard-headed assessment of how to safeguard the national interest


web_Boris inflates globe

Britain has spent much of the past 75 years in a struggle to avoid adjusting its international ambitions to diminished economic circumstance. Managing relative decline, this is sometimes called. Others prefer to talk about “punching above our weight”.

Ask serious students of defence why Britain is modernising its Trident nuclear missile and has just launched two aircraft carriers and the answer is summed up in two words: national prestige.

Standing alone in 1940 looms large in the nation’s collective memory. A stubborn reluctance to surrender imperial pretensions has battled a weak economy at home and decisive shifts in the geopolitical balance abroad. It has usually taken a series of economic crises to realign grand ambitions with actual capabilities. The shock of Brexit may well force another such reassessment.

There was nothing complicated about the outcome of this month’s general election. In Boris Johnson, the voters were offered a Conservative chancer waving the flag of English nationalism. Labour leader Jeremy Corbyn’s pitch was that of a hard left ideologue who generally sees the west as a villain. Anyone with an acquaintance with George Orwell could predict that the working classes might well break the habit of a lifetime to lend their votes to the Tories.

Re-elected with a handsome parliamentary majority, Mr Johnson has confirmed January 31 as the date for Britain’s EU exit. The parting of the ways after 47 years will demolish the European pillar of Britain’s foreign policy. The prime minister says it will be replaced with an expansive vision of “Global Britain”. So far this amounts to no more than an empty slogan.

What is needed instead is a hard-headed assessment of how best to safeguard the national interest once Britain sits outside the framework of the EU — and a subsequent willingness to realign once again aspirations with available resources. Mr Johnson seems to think that all will be well if only the country “gets its mojo back”. In truth, if Britain wants to keep hold of a reputation as a well respected nation it cannot continue to pretend to be a great power.

The over-reach is obvious in the shape of the armed forces, calculated to convey the appearance of a pocket superpower. Refusing to admit that Britain no longer possesses across-the-board, or full-spectrum, forces, successive defence ministers have hollowed out many essential capabilities.

The money is being spent on aircraft carriers without any obvious strategic purpose and on hugely expensive state of the art American fighter planes to sit on their decks. Modernisation of the submarine-based Trident nuclear missile system is swallowing another large slice of the budget. What unites the two programmes is that they say a lot more about burnishing Britain’s prestige abroad than about meeting real threats to its national security. If the latter were the priority the resources would be going in to cyber warfare, airborne and seaborne drones and space defence.

The election changed decisively the arithmetic at Westminster. Everything else, though, remains the same. Mr Johnson’s insistence on an end-2020 deadline for negotiations with Brussels means the best Britain will get from the EU is a bare bones deal covering trade in goods. The damage to the economy inflicted by Brexit will thus be at the pessimistic end of expectations.

The facts of geopolitics are likewise unaltered. The Pax Americana is ending as power shifts to China and other rising states and the US grows ever more reluctant to assume global leadership. The rules-based international system is fragmenting. Coming decades will more closely resemble the great power competition of 19th-century Europe than the end-of-history liberal order many imagined would persist after the end of the cold war.

These are all trends that will leave Britain — a middle-ranking nation with widely dispersed global economic and security interests — more vulnerable than most comparable democracies.

The last time the UK claimed a serious global role was during the 1960s when it operated a string of military bases across the Middle East and south-east Asia. After sterling’s devaluation in 1967, Harold Wilson’s government beat an enforced retreat from the last outposts of empire east of Suez. The withdrawal from Singapore and the Gulf marked Britain’s admission it was a European rather than a global power — a shift cemented by joining the European Community.

Half a century later, Mr Johnson’s government proposes to turn things on their head. Britain, we are to suppose, is once again a global power. The prime minister intends to send one of the navy’s carriers for a brief spin in the South China Sea to prove the point. American F-35 fighter planes will fill many of the spaces on deck because the government cannot afford to buy sufficient aircraft for both ships.

This charade will soon reach beyond absurdity. The 2016 referendum and the election have settled the issue of EU membership. Britain is leaving the union. But the facts of economic life and national security have not changed.

The EU27 will remain Britain’s largest economic partner; and the main threats to its security will come from within or just beyond the European neighbourhood. The Nato alliance with the US will remain the vital pivot of national defence. Outside as much as inside the EU, Britain’s overall security will rest on these two sets of relationships.

Farewell Paul Volcker Hello Monetary Madness

God bless Paul Volcker. He was truly a one of a kind central banker, and we probably won’t see another one like him ever again. It took his extreme bravery to crush the inflation caused by the monetary recklessness of Arthur Burns and the fiscal profligacy of Presidents Johnson & Nixon.

Raising interest rates to 20% by March 1980 was wildly unpopular at the time. But in the end, it was what the nation needed and paved the way for a long period of economic stability and prosperity.

Back in 1971, the world fully had developed a new monetary “technology.” Governments learned that money need no longer be representative of prior efforts, or energy expended, or previous production, or have any real value whatsoever. It can be just created by a monetary magic wand; and done so without any baneful economic consequences.

This phony fiat money can, in the short-term, cause asset values to increase far above the relationship to underlying economic activity. And now, having fully shed the fettering constraints of paper dollars that are backed by gold, central banks have printed $22 trillion worth of confetti since the Great Recession to keep global asset bubbles in a perpetual bull market. Now, anyone whose brain has evolved beyond that of a Lemur understands that this can only be a temporary phenomenon–one where the ultimate consequences of delaying reality will be all the more devastating once they arrive.

This magic monetary wand is also being used to push borrowing costs down to record low levels—so much so, that some governments and corporations are now getting paid when they borrow. Therefore, it’s no wonder to those of us who live in reality that both the public and private sectors tend to pile on much more debt when both real and nominal interest rates are negative. Indeed, debt has been piling up at a record pace. Amazingly, central bankers find themselves in complete denial when it comes to this reality.

To this point, The U.S. budget deficit for the month of November was $209 billion and is running a deficit of $343 billion for just the first two months of fiscal 2020.

And, we have the following three data points from my friend John Rubino at

• Total US credit (financial and non-financial) jumped by $1.075 trillion in Q3 2019, the strongest quarterly gain since Q4 2007. The total is now $74.862 trillion, or 348% of GDP.

• U.S. Mortgage Lending increased $185 billion, the strongest quarterly gain since Q4 2007.

• M2 money supply surged by an unprecedented $1.044 trillion over the past year, or by 7.3%.

Not only this, but Morgan Stanley’s research shows that nearly 40% of the Investment Grade corporate bond market should actually be rated in the junk category based upon their debt to EBITA ratios. In fact, the entire corporate bond market has a record net debt to EBITA ratio.

And, the total amount of US corporate debt now equals a record high 47% of GDP. In the third quarter of this year, US business debt eclipsed household debt for the first time since 1991. And, according to Blackrock, global BBB debt, which is the lowest form of Investment Grade Debt, now makes up over 50% of the entire investment grade market versus only 17% in 2001.

Here is another fun fact: The IMF calculated that in the next financial crisis– if it is only half as severe as 2008–zombie corporate debt (which consists of companies that don’t have enough profits to cover the interest on existing debt) could increase to $19 trillion, or almost 40% of the total amount of corporate debt that exists in the developed world.

The problem should be clear even to the primates that govern our money supply. Global governments have already proven completely incapable of ever normalizing interest rates, and every moment they continue to force borrowing costs at the zero-bound level compels these corporations to pile on yet more debt. This means the corporate bond market is becoming increasingly more unstable, just as it also raises the level from which bond prices will collapse–when not if, the next recession arrives.

And speaking of recession, during the next economic contraction, the US national deficit should rise towards $3 trillion per year (15% of GDP) and that will add quickly to the National Debt, which is already at $23 trillion (106% of GDP). Meanwhile, while US Treasury issuance will be exploding in size, the $10 trillion worth of US corporate debt will also begin to implode. This means the Fed should be forced to purchase trillions of dollars in Treasury debt at the same time it has to print trillions more to support collapsing corporate bond prices.

That amount of phony fiat money creation would eclipse QEs 1,2,3, & the Fed’s currently denied QE 4 all put together. I wonder what name Jerome Powell will put on his non-QE 5 when the time arrives? If investors are unprepared to navigate the dynamics of depression and unprecedented stagflation, it could mean the end of their ability to sustain their standard of living.

A totally different kind of investment strategy is needed during an explicit debt restructuring as opposed to one where the government pursues an inflationary default on its obligations. I believe governments will pursue both methods of default at different times. Determining when and how the government reneges on its obligations is crucial. That is what the Inflation/Deflation and Economic Cycle Model SM was built to do. Get prepared while you still have time.

Edwards, Druckenmiller And A Pair Of Simple Points

by: The Heisenberg
If you're looking for a reason to doubt the pro-cyclical rotation story, SocGen's Albert Edwards is happy to oblige.

And while there are plenty of reasons to be skeptical about the prospect of the reflation narrative getting serious traction in 2020, there are also good reasons to be constructive.

Here is a relatively quick take which stands as a rare nod from me to the merits of brevity and conciseness.
If you're looking for reasons to doubt the pro-cyclical rotation narrative that's part and parcel of many year-ahead market outlooks, you might take a look at how misguided consensus has been over the past decade when it comes to forecasting bond yields.
"At this time of the year sellside strategists will always wheel out their year-ahead forecasts [and] these will without fail predict a rise in both equity markets and bond yields," SocGen's incorrigible, yet exceedingly affable, bear wrote, in a Tuesday note.
(SocGen, WSJ)
As I put it elsewhere earlier this week, the upside bias on equity targets could be in part a reflection of the fact that, over time, stocks tend to rise, but the bond yield forecasts are less forgivable.
"It is bond strategists that really leave me perplexed, in that – in the teeth of a relentless bull market raging since 1982 – they still consistently forecast a year-ahead rise in yields against the trend," Edwards wrote.
If you follow Albert, you can probably guess that he doesn't see it as particularly likely that the reflation narrative is going to get fresh legs, leading to a breakeven-led rise in yields next year.
SocGen's house view, in fact, is for 10-year US yields to sit around 1.20% in Q4 of 2020.
Here's a helpful snapshot of sellside forecasts:
Goldman's relatively lofty 2.25% call is an extension of their above-consensus view on the US economy.
The bank expects growth to clock in at 2.3% in 2020, much higher than the 1.8% consensus expects.
You'll also note that the forecasts aren't as optimistic as they have been in previous years.
Although SocGen's house call is something of an outlier, even Goldman's upbeat take (and when I say "upbeat," I'm of course referencing the fact that when you project higher yields into the new year, you're usually projecting decent economic outcomes) is only 40bps or so above where yields were on Thursday.
In the bottom pane, you can see reflation optimism reflected in the steepest 2s10s since 2018.
That optimism is obviously reflected in record high stock prices too.
A handful of readers have recently echoed some of Albert's skepticism about whether and to what extent this optimism is warranted.
After all, Sino-US relations are still extremely fraught and we saw this week just how tenuous the Brexit situation still is (the pound totally erased its post-election rally when Boris Johnson raised the specter of a crash-out scenario again).
Rather than subject my audience here to another lengthy diatribe (my last post for this platform was nearly 3,000 words, and it seems like I may have hit the point of diminishing returns around halfway through it), I thought I'd offer two quick counterpoints.
The first is the notion that investors will be inclined to rotate out of bonds and back into stocks in 2020.
As you may or may not be aware, the disparity between equity flows (which were negative) and bond flows (which were massively positive) in 2019 is vast.
Have a look:
(Heisenberg, sources in the chart header)
Assuming the economic outlook stabilizes (which kind of begs the question, but you get the idea), one might very fairly suggest that the extreme flow divergence this year will at least partially reverse.
That goes double when you consider how low yields are (i.e., bonds are less attractive both from a yield and capital appreciation perspective).
The second is an appeal to history.
As I explained elsewhere on Wednesday, this admittedly superficial take is a bit convoluted due to the close proximity of blockbuster years in the 90s, but the visual below shows years since 1989 when the S&P has risen 25% or more, plotted with the subsequent number of consecutive years with gains and the average performance over those years.
Simply put, "objects in motion tend to stay in motion."
But perhaps the best reason to remain constructive on risk assets is that the combination of easy monetary policy and fiscal stimulus makes being bearish rather unpalatable, at least in the near- to medium-term.
If you don't believe me, just ask arguably the greatest investor to ever live.
"Well, you have very low unemployment here, you have fiscal stimulus in Japan, you have fiscal stimulus and a lot of confidence coming to Britain, we’re running a trillion-dollar deficit at full employment, apparently we’re going to have some kind of green stimulus in Europe and we have negative real rates everywhere and negative absolute rates a lot of places," Stanely Druckenmiller told Bloomberg this week, in an interview.
"With that kind of unprecedented stimulus relative to the circumstances, it’s hard to have anything other than a constructive view on markets, risk and the economy in the intermediate term," he went on to say. "So, that’s what I have."

Nothing further.

Imbalances that triggered the last market crash are no more

Two sectors at the heart of the crisis — household and financial — have undergone big changes

Colby Smith

Sheets of five dollar notes sit on a pallet before being printed with a serial number at the Bureau of Engraving and Printing in Washington, D.C., U.S., on Tuesday, April 23, 2013. Stocks rallied amid growth in U.S. home sales, better-than-forecast earnings and speculation the European Central Bank will cut interest rates. U.S. equities recovered after briefly erasing gains following a false report of explosions at the White House. Photographer: Andrew Harrer/Bloomberg
© Bloomberg

A graphic with no description

More than a decade on from global financial crisis, the imbalances that appeared to precipitate the crash have been corrected.

While debt levels have built up elsewhere since then, the situation is less worrisome now, according to the US economics team at AllianceBernstein.

The two sectors at the heart of the crisis — household and financial — have undergone big changes, the New York-based asset manager notes, with both undergoing what it calls a “secular deleveraging”.

The banks, for their part, are in better health: capital and liquidity ratios are higher, loan delinquencies are low and regulators are performing regular stress tests on the biggest and most important institutions.

Households, too, have brought down their absolute levels of indebtedness, as a share of gross domestic product. Still, not all is rosy.

The US government enthusiastically stepped in to the breach in the wake of the crisis to support demand: its much heavier debt levels now make it less able to come to the rescue next time.

Parts of the corporate sector, too, are starting to groan under debt accumulated at a time of record-low borrowing costs.

But while some corporate credit looks “bubbly”, it is not what the analysts call “systemically lethal”.

In part, this is because much of that debt is not held by the banks but by fund managers less vulnerable to runs.

Fed curbs repo volatility on final day of 2019

Markets arm of central bank injects $255bn to ease possible cash Crunch

Joe Rennison in London and Colby Smith in New York

The US Federal Reserve succeeded in keeping a lid on short-term borrowing costs on the final day of the year after injecting billions of dollars into the market to ease a possible cash crunch.

The cost of borrowing cash overnight in the repo market, where investors exchange high-quality collateral such as Treasuries for funding, rose to 1.88 per cent on Tuesday before falling over the first couple of hours of trading to 1.55 per cent.

That is in line with levels seen throughout December and far below the peak level of 6 per cent reached on December 31 2018, according to data from Curvature Securities.

“The market is very calm,” said Mark Cabana, an interest rate strategist at Bank of America Merrill Lynch.

“There really hasn’t been any pressure early in the day. I think the Fed has crushed any kind of year-end volatility with all of the operations they have done.”

Investors and analysts had feared a repeat of the spike in September when a scramble for cash pushed repo rates up as high as 10 per cent, alarming some market participants and prompting a series of actions from the Fed.

The markets arm of the central bank went all out to ensure the year-end period went smoothly, injecting $255.6bn to keep money flowing through the financial system. It had said it would offer up to $490bn, depending on demand.

The New York branch of the US central bank, responsible for market operations, provided $25.6bn in overnight funding on December 31, adding to $230bn of longer-term repo operations — in effect short-term loans — that will mature throughout January.

Elevated repo rates are more common at the end of the year, as banks often pull back from lending into the market ahead of important regulatory calculations taken before the start of the new year, leaving less cash available to investors.

Mr Cabana added that the Fed was helped by banks finding new ways to trade with clients outside of traditional repo lending, while still lowering year-end regulatory burdens.

For example, Goldman Sachs mimicked repo trades with hedge funds through the derivatives market, in a bid to lower its capital charges.

With the year-end hurdle cleared, investors’ focus has shifted to what comes next for the Fed and how it will go about weaning the market off the money it has provided.

In addition to the overnight and short-term loans the central bank has offered up, it has also expanded its balance sheet by purchasing Treasury bills, which have a maturity of one year or less, in an attempt to further bolster cash in the system.

“The Fed has delivered on its promise to flood the market with liquidity,” said Gennadiy Goldberg, a US rates strategist at TD Securities.

“But I highly doubt the Fed will be breaking out the ‘mission accomplished’ banner just yet, as they now have to worry about what they do from here.”