Ebb and Flow 

Doug Nolan


The U.S. economy created 943,000 jobs in July. 

With upward revisions, there were 938,000 jobs added in June and 614,000 in May – for a notable three-month employment surge of almost 2.5 million. 

The Unemployment Rate dropped five-tenths to 5.4%, the low since March 2020. 

For the two-decade period 2000 through 2019, Unemployment averaged 5.9%. 

Average Hourly Earnings were up 4.0% y-o-y in July, the strongest rise of the pandemic. 

And from Thursday’s Challenger data, July job cuts were the smallest since June 2000 (y-t-d cuts lowest on record). 

Throw in reports of acute labor shortages across industry groups and seemingly the entire economy, and it’s clear job markets are turning tighter by the week.

August 5 – Associated Press (Martin Crutsinger): 

“The U.S. trade deficit increased to a record $75.7 billion in June as a rebounding American economy sent demand for imports surging. 

The… deficit rose 6.7% from a revised May deficit of $71 billion. 

The June deficit set a record, topping the old mark of $75 billion set in March... 

In June, exports edged up a modest 0.5% to $207.7 billion while imports surged 2.1% to $283.4 billion. 

The politically sensitive goods deficit with China rose to $27.8 billion in June, up 5.8% from the May level. 

So far this year, the goods deficit with China, the largest that the United States runs with any country, totals $158.5 billion, an increase of 19.2% compared to the same period in 2020.”

Traditionally, Trade and Current Account deficits were important indications of excessively loose monetary policy. 

These days, no one – including the Fed – couldn't care less. 

Our Credit system and economy flood the world with dollar balances conveniently recycled back into U.S. securities markets. 

Instead of waning confidence in the world’s reserve currency, there is jubilation for liquidity abundance the world over. 

For now.

August 4 – Bloomberg (Reade Pickert): 

“U.S. service providers expanded in July at the fastest pace in records dating back to 1997 as measures of business activity, new orders and employment all improved. 

The Institute for Supply Management’s services index jumped to 64.1 last month from 60.1 in June, topping all estimates… 

‘Materials shortages, inflation and logistics continue to negatively impact the continuity of supply,’ Anthony Nieves, chair of the ISM’s Services Business Survey Committee, said… 

Prices paid by service providers jumped to 82.3 last month, the highest level since September 2005. 

Meantime, delivery times lengthened, with a gauge of supplier deliveries rising to its second-highest reading on record.”

August 3 – Bloomberg (Alex Tanzi and Katia Dmitrieva): 

“U.S. household debt rose at the fastest pace since 2013 in the second quarter, driven by a mortgage boom as Americans took advantage of low borrowing costs and sought more space to work from home. 

Household liabilities climbed $313 billion to $14.96 trillion as of the end of June, a 2.1% rise from three months earlier, the Federal Reserve Bank of New York said… 

Most of the increase came in mortgage balances. 

With the average 30-year rate declining in the period, millions of Americans with good credit took the opportunity to refinance and cut their monthly payments.”

August 6 – Bloomberg (Reade Pickert): 

“U.S. consumer borrowing surged in June by the most on record, reflecting large increases in credit-card balances and non-revolving loans. 

Total credit jumped $37.7 billion from the prior month after an upwardly revised $36.7 billion gain in May, Federal Reserve figures showed... 

On an annualized basis, borrowing increased 10.6%.”

Recall that CPI jumped 0.9% in June, with a y-o-y gain of 5.4%. 

Producer Prices surged 1.0%, as y-o-y inflation rose to 7.3%. 

The most recent data showed the national FHFA House Price Index up 18.0% y-o-y, with the S&P CoreLogic Index up 16.99%. 

Federal Reserve Credit has inflated $4.462 TN, or 120%, over the past 99 weeks. 

During this period, M2 “money supply” ballooned $5.450 TN, or 36%, to $20.4 TN. 

Of course, such unparalleled monetary inflation has consequences, immediate as well as longer-term. 

To believe the Fed can simply accommodate the financial markets with the most gradual and transparent “taper” and everything will magically normalize is more than wishful thinking.

Wall Street won’t admit it. 

The Fed clearly has its heels dug in. 

Risks are escalating for the overheated U.S. economy. 

Chair Powell and the FOMC have come under mounting pressure from the Republican fiscal conservatives. 

And there was this week an astute letter from influential moderate Democrat Senator Joe Manchin:

“With the recession over and our strong economic recovery well underway, I am increasingly alarmed that the Fed continues to inject record amounts of stimulus into our economy by continuing an emergency level of quantitative easing (QE) with asset purchases of $120 billion per month of Treasury securities and mortgage backed securities. 

The Fed has sustained $120 billion per month in asset purchases since June 2020, despite increasing vaccination rates to combat the virus and additional fiscal stimulus from Congress in the ARP. 

The record amount of stimulus in the economy has led to the most inflation momentum in 30 years, and our economy has not even fully reopened yet. 

I am deeply concerned that the continuing stimulus put forth by the Fed, and proposal for additional fiscal stimulus, will lead to our economy overheating and to unavoidable inflation taxes that hard working Americans cannot afford.

Simply put, our monetary and fiscal stimulus response met the moment of crisis when our economy suffered the medical equivalent of a heart attack. 

But, now it’s time to ensure we don’t over prescribe the patient by further stimulating an already strong recovery and therefore risk our ability to respond to future crises we are sure to face. 

I urge you and the other members of the Federal Open Market Committee to immediately reassess our nation’s stance of monetary policy and begin to taper your emergency stimulus response. 

While I appreciate your commitment to maximum employment and stable prices, it is imperative we begin to understand that long term policy responses tailored for an economic depression, like the Great Depression and Great Recession of 2008, may not be what is required for today’s economy and could result in higher than desired inflation if not removed in time.”

My own view holds that QE should be employed only in dire emergencies. 

To safeguard system stability, when used it must be limited in scope and duration. 

There’s a strong case that QE thwarted financial collapse in 2008, although I believe $1 TN was excessive. 

It was critical for the Fed to have followed through with their 2011 “exit strategy” policy normalization. 

Reinstating QE in 2012 in a non-crisis environment – where the Fed’s balance sheet doubled the 2011 level to $4.5 TN – was foolhardy inflationism that opened the monetary inflation floodgates. 

Restarting QE again in September 2019 in the face of increasingly manic securities markets and multi-decade low unemployment – was reckless.

It’s difficult to comprehend the $4.0 TN QE pandemic response. 

The Fed confronted a faltering Bubble of its own making. 

There’s a case for limited QE liquidity injections to accommodate a de-risking/deleveraging crisis dynamic. 

The Federal Reserve instead employed massive open-ended QE, first to thwart deleveraging and then to stoke Bubble excess. 

Never should the Fed and global central banks have allowed markets to believe QE was readily available to circumvent market adjustments and corrections. 

Prolonged QE has fomented market dysfunction and deep structural maladjustment.

July 31 – Bloomberg (Sam Potter and Elaine Chen): 

“Record inflows. 

Record fund launches. 

Record assets. 

If active money management is in decline, someone forgot to tell the ETF industry. 

Amped up by a meme-crazed market and emboldened by the success of Cathie Wood’s Ark Investment Management, stock pickers are storming the $6.6 trillion U.S. exchange-traded fund universe like never before -- adding a new twist in the 50-year invasion from passive investing. 

Passive funds still dominate the industry, but actively managed products have cut into that lead, scooping up three-times their share of the unprecedented $500 billion plowed into ETFs in 2021… 

New active funds are arriving at double the rate of passive rivals, and the cohort has boosted its market share by a third in a year.”

August 5 – Financial Times (Robin Wigglesworth, Kate Duguid, Colby Smith and Joe Rennison): 

“Hedge funds that exploit bond market dislocations, such as those blamed for exacerbating the US Treasury ructions of March 2020, have swelled to more than $1tn of assets for the first time. 

The strategy, known as ‘fixed income relative-value arbitrage’, — which typically involves using big dollops of leverage to profit from small but persistent anomalies — attracted another $5.5bn of investor money in the second quarter, according to HFR. 

That, coupled with buoyant markets, lifted total assets under management above the $1tn milestone.”

Manic securities market excess is conspicuous – equities, corporate Credit, ETFs, cryptocurrencies, “meme stocks,” IPOs, M&A, structured finance, etc. 

The precarious nature of housing market inflation and excess is similarly obvious. 

How it somehow became reasonable to stick with $120 billion monthly QE in the face of such momentous asset market inflation and speculation is difficult to understand.

The Fed dismisses Bubble and inflation risks. 

One has only to look at charts of the Fed’s balance sheet, system Credit growth, M2, and Treasury debt to appreciate that we’ve transitioned into uncharted waters with regard to monetary inflation. 

And it is not credible to simply assert that the associated jump in inflation will be transitory. 

Inflation psychology has evolved quickly – in commodities pricing, labor markets, and corporate pricing of goods and services. 

The Fed is delusional if it actually believes it has anchored inflationary expectations. 

The University of Michigan’s survey of one-year inflation expectations jumped to 4.7% in July, the high since 2008. 

And with the economy overheated, we should assume onerous fallout from another year of zero rates, along with an additional Trillion of QE. 

There is no precedent for such massive monetary stimulus in these circumstances.

Ten-year Treasury yields jumped seven bps Friday to 1.30%, a rather dramatic reversal from Wednesday’s intraday 1.13% low. 

Treasury bonds have been pulled lower over recent months by Chinese Credit deterioration and myriad global Bubble fragilities. 

There’s always an Ebb and Flow associated with financial instability, and this week there was a Beijing-directed hiatus in the evolving Credit crisis. 

With a relatively tranquil week for China (and Asia & EM), Treasuries turned more attentive to U.S. overheating.

The Shanghai Composite rallied 1.8%, and the growth-oriented ChiNext Index recovered 1.5%. 

An index of high-yield Chinese bonds saw yields drop a modest 41 bps to 12.38% - though yields remain 269 bps higher over three weeks. 

Huarong CDS dropped 140 bps to 1,088, but there was little relief from elevated CDS prices for the other “AMCs” and developers. 

Meanwhile, crisis dynamics for behemoth developer Evergrande have attained crucial momentum. 

August 6 – Bloomberg: 

“China Evergrande Group bonds dropped to record lows after reports that creditor lawsuits against the world’s most indebted developer will be consolidated, a step that has preceded several high-profile defaults by Chinese borrowers. 

Cases related to Evergrande and its affiliates will be centralized in a Guangzhou court, Caixin reported… 

Speculation about the move triggered a slump in the developer’s bonds late Thursday, with losses deepening after the city of Beijing tightened property curbs and S&P Global Ratings cut its assessment of Evergrande for the second time in as many weeks.

‘Evergrande’s liquidity position is eroding more quickly and by more than we previously expected,’ S&P analysts led by Matthew Chow wrote… 

‘The company’s nonpayment risk is escalating, not only for the substantial public bond maturities in 2022 but also for its bank and trust loans and other debt liabilities over the next 12 months.’” 

Evergrande yields (8 ¾ ’25) traded to almost 40% in Friday trading, as the market prepares for imminent default. 

The company’s woes pulled down developer bond prices, reversing part of what had been a decent rally earlier in the week.

Between Beijing’s recent bareknuckle reform measures and acute Credit market stress (Huarong, Evergrande, developers, high-yield, etc.), investor/speculator confidence has been shaken. 

For the most part, markets still view Beijing as having things under control. 

But there are widening fissures in market confidence.

A Friday Financial Times opinion piece (Simon Edelsten) pondered perhaps the crucial question confronting global markets: 

“What happens when investors lose faith in Beijing? 

It could take China years to win back confidence after recent state intervention in tech.” 

The article’s conclusion: “It has taken China decades to stimulate homegrown entrepreneurship. 

Undermining the most successful businesses so publicly will have a rapid and lasting impact across the economy. 

Nearly two decades ago, when I first visited China, the government was keen to demonstrate its care for shareholders and their rights. 

It is deeply troubling if that policy is being abandoned. 

As the Asian crisis demonstrated, it takes years to win back investors’ confidence.”

Chinese Credit instability Ebbed somewhat this week. 

I have my doubts “the fix is in.” 

Beijing still commands formidable market power. 

Yet I expect they’ll intervene only when they feel it’s necessary to restore stability. 

Unlike the Fed, they are not content to fan speculative excess. 

Especially if Evergrande collapses, I would expect the Flow of Credit instability to gain velocity. 

Moreover, expect each round of Ebb and Flow to beget ascending levels of systemic stress. 

And if the marketplace is beginning to lose faith in the almighty Beijing meritocracy, I see the “small” banking and local government finance sectors susceptible to “risk off” contagion. 

Meanwhile, more record highs this week for the S&P500 and major equities indices. 

Yet there remains an underlying instability that indicates heightened vulnerability. 

Commodity markets were notably unstable this week, with major declines in crude, copper and the precious metals. 

While the VIX closed the week at about 16, it again traded above 20 earlier in the week (Tuesday). 

And, importantly, volatility has increased for a vulnerable bond market. 

Bond fund flows have slowed markedly, with outflows this week. 

“Investors” should enjoy the summer doldrums while they last.

Pushing back

Joe Biden is determined that China should not displace America

His China policy is looking even tougher than Donald Trump’s



America must focus on “blunting Chinese power and order and building the foundations for us power and order”. 

That, at least, is the message of a recent book by Rush Doshi, until recently a scholar at the Brookings Institution, a think-tank in Washington, dc. 

“The Long Game: China’s Grand Strategy to Displace American Order” argues that China has worked for years to undermine America’s geopolitical dominance and shape a more illiberal world order that better protects and serves China’s interests. 

It concludes that these efforts need to be repaid in kind.

This is a striking rebuke to decades of American foreign-policy thinking focused on “engagement” with China. 

The rebuke gains extra weight from the fact that Mr Doshi is now a China director on President Joe Biden’s National Security Council, where he works under Kurt Campbell, his mentor and a leading architect of the administration’s China strategy.

Engagement was already on its uppers. 

Donald Trump had replaced it with something more belligerent and capricious. 

Many hoped that Mr Biden would bring some order to the chaos and lay down rules for a return to some sort of engagement, albeit on less friendly terms than those practised by the Obama administration in which he served. 

But although Mr Biden’s administration is indeed forgoing the caprice and wilfulness of his predecessor, in other respects it is toughening policy, assiduously building a strategic framework for countering and checking China’s rise.

Unlike Mr Trump, Mr Biden seems sincerely worried about a world in which China’s authoritarian model wins. 

That makes him more serious about the policies implemented, often haphazardly, by the hawks who served in the previous administration. 

In its first six months Mr Biden’s administration has, to the surprise of many, officially affirmed the label of “genocide” applied by the last administration to atrocities in Xinjiang, and also worked with allies to impose further sanctions on the perpetrators. 

It has kept in place and refined Mr Trump’s prohibitions on doing business with Huawei and a long list of technology companies and military-affiliated businesses (see chart 1). 

It has made countering China a priority in talks with allies around the world, and shown no urgency to hold a summit with Xi Jinping, China’s president.


Mr Biden is positioning America as the West’s leader in a “contest with autocrats”, as he put it at the g7 summit in June. 

In an interview with The Economist a senior administration official said China sees the next 10 to 15 years as a window of opportunity in which to “assert its authority globally”: continuing its attempts to dominate critical technologies and rewrite the rules of the global order, and cowing its critics so as to make the world safe for autocracy. 

This is not a secret. 

Mr Xi has outlined China’s ambitions to exert influence on the global order, seizing a moment when the Communist Party views the West to be in decline. 

Even so, people in the West, the official said, are only beginning to recognise “that we’re dealing with a country that is perhaps less interested in coexistence, and more interested in dominance”. 

The time to take a stand, therefore, is now.

Build then blunt

Defining the relationship as one of two antagonists with antithetical values makes it sound like the cold war. 

But there are crucial differences, none more notable than China’s inextricable integration into the global economy. 

America cannot try to contain it as it did the Soviet Union; instead Mr Biden wants to counter China’s influence by increasing America’s own.

The emerging strategy, while still protean, sounds of a kind with Mr Doshi’s prescription for “blunting and building”. The building comes first. 

Mr Biden’s aides invariably start any discussion of China strategy with the need to restore American greatness after decades of decline. 

“Rarely has a great power like the United States gone on such a detour,” says the senior official. 

“It’s tragic.” 

America must recover from all that, and invest in itself, Mr Biden’s aides say, so that it can deal with China from a position of strength.

Hence the United States Innovation and Competition Act, which passed the Senate in early June packed with spending intended to improve America’s competitiveness. 

It would authorise $52bn to boost semiconductor research and manufacturing in America and $29bn for a new applied-sciences fund that would support projects in advanced materials, robotics, artificial intelligence and other technologies. 

It also contains extra money for going to the Moon.

Spending does not have to be aimed so precisely to be part of the policy. 

Mr Biden’s $1.9trn pandemic recovery package, which passed in March; his multi-trillion dollar proposals for “hard” and “soft” infrastructure; his provisos on buying American: all can be read as part of a rebuilding policy aimed at China while also looking to fulfil lavish campaign promises.

But ambitious as they look in Washington, these numbers cannot compare with Chinese spending on infrastructure and industrial policy. 

And they are shrinking. 

The core infrastructure plan has been whittled down to $600bn in negotiations with Republicans whose distaste for handing victories to Mr Biden exceeds their animosity to China (though Democrats want to add back $3.5trn in another package).

Republicans such as Ted Cruz, Marco Rubio and Josh Hawley, all self-professed China hawks, are unlikely to abandon their party’s opposition to Mr Biden’s domestic agenda when they have their eyes on his job.

Even if America were united in its efforts, though, building back at a rate that would seriously diminish China’s current prospects is not possible. 

Barring a serious setback, China’s economy will become the world’s largest within its 10-15 year “window of opportunity”. 

The country’s gigantic market will exert, as Communist Party lingo puts it, a “powerful gravitational field” far beyond its borders. 

It will be able to spend even more on its armed forces. 

The country’s investments in research and development will make its technological prowess increasingly formidable.

That is why an antagonistic policy requires what Mr Doshi calls “asymmetric blunting”: ways of undermining China’s attempts to rebuild the world order that do not cost too much. 

Militarily, that means adopting an approach of “deterrence by denial” in areas just beyond internationally recognised Chinese waters, investing in state-of-the-art weapons to stop China seizing control of waters or islands (like Taiwan) to which it considers itself entitled. 

Economic blunting tactics include enforcing export controls so that American companies do not fuel China’s rapid development of critical technologies—a tool that the Trump administration used to cripple Huawei and to impede China’s biggest chipmaker, Semiconductor Manufacturing International Corporation. 

Political blunting includes countering China’s influence in the United Nations and other multilateral institutions.

Sharpen up

Because such strategies require partners, their cultivation is a core tenet of Mr Biden’s strategy. 

He has been courting other governments and sorting out old grievances. 

He has agreed a suspension of tariffs in a 17-year-old dispute with the eu over subsidies to Airbus, an aerospace company. 

He has also waived sanctions on the company building the Russian-led Nord Stream 2 pipeline as a favour to Germany, which will be the recipient of most of its gas. 

In so doing he signalled that his administration views potential co-operation with allies on China as more important than confronting Russia. 

In March America agreed a new deal on funding for the main American military base in Seoul.

This cultivation has borne some fruit. 

In March Britain, Canada and the eu joined with America in imposing sanctions on Chinese officials and entities over Xinjiang—the first time any other governments had done so. 

In May South Korean President Moon Jae-in, on a visit to the White House, agreed to a mention of preserving the status of Taiwan in the subsequent joint statement. 

In June the g7 and, a couple of days later, a nato summit both produced statements recognising the threat posed by China.

Serious blunting, though, requires more than co-ordinated statements and (largely symbolic) sanctions. 

Here there is less to report. 

Build Back Better World, or b3w, a response to China’s Belt and Road Initiative announced at the g7 summit, has no new institutional framework or funding. 

Mr Biden has worked with the g7 and the Quad, a military grouping with Australia, Japan and India, to counter China’s coercive, strings-attached vaccine diplomacy. 

But the commitments of vaccine doses are tiny compared with the need. 

He has not as yet put serious resources to his broader vision of providing middle-income countries with alternatives to taking money and business from China. 

Congress would not let him.

Where America does not lead, its allies seem unlikely to go of their own accord. 

In May the European Parliament responded to China’s bullying over the eu’s earlier Xinjiang sanctions by freezing ratification of an investment treaty. 

But many governments still want such deals and are not looking for trouble. 

On July 1st Rishi Sunak, Britain’s chancellor, called for a “mature and balanced relationship” with China, eyeing the City’s potential to sell financial services into the world’s second-largest national market. 

On July 7th Boris Johnson, the prime minister, said he did not want to scare away investment because of an “anti-China spirit”.

Emmanuel Macron, the French president, and Armin Laschet, who may succeed Angela Merkel as German chancellor, have shown a lack of enthusiasm for confronting China. 

Smaller countries feel similarly. 

Not coincidentally, the number of countries with which China shares more trade than America is far greater than the other way round (see chart 2).


There are also American voices opposed to a tougher line. 

Businesses and financial institutions are lobbying hard to maintain access to the China market and for the easing of export controls. 

On July 7th more than 40 progressive groups wrote to Mr Biden urging him to drop America’s “antagonistic posture” towards China and to co-operate on climate change. 

Such calls are music to Mr Xi’s ears. 

As Mr Doshi writes, Chinese officials routinely treat America’s wish for progress on major challenges—such as climate or nuclear non-proliferation—as opportunities for leverage. 

China’s determination to link issues America would like to keep separate makes America’s interest in cordoning off areas for co- operation some what moot. 

They are not decisions it can make on its own.

The climate looks likely to fall victim to this antagonism. 

Both countries will lower their emissions (though Mr Biden’s ambitions may be thwarted by opposition at home) but it will be hard for them to come together to set rules of the road for others. 

There are economic risks, too. 

There are almost no advocates for free and unfettered trade around Mr Biden, and that suits the architects of his China policy well.

During the 2020 presidential campaign Jake Sullivan, now Mr Biden’s national security adviser, co-authored an article calling on foreign-policy experts to stop deferring to economists and move past the assumption “that more trade is always the answer”. 

He is in no rush to get rid of Mr Trump’s tariffs and “phase one” trade deal, which required China to meet specific import quotas; they may not be to his taste, but they could supply leverage for future negotiations. 

This was despite the judgment of economists outside the administration—and some inside—that the tariffs hurt America more than they hurt China.

There are also areas where trade with China is seen as a risk in and of itself. 

China’s dominance over the markets for some key resources, while not yet a national-security problem, could become one. 

Mr Sullivan, Mr Campbell, Mr Doshi and others want America to reduce the degree to which it relies on its antagonist for some critical commodities. 

In June the administration completed a supply-chain review that identified areas that China dominates—including rare-earth metals, lithium and cobalt (vital for high-capacity batteries) and some drugs and drug ingredients—and called for America to work with other countries on how to wean themselves off the Chinese market.

Such concerns could lead to a bifurcation in global trade. 

But voices warning of the economic costs such a split would impose are exactly those to which Mr Sullivan wants policymakers to pay less heed. 

If his security-first view prevails Mr Biden may go further to decouple the two economies than did Mr Trump, parts of whose administration exploited his inattention in order to do less than he would have wished. 

The treasury secretary, Steven Mnuchin, delayed efforts to impose sanctions on Chinese institutions. 

Officials at the Bureau of Industry and Security (bis) dragged their feet on drawing up a list of emerging technologies that could be subject to broad export controls. 

Customs and Border Protection issued most of its orders to block imports of goods made by forced labour in Xinjiang only in 2020, after Mr Trump had taken to blaming China for the pandemic.


Mr Biden’s administration is more responsive to his intentions. 

The machinery that can be used to blacklist more Chinese companies has been fine-tuned, in part to make it more resistant to legal challenges. 

It has maintained virtually all the existing sanctions, export controls and customs orders, and instituted a few more that were under way before Mr Trump left office. 

These included a ban in June on imports from a Xinjiang-based company which produces the type of silicon needed for solar cells, because of concerns about the forced labour of Uyghurs there. 

Some 45% of the world’s supply of this highly refined silicon comes from Xinjiang, and sanctions against more of its manufacturers are expected, if not from the administration, then through a bill pending in Congress.

How blunt, exactly?

In a speech on July 13th Mr Sullivan signalled concerns about companies evading export controls “in ways that harm national security”. 

What that posture means in terms of slowing China’s progress in technologies such as artificial intelligence and quantum computing is still a matter of concern for those watching proceedings. 

The tech industry has its worries about China (particularly over the long-term security of Taiwan Semiconductor Manufacturing Company, the main supplier of the highest-end chips). 

But it still wants to sell it more stuff. 

The most ardent foreign-policy hawks want the toughest actions, including things they are sure the Biden administration would not dare to do, such as banning dollar-denominated transactions with leading Chinese chipmakers.

Both sides have been keenly interested in who would serve as the new head of the bis, seeing the position as a bellwether. 

But when, on July 13th, they learned it would be Alan Estevez, a former Obama-era Pentagon official with experience conducting national-security reviews of foreign investments, they seemed at first little the wiser. 

As a nominee to a sensitive post his chief attribute may be a lack of preconceptions as to how he will approach the job.

Beyond the question of how hard to push, though, lies the disconcerting realisation that China may well be an immovable object. 

If American businesses turn away from China, others will step in. 

Bonnie Glaser, a China expert at the German Marshall Fund, a think-tank, says the best hope of shaping China’s choices lies in forming an “anti-China coalition” (though not explicitly calling it that). 

Like those around Mr Biden, she believes that, even then, the odds of affecting change will not be good, but “we have to try”.

An us-v-them approach has problems. 

When Mr Biden presents it as a dichotomy of democracies versus autocracies, European officials wince—and the status of a country like Vietnam, which Mr Biden wants on-side, becomes problematic. 

Jude Blanchette of the Centre for Strategic and International Studies, another think-tank, argues that the Biden administration would be better-served if it stopped paying such close-up attention to China and instead zoomed out to take a broader view of the world. 

America reacts to everything Chinese leaders do, he says: they adopt an industrial policy, America adopts an industrial policy; they secure supply chains, so does America; they have a Belt and Road Initiative, so must America.

Mr Blanchette argues that America should take a different page out of Mr Xi’s playbook: talk less about its adversary and more about the world it wants to build. 

“Xi just does not talk about America a lot. 

When they articulate their vision it’s not an America strategy,” he says. 

“It’s ‘this is the role China wants to play in the world over the next 10, 20, 30, 40, 50 years’.” 

Like some members of the Biden administration, Mr Blanchette looks to the early days of the cold war for inspiration. 

Then America placed its attempts to contain the Soviet Union within a broader vision of the world. 

If today it could articulate such a vision again, it might become clearer how China fits in and open up a policy shaped by America’s continuing role, rather than purely by China’s rise. 

The other kind of mistake

Robert Armstrong


You just can’t please everyone. 

There is an emerging consensus, as I wrote on Thursday, that the Fed is preparing to make a mistake — tightening rates too early and too fast, thereby killing economic growth while it is still in the cradle. 

Some people disagree, though. 

Their view is not that the Fed is muddling along OK (my rather lonely opinion), but rather that the Fed is actually making the opposite error — not tightening soon enough. 

Mohamed El-Erian, writing in Bloomberg earlier this week, argued that the simultaneous rise in consumer and producer prices “suggests that realised inflation is being accompanied by additional inflation in the pipeline”, while the Fed is being maddeningly vague about when it will react. 

This could mean trouble:

The facts on the ground . . . call for the world’s most powerful central bank to start easing its foot off the stimulus accelerator. 

For example, it should cut back the mortgage component of the $120bn of monthly asset purchases, an element fuelling an already red-hot real estate market that is pricing many Americans out of new houses without any notable economic benefit elsewhere. 

By refusing to do so, the Fed runs a higher risk of having to slam the policy brakes down the road. 

This comes with the threat of the Fed inadvertently engineering a recession.

El-Erian thinks abrupt tightening will crimp growth only if “market accidents don’t happen first, the probability of which is also increasing”. 

(It seems to me that when markets are “red hot”, a recession without a market accident first is quite unlikely. 

An overheated market is a great leading indicator of, and catalyst for, a recession.)

One might argue El-Erian and the other Fed-mistake-anticipators are not so far apart. 

They both worry that the Fed will overtighten. 

The difference, though, is that instead of yelling “don’t touch that dial!”, El-Erian is shouting “turn it a little now so you don’t have to turn it a lot later!”

Rick Rieder, who runs fixed income for BlackRock, hits some of the same notes as El-Erian. 

Writing after the hot CPI print, he said:

Policy adjustments that are intentionally late . . . can create distortions in the economy and markets that (ironically) risk undermining the very successes that policy has achieved up to this point . . . we need look no further than the housing market to see how this plays out. 

As a result of huge price gains through the pandemic, accompanied by easy policy, new home sales have fallen 23 per cent . . . 

The Fed should outline the tapering programme (especially in mortgages), as we appear to already be at, or close to, maximum employment (at least as characterised by job availability) and simultaneously may be at risk of overheating in pricing.

I was struck by the focus on “distortions” rather than on what seems to me to be the clear and present danger of an explosion in some corner of the market that scares everyone, leading to general flight from risk, negative wealth effects, cats and dogs living together, and recession. 

So I called Rieder up.

He emphasised that there were three things he was worried about: inflation being stickier than expected (he’s looking closely at the way service industries are passing on costs to consumers); higher prices for basics like food turning into a regressive tax that ultimately kills demand; and high asset prices stifling certain markets, as in the housing example. 

Interestingly, he sees low Treasury bond yields as an example of this last point. 

Everything else is so expensive, and everyone has made so much money, that the safety and liquidity of a Treasury that yields something, if not very much, is appealing. 

“I look at high-yield bond deals at 2.5 per cent, and Treasuries at 1.3 don’t look all that bad,” he says. 

“Real rates and Treasuries are priced wrong, but they’re liquid.”

But if we are seeing what looks like a flight to the safety of Treasuries from overpriced assets, shouldn’t we be worried about a crash in risk assets? 

Rieder thinks that equity valuations are not that high and the stock market will move higher. 

Furthermore, the abundant liquidity in the current market means that gradual tightening “just is not that scary”. 

“But the longer you let it go, then [the Fed] has to move faster and harder, that is when it hurts the market. 

I don’t think we are there yet, but every month that goes by you create a riskier proposition.”

Why aren’t bank stocks getting hit harder?

If you are one of those people who think the Fed is going to kill growth, and rates are going to remain low for the long term as a result, you probably don’t want to buy bank stocks.

People used to talk a lot about how bank profitability was driven by the slope of the yield curve, because banks fund themselves at the short end and make loans at the long end. 

This isn’t really true any more (banks don’t use as much short-term funding as they did, and thank God). 

Now it’s about the level of rates, and short rates in particular, as most loan products are priced on the short rates plus a spread. 

The excellent bank analyst Brian Foran of Autonomous sums it up this way: if rates rise by 1 per cent across the yield curve, the average bank’s profits will rise about 15 per cent, with two-thirds of that bump coming from higher short-term rates.

The rates on long-term bonds (in theory) tell us about the long-term path of short-term rates. 

So the recent fall in the 10-year is telling us (in theory) that short-term rates will be low for a long time. 

Bad news for banks!

But, oddly, bank stocks are not doing all that badly. 

Here is the stock performance of the six biggest since last November, when they came into vogue with the “reflation trade” (data from Bloomberg):


The stocks rolled over when 10-year yields did, back in May, but the damage has not been all that bad. 

They are still miles above the pre-reflation trade lows. 

The largest banks have reported second-quarter earnings in the past few days, and the results were better than expected. 

Much of that is down to excellent credit quality — Covid-era loss reserves being released and low loan charge-offs. Foran believes that credit quality accounted for 80 per cent of the earnings outperformance. 

Trading desks didn’t do well, but a boom quarter in dealmaking fees made up for that. 

Loan growth is showing very tentative signs of recovery, led by credit cards. 

The markets are not quite buying it, though. 

Here is a classic bank chart, which plots banks’ return on tangible equity (the most basic measure of bank profitability) against price-to-tangible book ratios (the most basic measure of their valuation). 

All data comes from the banks themselves:


Usually there is a tight linear correlation between returns and valuations (so all the banks cling to a straight, upward-sloping trend line). 

Right now they are all over the place. 

The very high returns at Goldman and JPMorgan should force them way to the right, that is, give them higher valuations. 

Citigroup and to a lesser extent Bank of America seem too far to the left, too — why haven’t their high returns pushed their valuations higher?

What the chart is telling you is that the strong investment banking results at JPMorgan, Goldman and Bank of America are unlikely to last. 

The market has more confidence that the big regional banks like US Bank (USB), Truist (TFC) and PNC, which depend less on capital markets, will be able to maintain their returns. 

Morgan Stanley’s wealth management business is a stabiliser, too (Wells Fargo is a whole different conversation).

To my eye, though, all the valuations look high, if we think the reopening economy will quickly fade back towards sluggish pre-pandemic normality. 

Credit is not going to get better. 

If growth is soft, why would loans grow? 

Especially given that bond markets are handing out all but free money? 

It is not obvious to me why investors are willing to pay 2 times book value for banks right now. 

That’s close to the top of the historical valuation range.

On this question, Charles Peabody of Portales Partners makes an encouraging point. 

Bank stocks traditionally do well at the beginning and end of economic expansions, he notes. 

At the beginning, improving credit quality pushes their earnings up, and at the end, loan growth does the same. 

In the middle of the cycle, they tend to sag. 

So:

“I think this is a classic mid-cycle correction and eventually we will get all the things that people are disappointed we are not getting right now — higher rates, loan growth, and so on.”

In a world of dreary data, then, bank stocks’ high valuations and relatively resilient stock prices are sending a positive message: this, too, shall pass. 

The inflation kerfuffle and the bond yield collapse may just give way to the renewed growth we were hoping for a few months ago.

Inflation? Not in Japan. And That Could Hold a Warning for the U.S.

If the United States’ bout of rising prices soon eases, its economy could fall back into the cycle of weak inflation that preceded the pandemic — a situation much like Japan’s.

By Ben Dooley

A shopping street in Tokyo last month. The Japanese economy continues to struggle with deflation despite policies to coax prices higher.Credit...Carl Court/Getty Images


TOKYO — In the United States, everyone is talking about inflation. 

The country’s reopening from the coronavirus pandemic has unleashed pent-up demand for everything from raw materials like lumber to secondhand goods like used cars, pushing up prices at the fastest clip in over a decade.

Japan, however, is having the opposite problem. 

Consumers are paying less for many goods, from Uniqlo parkas to steaming-hot bowls of ramen. 

While in the United States average prices have jumped 5.4 percent in the past year, the Japanese economy has faced deflationary pressure, with prices dipping 0.1 percent in May from the previous year.

To some extent, the situation in Japan can be explained by its continued struggles with the coronavirus, which have kept shoppers at home. 

But deeper forces are also at play. 

Before the pandemic, prices outside the volatile energy and food sectors had barely budged for years, as Japan never came close to meeting its longtime goal of 2 percent inflation.

It wasn’t for lack of trying. 

Over nearly a decade, Japanese policymakers have wielded almost every trick in the economist’s playbook in an effort to coax prices higher. 

They have juiced the economy with cheap money, spent huge sums on fiscal stimulus like public works and lowered interest rates to levels that made borrowing nearly free.

But as Japan has learned the hard way, low inflation can be an economic quagmire. 

And that experience carries a warning for the United States if its current bout of inflation eases, as many economists expect, and its economy falls back into the cycle of weak inflation that preceded the pandemic.

“Most economists, me included, are pretty confident that the Fed knows how to bring inflation down,” including by raising interest rates, said Joshua Hausman, an associate professor of public policy and economics at the University of Michigan who has studied Japan’s economy.

However, “it’s much less clear, partly because of Japan’s experience, that we’re very good at bringing inflation up,” he added.

For consumers, falling prices sound like a good thing. 

But from the perspective of most economists, they are a problem.

Consumers are paying less for many goods, from Uniqlo parkas to steaming-hot bowls of ramen.Credit...Kazuhiro Nogi/Agence France-Presse — Getty Images


Inflation, they like to say, greases the economy’s gears. 

In small amounts, it increases corporate profits and wages, stimulating growth. 

It can also reduce the burden of debt, bringing down the relative costs of college loans and mortgages.

Japan’s inability to lift inflation is “one of the biggest unsolved challenges in the profession,” said Mark Gertler, a professor of economics at New York University who has studied the issue.

One popular explanation for the country’s trouble is that consumers’ expectations of low prices have become so entrenched that it’s basically impossible for companies to raise prices. 

Economists also point to weakening demand caused by Japan’s aging population, as well as globalization, with cheap, plentiful labor effectively keeping costs low for consumers in developed countries.

The picture once looked very different. 

In the mid-1970s, Japan had some of the highest inflation rates in the world, approaching 25 percent.

It wasn’t alone. 

Runaway prices set off by the 1970s oil crisis defined the era, including for a whole generation of economists who were groomed to believe that the most likely threat to financial stability was rapid inflation and that interest rates were the best tool to combat it.

But by the early 1990s, Japan began experiencing a different issue. 

An economic bubble, fueled by a soaring stock market and rampant property speculation, burst. 

Prices began to fall.

Japan attacked the problem with innovative policies, including using negative interest rates to encourage spending and injecting money into the economy through large-scale asset purchases, a policy known as quantitative easing.

Shops and restaurants closed during a state of emergency in Osaka, Japan, in May. To some extent the situation in Japan can be explained by its continued struggles with the coronavirus.Credit...Carl Court/Getty Images


It seemed to do little good. 

Still, economists at the time saw Japan’s experience not as a warning to the world, but as an anomaly produced by bad policy choices and cultural quirks.

That began to change with the financial crisis of 2008, when inflation rates around the world plummeted and other central banks adopted quantitative easing.

The problem has been most notable in Europe, where inflation has averaged 1.2 percent since 2009, economic growth has been weak and some interest rates have been negative for years. 

During the same period, U.S. inflation averaged just below 2 percent. 

The Federal Reserve has kept its main interest rate close to zero since March 2020.

Some prominent economists viewed the low inflation as a sign that the U.S. and E.U. economies might be on the brink of so-called secular stagnation, a condition marked by low inflation, low interest rates and sluggish growth.

They have worried that those trends will deepen as both economies begin to gray, potentially reducing demand and pushing up savings rates.

In 2013, under newly elected Prime Minister Shinzo Abe, Japan began its most ambitious effort to tackle its weak economic growth and low inflation.

The government embarked on a grand experiment of huge monetary and fiscal stimulus, buying enormous quantities of equities and lowering interest rates in hopes of encouraging borrowing and putting more money into the economy. 

As the supply of cash increased, the thinking went, its relative value would decline, effectively driving up prices. 

Flush with money, consumers and companies alike would spend more. 

Voilà, inflation.

Former Prime Minister Shinzo Abe leaving his last cabinet meeting in Tokyo last year. Under Mr. Abe, Japan began an ambitious but unsuccessful effort to tackle its weak inflation.Credit...Kazuhiro Nogi/Agence France-Presse — Getty Images


To encourage spending, Japan adopted a policy, known as forward guidance, aimed at convincing people that prices would go up as it pledged to do everything in its power to achieve its inflation target of 2 percent.

But the government’s efforts at persuasion fell short, so there was little urgency to spend, said Hiroshi Nakaso, a former deputy governor of the Bank of Japan and head of the Daiwa Institute of Research.

Japan found itself in a vicious circle, said Takatoshi Ito, a professor of international and public affairs at Columbia University, who served on Japan’s Council on Economic and Fiscal Policy.

Consumers came to expect “stable prices and zero inflation,” he said, adding that as a result, “companies are afraid of raising prices, because that would attract attention, and consumers may revolt.”

The sluggish economy made companies reluctant to raise wages, he said, “and because real wages didn’t go up, probably consumption didn’t go up, so there was no increase for demand for products and services.”

As inflation hardly moved, some economists wondered if Japan’s stimulus had been too conservative, even as it racked up one of the world’s largest debt burdens.

Policymakers, citing a need to pay off the country’s debts and meet the growing costs of caring for an aging population, hedged against the spending by twice raising the country’s consumption tax, apparently weakening demand

A bus station in Tokyo. Economists point to Japan’s aging population as one reason for weakening demand.Credit...Charly Triballeau/Agence France-Presse — Getty Images


In the end, Mr. Abe’s experiment, known as Abenomics, may not have been as successful as hoped. 

But it has informed policymakers’ response to the pandemic, said Gene Park, a professor of political science at Loyola Marymount University in Los Angeles who studies Japan’s monetary policy.

One takeaway, he said, is that governments could spend more than they had ever thought possible without setting off a rapid rise in inflation. 

Another is that they might have to spend considerably more than they had once considered necessary to stimulate growth.

Japan “has given the U.S. more freedom to experiment with bolder measures,” Mr. Park said.

During the pandemic, Japan, too, has tried to apply the lessons learned since 2013. 

The government has paid shops and restaurants to stay closed, handed out cash to every person in the country and financed zero-interest loans for struggling businesses.

Prices fell anyway. 

That was partly at the behest of the government itself, which recently pressured telecom companies to lower mobile phone fees it deemed too high. 

Most Japanese consumers are also still waiting to be vaccinated against the coronavirus, holding back economic activity.

Even after the pandemic wanes, however, Japan’s inflation rates are likely to stay low, said Sayuri Shirai, an economics professor at Keio University in Tokyo and a former member of the Bank of Japan’s board.

After all, the primary problem remains unchanged: No one is really sure why prices have stagnated.

“The central bank probably doesn’t want to say that they cannot control inflation,” Ms. Shirai said. 

“Therefore, this issue has just been left without a clear discussion.”


Ben Dooley reports on Japan’s business and economy, with a special interest in social issues and the intersections between business and politics.