Daily Comment (April 6, 2018)
by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EDT] Happy employment day! We cover the data in detail below but the quick take is that it was much weaker than expected. Payrolls came in well below forecast and the unemployment rate held steady compared to an expected small decline. The data should be taken with caution because the parade of winter storms that hit the Northeast last month probably affected the report. The other major issue is, again, trade. Here is what we are watching this morning:
Tit for tat: Last night, President Trump suggested another $100 bn of new tariffs on China because of its reaction to the first salvo. The usual market response developed; equity futures slid while gold and Treasuries rallied. However, the reaction was not as pronounced compared to earlier periods. It appears the financial markets are steadily adjusting to the president’s social media messages and beginning to focus more on the endpoint than the tweet. The situation with China remains fluid and there is still the probability of a trade war. But, there is also the potential for the outcome we have seen with NAFTA as it seems the U.S., Canada and Mexico are nearing an agreement. When the discussions began, it looked like the treaty was in deep trouble. Now, it looks like all the rhetoric was a negotiating stance.
It is still important to remember that China has taken advantage of the U.S. and the West during its development. This isn’t anything new. Export promotion has become the development model of choice since the end of WWII. The basic recipe is to implement policies that curtail consumption and boost investment. These policies include an undervalued exchange rate, import restrictions, easy corporate borrowing and intellectual property theft. The program works if the global superpower tolerates it. The U.S. did tolerate this behavior during the Cold War, although there were occasional pushbacks (the Plaza Accord, “voluntary” Japanese vehicle import restrictions, etc.). However, every nation that deploys the model reaches a point of development where it no longer works. First, other nations begin to retaliate against the trade surpluses. Second, debt levels usually become untenable. There are essentially four paths to transition away from export promotion. The first is to boost household consumption by reducing saving. This approach can create a debt crisis; in the U.S., resolving this crisis was called “anyone, anyone, the great, Great, Depression.”[1] In Japan, it has led to 30 years of stagnation. The second path is war. War allows the nation to redirect its excess capacity to the war effort instead of exports. The winner destroys the export capacity of his enemy and can keep export promotion policies in place, perhaps even gaining colonies (see below). The third path is to raise the value chain. The excess capacity is transformed into higher value goods. Germany has used this path since the 1980s and the China 2025 plan looks like a similar plan. The fourth path is colonization, where colonies are forced to absorb the excess production caused by malinvestment. The U.K. used this system with its commonwealths, Germany is using it now with the Eurozone and China hopes to use the same method with the “one belt, one road” program. China knows it is at a critical point where it needs to transition its economy. Chairman Xi has amassed enough power to give him the wherewithal to make these difficult changes.
To some extent, U.S. goals of reducing its trade deficit with China are consistent with China’s goals of restructuring its economy. However, China won’t simply accept U.S. trade impediments as they are seen as a form of attack on its sovereignty. Encouraging a stronger CNY and dictating global trade rules, as TTP would have done, would have been a better path. Thus, we have the risk of a trade war, but such a conflict is still avoidable.
Oil tariffs? There are growing fears that China will put tariffs or quotas on U.S. crude oil exports. Tariffs might occur, but they would likely be ineffective. U.S. oil exports to China are rising but are still only about 300 kpbd as of January. Nevertheless, if China raises the cost of U.S. oil exports, other nations will fill the U.S. market share. But, since oil is mostly fungible, the flows will change but U.S. exports should remain the same. For example, let’s say Saudi Arabia fills the U.S. market share. Unless the Saudis increase output and violate their OPEC quota, they will reduce oil sales to some other customer and the U.S. will likely fill that gap. The same thing could happen with soybeans. China needs commodities, and selectively slapping tariffs on U.S. commodity exports will have an effect on flows but not necessarily on overall exports.