Paranoia Strikes Deep
Almost 12 years we’ve been waiting for this.
And last week, it happened.
Then 48 hours later, it all came undone.
Allow me to backtrack.
While I was in Vancouver at the Sprott Natural Resource Symposium, I had a one-on-one interview with Jim Rickards.
The timing of our chat couldn’t have been better.
It was Thursday in Vancouver. The US Federal Reserve had just cut interest rates. We talked all things central banks and trade wars. Ironically, we revisited the topic of currency wars. And as Jim pointed out, the currency war isn’t over. It started back in 2010. Right now, we’re in the eye of the storm.
Less than eight hours after that interview, the Aussie market opened. And the S&P/ASX 200 [ASX:XJO] traded above the pre-crisis high of 6,829.
Did investors rejoice?
If they did, it didn’t last long.
See, yesterday as the markets opened, reality set in.
The Chinese government ‘allowed’ the yuan to fall a little against the US dollar last Friday. Then on Monday, the yuan tumbled a massive 2% against the greenback.
That took the steam out of the Aussie market during Monday trade, with the XJO dropping 1.73%.
However, this morning at the time of writing, the XJO was a whopping 5.8% lower at the open, falling to 6,461.
Just like that, the ‘pre-crisis high’ was over.
Similar moves happened in the US, with the Dow Jones and the S&P500 both down 2.90%.
Australia’s market has seen bigger falls because of our economic reliance on China.
To borrow a line from Buffalo Springfield, the ‘paranoia strikes deep’ that the trade wars are worse for Aussie investors than first thought.
Of course, Australia’s relationship with China — and the risk to investors — is something Jim and I have been covering for more than a year at Strategic Intelligence Australia.
Read on for more from Jim.
Until next time,
The China-US Trade War Just Got Worse
We’ve heard a lot about the China-US trade war from the US side.
President Trump and Vice President Pence have strongly criticised the Chinese for subsidised Chinese exports, theft of intellectual property, requiring US companies in China to hand over trade secrets, currency manipulation and other unfair trade practices.
In his landmark speech on 4 October 2018, Vice President Pence laid out these and many other violations of international agreements by China.
Pence’s speech is generally understood as not being limited to the trade war, but being a declaration of a new cold war if China does not improve its behaviour.
After these well-publicised critiques, what is China saying in its own defence?
The news here is not encouraging.
China is showing no signs of a change in posture.
In fact, China is digging in for a long struggle in which it rejects US claims as an infringement of China’s ‘core interests’.
China has pivoted from talk about trade to discussion of territorial issues such as Taiwan and the South China Sea.
China also rejects US efforts to alter the behaviour of China’s state-owned enterprises (SOEs), which compete in the private sector but are government owned, controlled and subsidised.
Both the US and China are escalating their countervailing claims and rhetoric. The end of the trade war is not in sight.
In fact, it is rapidly turning into a deeper competition that will slow global growth for years to come.
Some investors are turning to cash, US Treasury notes and gold as safe havens while these two global giants fight it out.
China will lose the trade war — but it may not care
The fact that China will lose the trade war with the US was always a forgone conclusion.
The reasons are obvious.
Foreign trade is a much larger percentage of Chinese GDP than it is for the US, so a trade war was always bound to have more impact on China than the US.
Also, China only buys about US$150 billion of goods from the US each year while the US buys about US$500 billion from China.
That’s the source of the US$350 billion trade deficit.
This means that if China tries to match the US in tariffs dollar for dollar, it runs out of headroom at US$150 billion, while the US can keep going up to US$500 billion and inflict far more pain on China. Other forms of Chinese retaliation are mostly nonstarters.
China cannot dump US Treasuries without hurting its own reserve position and risking an account freeze by the US. China cannot turn up the pressure by stealing intellectual property because it’s already doing that to the greatest extent possible.
The bottom line is that the US will win the trade war, and either China will open its markets and buy more US goods or the Chinese economy will slow significantly.
Still, there are suggestions the Chinese may not care.
Chinese leaders care first and foremost about their own leadership and the perpetuation of the Chinese Communist Party, rather than economic growth or the welfare of their people.
If the Chinese view the trade war as just one step in a protracted cold war involving trade, electronics, military assets and regional hegemony, then we’re in for a long period of contracting growth, which will not be confined to China but will affect the entire world.
A forgone conclusion
What most surprised me about the trade war was not that it started, but that the mainstream financial media denied it was happening for so long.
The media have consistently denied the impact of this trade war. Early headlines said that Trump was bluffing and would not follow through on the tariffs. He did.
Later headlines said that China was just trying to save face and would not retaliate. It did.
Today, the storyline is that the trade war will not have a large impact on macroeconomic growth. It will.
The mainstream media have been wrong in their analysis at every stage of this trade war.
The bottom line is that the trade war is here, it’s highly impactful and it could get worse.
The sooner investors and policymakers internalise that reality, the better off they’ll be.
For years, I’ve been warning my readers that a global trade war was likely in the wake of the currency wars.
This forecast seemed like a stretch to many. But it wasn’t.
I said it would simply be a replay of the sequence that prevailed from 1921-39 as the original currency war started by Weimar Germany morphed into trade wars started by the United States, and finally shooting wars started by Japan in Asia and Germany in Europe.
History doesn’t repeat, but it does rhyme
The existing currency war started in 2010 with Obama’s National Export Initiative, which led directly to the cheapest US dollar in history by August 2011.
The currency war evolved into a trade war by January 2018, when Trump announced tariffs on solar panels and appliances mostly from China.
nfortunately, a shooting war cannot be ruled out given rising geopolitical tensions.
The reasons the currency war and trade war today are repeating the 1921-39 sequence are not hard to discern.
Countries resort to currency wars when they face a global situation of too much debt and not enough growth.
Currency wars are a way to steal growth from trading partners by reducing the cost of exports.
The problem is that this tactic does not work because trade partners retaliate by reducing the value of their own currencies.
This competitive devaluation goes back and forth for years.
Everyone is worse off and no one wins.
Once leaders realise the currency wars are not working, they pivot to trade wars.
The dynamic is the same.
One country imposes tariffs on imports from another country.
The idea is to reduce imports and the trade deficit, which improves growth. But the end result is the same as a currency war. Trade partners retaliate and everyone is worse off as global trade shrinks.
The currency wars and trade wars can exist side by side as they do today.
Eventually, both financial tactics fail and the original problem of debt and growth persists.
At that point, shooting wars emerge.
Shooting wars do solve the problem because the winning side increases production and the losing side has infrastructure destroyed that needs to be rebuilt after the war.
This US-China trade war will not end soon, because it’s part of something bigger and much more difficult to resolve.
This is a struggle for hegemony in the 21st century.
The trade war will be good for US jobs but bad for global output.
The stock market is going to wake up to this reality.
The currency wars and trade wars are set to get worse.
All the best,