RealClearMarkets Articles

There is one big problem at the heart of President Trump’s trade policy. He just doesn’t understand the issue. Trump doesn’t grasp why we trade, its benefits and how the world has moved ever further from his 18th-century mercantilist view of the global economy.

Instead of comprehending that trade - importing as well as exporting - is the way we benefit from the relative expertise of others, he seems to see trade as just a series of transactions entered into a ledger, with the goal of coming out in the black every time.

As he often does on trade, Trump spelled out his attitude honestly. The problem: It’s dead wrong. Last year, as he launched his futile trade war with China, he explained why he thought the United States would have no problem pursuing a protectionist policy: “When a country is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good and easy to win.”

In an apparent reference to the U.S trading relationship with Mexico, Trump tweeted: “When we are down $100 billion with a certain country and they get cute, don’t trade anymore - we win big. It’s easy.”

Judging by last year’s summit in Quebec, during which President Trump left early and didn’t endorse the joint communique, this weekend’s 45th G-7 meeting of the seven major industrialized economies may very well turn into a circus. And if so, the elephant in the room is likely to be President Donald Trump’s trade policy.

The President’s imposition of tariffs on Chinese goods and his constant threats to take further action have been hammering global markets. Further exacerbating matters, Trump suggested at a recent campaign rally that the European Union could soon be in the crosshairs for additional tariffs.

So while storm clouds are looming as Trump and other G-7 leaders meet in Biarritz, France, there’s also a silver lining. These leaders have a golden opportunity, in person, to collectively convince the President to dial back his protectionist tendencies and to avoid an escalation of the trade war. And that result is not out of the question. Despite his flair for the dramatic, the President has shown restraint when presented with the right arguments.

Last summer, for example, in advance of what was expected to be a contentious meeting with EU Commission President Jean-Claude Juncker, Trump took to Twitter to warn the EU to stand down on tariffs, barriers, and subsidies or risk a trade war. But after a day of discussions, the two men emerged with a handshake agreement to resolve certain trade issues and work towards zero tariffs.

It doesn’t matter that the yield curve has been warning about this for well over a year. For most people, they were left unaware of any dangers. Aside from the occasional high level mentions here or there, for all 2018 there was the unemployment rate and nothing else as far as the economy was concerned. Federal Reserve Chairman Jay Powell said so numerous times.

This year has gone very differently. The 2s10s, the difference between the 10-year US Treasury yield and the 2-year US Treasury yield, has finally turned negative meaning inversion. Widely considered a recession signal, all of a sudden everyone’s a bond watcher.

Among the numerous other factors that have been displaying this disappointment is the increased intrusion of politics into monetary policy. The Fed has never really been independent, at least not in that way. Independence for the central bank really means accountability, or lack thereof.

It has been President Trump who is now attempting to bridge that gap – though for all the wrong reasons. The growing uncertainty in the economy, according to the President, is Jay Powell’s fault. Having characterized the situation several times as the greatest economic boom in the country’s history, it was apparently driven off course by the eight rate hikes since his election. I guess that mean Janet Yellen needs to be called in, too.

Imagine if Amazon were just a bookseller. As in imagine if Amazon, having unearthed a way to connect buyers with sellers, had stopped at the first product it initially revolutionized retail with.

If so, Amazon probably doesn’t exist today. Either it would have been swallowed by a much bigger player, or it would have been overrun by online retailers (along with physical retailers possessing better brand recognition) with much more expansive plans.

Importantly, Amazon never planned to just be a bookseller. When its share price moved above $100 around 2000, and amid a major run-up for internet companies, its price had little to do with book sales even though book sales were a major driver of Amazon’s business back then. Instead, Amazon’s share price was a projection of all that it would eventually do to connect buyers and sellers. Books, CDs, and DVDs were merely the beginning of much, much more. Founder Jeff Bezos made plain to institutional investors that he was building something much greater than an online version of Barnes & Noble.

All of the above helps explain why investors weren’t turned off by Amazon’s “Amazon.org” nickname. No doubt it was losing money in gargantuan sums, but it was doing so with a much bigger purpose in mind. These investments, investments that often failed spectacularly, would unearth crucial information that Bezos could use in order to create one of the greatest businesses the world had ever seen.

Every summer for the past several decades I have organized a series of Friday lunches in eastern Long Island for serious investors. More than 100 people attend the four sessions, with 25–30 at each one. The participants include hedge fund, private equity and real estate billionaires, venture capitalists, an academic and some corporate leaders. I moderate a discussion of the key issues facing the financial markets for the better part of two hours. This year, several significant events occurred between the first two and the second two sessions. First, the Federal Reserve cut the Fed funds interest rate by a quarter of a percentage point; second President Trump announced a 10% tariff increase on $300 billion of Chinese goods; third, China allowed its currency, the renminbi, to decline to more than seven to the dollar; and fourth, the Hong Kong disturbance took place.

These events sent both the stock and bond markets into turmoil, rocking the complacency of investors throughout the world. The Standard & Poor’s 500 dropped sharply from its high, the 10-year U.S. Treasury yield declined to below 1.6% and the prospect of a recession in 2020 increased. At the first two lunches, most investors were positive, thinking the S&P 500 would continue to make some modest progress through the end of the year and the next recession would not occur until 2021. At the two August lunches, many thought the market could lose ground in the final months of 2019 and that the likelihood of a recession was increasing for 2020. Investors had been assuming that a trade deal with China would be reached sometime prior to the 2020 election, but when Treasury Secretary Mnuchin and Trade Representative Lighthizer returned from Shanghai and told the president that talks with the Chinese had not gone well, Trump reacted strongly by announcing the new tariffs and the stock market began its long slide down. Yields on Treasury securities plummeted as the prospects for a recession in 2020 increased. The turbulence in the capital markets is sure to have an impact on the willingness of both consumers and corporations to make spending commitments. As a result, earnings estimates for companies and GDP estimates for the economy are likely to be adjusted downward. If the current negative conditions continue, Donald Trump’s prospects for a second term will become darker, and that increases the likelihood that he will do something to reverse the trend. One step he could take is to defer the imposition of the new tariffs beyond the September 1st announced date and do everything possible to resume trade discussions with China on a positive basis. By the middle of August he had done just that on some goods covered in the tariff increase, thereby improving the prospects for renewed talks with China.

At three of the sessions, I went around the table asking, “What do you think is the most important issue facing the financial markets over the next twelve months?” Naturally, the trade war with China, a possible recession because of a monetary policy or other mistake, and the unpredictability of Donald Trump were often mentioned. What was seldom brought up in the discussion that followed was climate change, gun control, health care policy and the political polarization between the left and right around the world. There was some discussion of the high and growing level of government debt, but few believed that was a near-term problem. There was not much of an appetite for Bitcoin, Libra, or any other crypto-currency, but there was broad support for the significance and viability of blockchain technology.

The political situation in the United States was vigorously discussed at all four lunches. Most of the participants, regardless of party affiliation, thought Donald Trump would have a second term, although there was less enthusiasm for that point of view after the announcement of the tariff increases at the end of July. Notably, some long-time Democratic supporters were more concerned about Elizabeth Warren, Bernie Sanders or Kamala Harris winning the nomination and possibly the election than they were about a Trump second term. They felt that if a Democratic progressive took over the White House pushing for universal health care, a suspension of employer-based health insurance, free college for all and other costly programs, the damage to our fiscal condition, and ultimately to the party itself, would be serious. Critics of the president believed that his impetuous nature might hurt him to the point where some moderate Republicans would decide not to support him.

Maybe one of the reasons so many see a recession on the horizon is that the president and the White House keep acting like it is.

The U.S economy certainly has significant strengths. GDP growth is slowing, down to about 2.1 percent, but not close to negative territory. The unemployment rate is down, continuing the slow but steady job creation levels that began when President Obama was in office.

But there are grey clouds that could indicate a storm is on its way. The inverted yield curve is the sign that has been most worrisome to the stock market, indicating a precipitous decline in confidence. But there is considerable evidence that investor skittishness reflects trends in the real economy.

U.S manufacturing is already in a recession, having suffered two consecutive quarters of negative growth, with the quarter that ended June 30th showing a 1.2 percent decline. Manufacturing in the United States is now at its slowest rate of growth since the 2009 recession.

New York Attorney General Letitia James seems to be a little confused. Make that a lot confused. James is currently spearheading a group of 15 state attorneys general suing to stop the merger between wireless carriers Sprint and T-Mobile. In explaining her actions to reporters, she said, “To be clear: The free market should be picking winners and losers, not the government, and not regulators." 

To that we say, “Amen.”

So, if Ms. James is such a strong adherent of the free market, why in the world would she be heading to court at the 11th hour with a lawsuit to stop a merger that was initiated, crafted, refined and affirmed entirely by the guiding principles and operating mechanisms of the free market?

It’s like pronouncing your unwavering support for healthy eating, and then joining forces with Krispy Kreme to attack the local farmers market.

President Trump has repeatedly cited the steel industry as an example of the effectiveness of his import taxes. Unfortunately, it is proving how ineffective - even counter-productive - they are.

Just a few days ago, U.S. Steel illustrated the industry’s problems when it idled a plant in Michigan, laying off about 200 workers. This follows the company’s announcement in July that it would also idle a plant in Gary, Indiana. The two moves will cut U.S Steel production by about 200,000 tons.

The industry is mothballing plants, laying off workers, eliminating jobs, dropping prices and taking a beating in the stock market. Since Trump imposed tariffs of 10-25 percent on steel and aluminum 16 months ago, steel has become a textbook example of the costs of protectionism.

Ironically, while the tariffs were intended to save the steel industry, they have actually sped its decline.

In the spring of 2013 Apple conducted a very successful, $17 billion debt offering. It was heavily oversubscribed at long and short maturities, and reflected the fact that investors trust the creditworthiness of one of the world’s most valuable corporations almost as much as they do the U.S. Treasury. 

Apple’s popularity with investors rates discussion in consideration of all the recent hand wringing within the business media about the inverted yield curve. According to pundits on the left and right, the curve has inverted before every recession since 1955. Supposedly higher yields on two-year Treasuries relative to 10-year debt signal an overly restrictive Fed based on near-term borrowing becoming more expensive than long-term. So with the yield curve allegedly predictive of every recession going back decades, it's useful to stop right there and ask if so, as in if recessions are in fact man-made creations of the Fed, why market actors have never bothered to work around what has long been artificial. 

It's seemingly a fair question, but to the yield-curve triggered, there's very little introspective thinking of this kind to be found. According to the obsessed, credit is tight all because of the Fed, the economy is slowing in response to said tightness, plus if we take the presumed logic of pundits to its inevitable conclusion, lower rates at the longer end of the Treasury curve signal reduced inflation expectations in the actual marketplace since, according to the Washington Post’s Jonelle Marte, “Inflation picks up when the economy gets hot.” It apparently never occurred to Marte to look beyond what seems true, only to find reality: economic growth that is always and everywhere a consequence of copious investment is all about falling, not rising prices,

After that, the follow-on assumptions that inform so much yield-curve babbling are rather easy to dismiss. More to the point, the limited knowledge of the pundit class becomes ever more apparent every time a supposedly predictive economic indicator starts predicting things. Little of what’s expressed as truth about an “inverted” yield curve stands up to the most basic of scrutiny.

President Trump virtually conceded on the weekend that his tariffs on China are hurting U.S businesses - a 180-degree departure from his insistence that U.S tariffs somehow help the United States.

But two big questions remain: Does he actually realize that he walked back his previous claims about the benefits of tariffs? And how long before he returns to touting the benefits of tariffs?

Trump has continually argued that his tariff taxes are good for the United States because of the revenue they garner for the federal government, denying what anyone familiar with trade knows - a country’s tariffs hurts its own producers, middlemen and retailers.

Trump made the concession after a meeting with Apple CEO Tim Cook. Apple is one of the biggest potential losers from tariffs on China, since the company conducts so much of its production in that country. Cook made his case to Trump, and the latter indicated he had been impressed by the arguments.

Amid trade tensions with China that remain high, President Trump has felt the need to assuage concerns about the potential consequences of this tension with the U.S.'s largest trade partner. In a Tweet late last week, the President declared, “Our Great Farmers know how important it is to win on Trade. They will be the big winners!”

Despite this proclamation, the mask seems to be slipping more and more on this foolish trade war in which America now finds itself. Sen. Rick Scott (R-Fla.) introduced a proposal recently to use the tariff revenue to pay for additional tax cuts. This is a tacit admission that the tariffs are being paid for by American consumers and not, as the President declares, the Chinese government.

The administration then announced it would delay the onset of the latest round of proposed tariffs, which were set to go into effect September 1, to December 15th. The administration said it did not want to adversely impact the Christmas shopping season. Which is odd, considering the administration’s insistence that it is China paying the tariffs. Why would that impact Christmas shopping in America? It becomes less odd when you realize that tariffs are merely taxes on Americans who consume foreign made goods. The administration knows this, but hopes you won’t bother to figure it out on your own.

This brings us now to farmers, the supposed “big winners” of this trade dispute with China. China is one of the top 5 global consumers of U.S. agricultural commodities, even in the midst of the current trade dispute. The Chinese government has now asked state-owned companies to stop buying U.S. agricultural goods as a retaliatory measure to the Trump administration’s actions. In no sense are farmers the victors in this situation.

Whether central banks are or should be or could be “independent” of the rest of the government is a key question in political economics and political finance.  Given the great power of the unelected managers of central banks in a fiat currency system, the potentially huge costs of their mistakes, and their obvious ability to move markets, it is a question of substantial magnitude. 

Unsurprisingly, the Federal Reserve itself is a big proponent of its own independence.  Former Fed chairmen Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen took to the Wall Street Journal on August 6 to make the independence case.

An interesting, perhaps more balanced, approach is taken by Canada, another economically advanced, democratic country with a sophisticated financial system, for its central bank, the Bank of Canada.  The Bank of Canada Act strikingly contrasts with the theory of independence in this respect.

Specifically, the Bank of Canada Act has a section entitled “Government Directive.”  This section provides for the explicit coordination between the central bank and the executive, and the ultimate superior authority of the Parliamentary government in monetary actions.  To understand the provisions I am about to quote, “Minister” means the Minister of Finance, equivalent to the Secretary of the Treasury in the U.S. government.  “Governor” means the head of the Bank of Canada, equivalent to the Chairman of the Federal Reserve System. “Governor in Council” means quite a different Governor, namely the Governor General of Canada, acting on advice of the Prime Minister and the Cabinet, formally representing the authority of the Crown.

Last week, President Trump summed up his philosophy of the global economy in eight words: “As others falter, we will only get stronger.”

The meaning is clear, and it summarizes Trump’s attitude perfectly. But it is dead wrong, it is based on an abysmal failure to understand how the global economy functions, and it reflects a view that is not only uneducated but dangerous.

Quite simply, we don’t get stronger as others falter - we get stronger as others succeed. Trump’s attitude might make some sense if the United States was Coke and if China, say, was Pepsi. But they are not. That would be a complete misunderstanding of the U.S relationship with other countries.

China and the United States are not just each other’s competitors. They are each other’s customers and suppliers, borrowers and lenders, investors and investment opportunities.

What is it about term premiums? If you were to ask any Economist, they would tell you a term premium is the additional return a bond investor demands in order to lend money for a longer period of time. A premium for more term. Even the US government must pay. Should the government wish to sell, say, a three-year note, whomever is buying it will demand some additional yield above what the government offers on a two-year security.

It sounds simple and straightforward, easily intuitive.

Irving Fisher long ago decomposed bond yields into these kinds of constituent pieces. This Fisherian deconstruction is accepted as three parts: term premiums are one, inflation expectations another, and the anticipated path of short-term money rates the last.

You cannot observe a term premium – though it seems like it should be a matter of simple mathematics. Take the yield on the two-year note and subtract it from the yield on the three-year; voila, term premium.

Ask most independent financial advisors what their clients’ number-one investment goal is and most often you’ll get the response “they don’t want to run out of money in retirement.”

These clients may get to pick when they want to retire, but they don’t get to pick where the S&P 500 is when that time comes, nor the price of bonds.  So, priority one for advisors should be protecting their clients’ nest eggs from market volatility so that their retirement doesn’t get derailed or pushed back.  And while many advisors think their clients may have a diversified strategy largely through traditional modern portfolio theory with a 60-40 allocation of publicly available stocks and bonds – new research shows that smart diversification includes having an allocation in alternative assets for truly reducing risk and attaining excess returns for accredited investors.

Studies show alternatives are an effective retirement plan option, especially in TDFs (Target Date Funds). This timely research should prompt advisors to reconsider traditional retirement planning. Broadening investment alternatives in a target-date fund structure enhances returns, according to new research by Georgetown University’s Public Policy Center for Retirement Initiatives, in conjunction with Willis Towers Watson.

Key findings of the research point to three important conclusions:

A frequent theme in this column is one about the fallability of the brilliant. Jeff Bezos regularly acknowledges how often his experiments prove much less than great, the best venture capitalists admit that more than nine out of ten capital commitments result in bankruptcy, and then the world's best traders note that they're wrong almost as often as they're right. It's incredibly difficult to predict the future, and that's an understatement.

This truism came to mind while reading Washington Post columnist Catherine Rampell’s lament about the Department of Agriculture’s recent decision to relocate the Economic Research Service (ERS) from Washington, D.C. to Kansas City. Rampell reports that in response to the announced change, only 116 ERS employees had agreed to move. The columnist is up in arms. Rampell claims that the “small-but-mighty ERS is arguably the world’s premier agricultural economics agency. It produces critical numbers that farmers rely on when deciding what to plant and how much, how to price, how to manage risk….” Someday Rampell will admit she overreacted here. 

Up front, “arguably the world’s premier agricultural economics agency” doesn’t much excite the mind. Or conjure up images of genius on the job. Figure that the Federal Reserve is ‘the world’s premier central bank,’ and by extension it logically employs some of the economics profession’s greatest minds, but the track record of those allegedly wise minds….Just about every prediction made by Fed economists over the decades has been spectacularly wrong. In that case, how expert could the economists in the employ of the ERS be?

In fairness to the economists at the Fed, of course they’re always wrong. Really, does anyone think they’d work at the Fed if they had a tendency to be right? If known to see into the future with any kind of regularity these economists would soon be earning gargantuan sums in the private sector. Figure that billions are wagered every minute of every day about matters economic around the world, which means that anyone possessing the ability to “see around the corner” won’t toil for very long in government.

Markets cheered when the Trump Administration announced on Tuesday it would delay new tariffs on certain consumer products. Optimism quickly evaporated on Wednesday, though, after a spate of weak economic data stoked fears of a global economic slowdown.

It’s a great illustration of why markets are volatile right now. It’s all about one word: uncertainty.

Investors are in an environment where at any moment a policy announcement may cross the tape and produce a big swing in their portfolio. Meanwhile, economic risks that have been quietly lurking in the background, are now suddenly growing much louder.

Which have you been paying more attention to?

"The CCP’s greatest fear is national fragmentation. It is willing to counter this existential threat in any way possible in order to maintain order, even in Hong Kong."

Since assuming leadership in 2012, President Xi Jinping of China has focused on consolidating and solidifying power at home and projecting Chinese influence firmly abroad. The outcome of the current crisis in Hong Kong will inevitably shape this process for years to come and clearly presents President Xi with one of his greatest domestic and foreign policy challenges. 

Although triggered by a proposed law to extradite suspects in Hong Kong to mainland China, the current crisis is largely a reaction to years of gradual encroachment by the Chinese Communist Party (CCP) on Hong Kong’s autonomy. The 1997 handover of Hong Kong from British to Chinese rule  was underpinned by the “one country, two systems” principle. 

However, the notion that Hong Kong would remain a purely apolitical, economic-business center was not realistic for the long-term. Politics would eventually, and somewhat inevitably, come to the forefront, and now it has. 

You should be afraid, very afraid. Or so I’m told when I imprudently open email solicitations and read the news articles linked in those solicitations. Why should I be afraid? Because, if I’m like most Americans, I am approaching old age with too little savings to enjoy a secure and adequate retirement. The frequent warnings may contain a kernel of truth (see here, here, and here). Still, it’s hard to see much evidence for the scary headlines when we examine the relevant income statistics. They show the elderly and retired are doing pretty well. What is more, their incomes compare favorably to those of the nonelderly. Their incomes are considerably better than the incomes of their parents and grandparents when they were the same age.

Consider the official poverty statistics, which classify Americans as poor or not poor based on inflation-adjusted cash income thresholds that were established several decades ago. In 1959, about 35 percent of the population past 65 was classified as poor. This was by far the highest poverty rate of any age group. Thanks to liberalized Social Security benefits, broader participation in workplace retirement plans, and higher savings, the old-age poverty rate fell to 15 percent in 1979 and to just 9.2 percent in 2017. Income poverty in the elderly population is now lower than it is among nonaged adults. It is substantially lower than the poverty rate among children.

Other income statistics calculated by the Census Bureau reinforce the impression that the nation’s elderly have fared pretty well compared with younger adults and children. The Bureau separately tabulates the incomes of households headed by people of different ages. Since 1979, both the median and average incomes of households headed by someone past 65 have climbed faster than the incomes of households headed by people in younger age groups. The difference is not small. Census statistics show that the average real income of elderly households climbed 82 percent between 1979 and 2017 while the average income of households headed by someone younger than 65 increased just 37 percent.

Critics of the standard income and poverty statistics note that the statistics omit items that are crucial for evaluating family well-being. A special burden for the elderly is health care spending. Older adults tend to face high costs for insurance premiums and out-of-pocket fees to health providers. This reduces the money they have left over to pay for other essentials. Of course, nonaged adults also face these health costs. If prime-age Americans hold a job, especially if they are also rearing children, they must pay for getting to work and for the care their children receive when a parent is working. Older Americans, who tend to be retired, do not face these work-related expenses.