Daily Comment (March 20, 2017)

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Although it has been a quiet morning, there was a lot of news over the weekend.  Here’s what we saw as noteworthy:

Mnuchin won’t disavow protectionism: The G-20 communiqué usually includes language supporting free trade and opposing protectionism.  Of course, in practice, there really is no nation that has completely open trade but some have more than others.  Instead, free trade is seen as an ideal; something that one should aspire to but realize that one will always fall short.  That wasn’t the outcome among the finance ministers at this weekend’s G-20 meeting in Baden-Baden.  The new U.S. treasury secretary, Steven Mnuchin, would not support such language.  Germany’s finance minister, Wolfgang Schäuble, suggested that Mnuchin has “no mandate” to settle on what U.S. trade policy is all about.  President Trump has made it clear that his administration intends to change America’s trade policy.  Since the end of WWII, the U.S. has steadily opened its markets to foreign nations as part of its reserve currency role.  Foreign nations have obviously taken advantage of this, implementing export promotion policies to achieve developed nation status.  Trump is suggesting that trade is the key factor behind the decline of the U.S. middle class and is determined to force nations to change their policies to boost American jobs.

Why did the U.S. engage in this policy?  We believe for two reasons—to win the Cold War and promote global growth.  We wanted to build the Free World and we did so by allowing foreign nations to trade with us.  This gave other nations a steady source of demand; they created economies designed to export by suppressing domestic demand and restraining their currency’s appreciation.  The second reason is all about world growth in general, based on the idea that a world that trades with each other may be less likely to go to war.  To provide the currency of choice for trade, the U.S. must run a trade deficit; a surplus acts as a global contraction of the money supply.

In our opinion, Trump represents a clear break in this policy.  However, support for the financial side of American hegemony has been weakening for some time.  Free trade deals have become politically difficult to pass through Congress.  Even if Clinton had won the presidency, TPP and TTIP were dead.  It’s been so long since the U.S. has fought a world war that we have forgotten why these policies were put in place.  This G-20 event is further evidence that change is underway.

60 Minutes takes on HB-1 visas: Newsmagazine 60 Minutes opened last night with a story about a group of IT workers in California who were replaced with foreigners on HB-1 visas and were given incentives to train their replacements.  It’s the kind of report that gets attention and is part of middle class angst over trade.

Was Tillerson “snuck” in China?  While visiting China over the weekend, SOS Tillerson seemed to adopt language China has been supporting for some time.  These statements included terms like “mutual respect” and “win-win” cooperation.  This language issue is a classic example of strategic ambiguity.  For most American ears, terms like mutual respect are benign.  However, China interprets these as sphere of influence concepts.  In other words, mutual respect means China won’t interfere with U.S. relations in South and Central America and the U.S. will give China a free hand in the Far East.  Did Tillerson understand China’s take on this language?  It’s possible that given his newness to the job and the lack of support staff, he easily could be unaware.  Or, he may be preparing the world for a removal of U.S. power and the creation of regional hegemonies.  If we had to guess, we would go with Tillerson’s inexperience as the explanation.  The next point suggests why.

Trump is preparing to confront China on trade in early April: According to Axios,[1] Trump is planning to press Chairman Xi on trade policy with regard to autos.  U.S. automakers face a 25% tariff when they try to import into China.  In response, U.S. automakers build manufacturing in China but, to do so, they must undergo joint ventures with a Chinese firm that is, by law, the majority owner.  Chinese automakers face a 2.5% tariff when exporting to the U.S.  Why don’t we see more Chinese cars in the U.S.?  Mainly due to poor quality.  Chinese manufacturers haven’t mastered the techniques to meet Western quality standards.  However, China has been eyeing the U.S. market for some time and we would expect quality to improve.  According to Axios, Trump will make a series of demands that will include that China must build plants in the U.S.  They can be fully owned by Chinese firms but only if the U.S. firms in China are relieved from the joint venture rule.  In addition, profit repatriation will be limited.  This gives a flavor for how the president may be looking to negotiate on trade.

Greece spinning toward another crisis: Eurozone finance ministers are meeting today to reiterate that the Tsipras government needs to comply with all the terms attached to emergency loans.  Greece isn’t really prepared to meet all the demands, which include highly unpopular pension reforms.  Markets are ignoring this issue simply because Greece always seems to “blink.”  This is because there really is no solution to Greece’s debt problem other than default and Grexit.  Would a Greek exit be a big deal?  By itself, probably not, but if Greece leaves the Eurozone and thrives, it will tempt other big economies to do the same which would spell the end of the single currency as we now know it.

Article 50 on March 29: PM May has indicated she will begin the Brexit process by declaring Article 50 on March 29.  Assuming rationality, Brexit should not be a crisis; Britain will need the EU for trade and the EU needs Britain for defense and financial services.  However, the EU fears that if Britain gets too good of a deal then other nations may decide to exit as well.  Although these fears are not unfounded, it should be noted that the U.K. is a special case; it’s a big economy and it is well integrated into Europe.  Striking a deal makes sense and one should emerge if emotions are managed.

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[1] https://www.axios.com/axios-sneak-peek-2319878918.html?utm_source=The+Sinocism+China+Newsletter&utm_campaign=e55d7dcd71-EMAIL_CAMPAIGN_2017_03_20&utm_medium=email&utm_term=0_171f237867-e55d7dcd71-29661833&mc_cid=e55d7dcd71&mc_eid=e77499fecc