Daily Comment (May 21, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Monday!  There was a lot of weekend news.  Let’s dig in:

Trade war postponed: Yesterday, Treasury Secretary Mnuchin announced that China and the U.S. have postponed any trade actions while talks continue on the structure of the trading relationship.  Equity prices rose, the dollar moved higher and grain prices jumped.  Grains are up on relief that corn, sorghum and soybeans won’t be targeted by China for retaliation.[1]  It doesn’t appear that anything has been resolved; the reason for the delay in trade action may be due to the next item.

Does Trump have a bandwidth issue?  All presidents find that the office is complicated; pulling on one thread leads to issues somewhere else.  The upcoming summit with North Korea has become increasingly fraught with risk.  Earlier, it looked like the path to the summit was going smoothly.  Talks between the North and South appeared warm.  Kim had hinted at denuclearization.  Then, last week, North Korea turned hostile, indicating it would never trade away its nukes.  It’s unclear what prompted the change.  It may be due to John Bolton’s appointment as national security director as he has held hardline positions against North Korea (and many other countries as well).  We note that Kim visited Beijing just before the turn in tone; it may be that China urged Pyongyang to turn hostile to give China leverage in trade talks.  That might explain the “time out” on trade noted above.

The president has pressed the DOJ to open an investigation into the FBI’s actions during the 2016 election.  The administration is trying to negotiate a trade deal with China.  NAFTA talks appear stalled.  The president seems to want a historic summit with North Korea.  There is the Iran issue.  And Venezuela, too.  Needless to say, there are a lot of “plates spinning.”  We suspect the trade postponement with China is due, in part, to having so many policy actions underway.

We note the media is viewing the China postponement as a “climb down.”[2]  That take is probably unfair but the administration did raise hopes for sectors of the economy that want trade protection.  Backing away disappoints those sectors.  In addition, there is obvious confusion on the part of the negotiations.  China is using its usual playbook—it is promising to buy lots of raw materials (grains, LNG, oil) but does not want to give in at all on technology.  There have been discussions about a $200 bn reduction in the deficit with China, but no nation has indicated it will change policy to reduce the trade imbalance.

Often, in the financial media, one will hear offhand comments like, “The U.S. runs a trade deficit because we under save.”  Although true on its face, it makes it sound as if it’s all the fault of spendthrift Americans.  These commentators don’t seem to get that in a world with open trade a nation that purposely creates policies to generate saving over investment will lead to trade deficits elsewhere.[3]  The only way to stop that from happening is to (a) change the saving/investment policy in high trade surplus nations, or (b) enact trade barriers.  Until we trade with Martians, the world cannot run a trade surplus since one nation’s surplus, by definition, becomes another nation’s trade deficit.  This condition is exacerbated by the dollar’s reserve status as nations are willing to run trade surpluses with the U.S. to acquire dollars.[4]  If the U.S. really wants to end the trade deficit, policies designed to boost saving should be implemented.  These would include higher interest rates, a weak dollar policy, consumption taxes and a weaker social safety net.  However, if the U.S. did this, the world economy would implode.  The absence of a global hegemon was a major cause of the Great Depression.[5]

Will the EU prompt a sanctions war?  Reuters[6] is reporting that the EU is considering direct sovereign transfers to Iran to pay for oil exports.  Individual companies are uncomfortable with violating American sanctions because they want access to the U.S. financial system.  The EU is taking the position that the administration won’t prevent a whole country from accessing the U.S. financial system.  Although we tend to agree with the EU that the U.S. probably would not go after countries, the damage that this action would do to transatlantic relations would be significant.  Relations have been strained before but if Europe decides to “go it alone” it could lead to a “thaw” in another frozen conflict area.  At the same time, there are reports that the EU, Russia and China are working on a new agreement that would address U.S. concerns over Iran’s missile program and its support of proxy groups in the region.[7]  Thus, the EU threat may be part of the bargaining process.

Italian politics: Reports indicate that Giuseppe Conte, a 54-year-old law professor, is likely to be nominated as Italy’s next prime minister.  He is a little known figure, which is the usual ploy when coalition partners don’t really agree on a candidate.  If Italy’s president agrees to Conte, we will be watching to see how the key ministries are distributed in the new government.

Maduro wins[8]: This is not really news as his victory was widely expected.  The turnout was very low, only 48%; the last election had an 80% turnout.  Some pundits noted that letting one of the other independent candidates win would have been a savvy policy.  Most of the world has refused to recognize this election as legitimate and there are expectations of further sanctions on Venezuela.  Letting another candidate win would have made new sanctions less likely.  Since Maduro clearly didn’t feel secure enough to take that path, we expect further action against Venezuela.  If the U.S. embargos Venezuelan oil imports, oil prices will likely move higher.

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[1] An additional factor supporting grain prices is that the Midwest continues to receive heavy rainfall, which has slowed fieldwork and may result in less acreage being planted.

[2] https://www.washingtonpost.com/news/wonk/wp/2018/05/20/china-is-winning-trumps-trade-war/?utm_term=.39d94a9fc198 and https://www.ft.com/content/fdf48df2-5c46-11e8-9334-2218e7146b04 (Interesting to note is that Chinese media commentators are just as critical of Chinese trade negotiators, feeling they were also weak.)

[3] The best analysis of this issue comes from Michael Pettis.  Pettis, M. (2013). The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy. Princeton, NJ: Princeton University Press.

[4] To put it another way, we get stuff for T-bills.

[5] Kindleberger, C. (1986). The World in Depression, 1929-1939 (2nd ed.). Berkeley, CA: University of California Press.

[6] https://www.cnbc.com/2018/05/18/eu-considers-iran-central-bank-transfers-to-beat-us-sanctions.html

[7] https://www.reuters.com/article/us-iran-nuclear-meeting/europe-china-russia-discussing-new-deal-for-iran-newspaper-idUSKCN1IL016

[8] https://www.ft.com/content/23bdde0a-5ca4-11e8-9334-2218e7146b04?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56