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Trump’s RecipeForDisaster RichardDuncan h5p://www.richardduncaneconomics.com MACROWATCH Avideo-newsle-eranalyzingtrendsinCreditGrowth,Liquidity andGovernmentPolicytoan>cipatetheirimpactoneconomic growthandassetprices h-p://www.richardduncaneconomics.com ToSubscribetoMacroWatchata50%discount,visitthe MacroWatchwebsite,clicktheSubscribetaband,when prompted,usethediscountcouponcode:financial It’sTooSoonToKnow,But… • Wesimplydon’tyetknowwhateconomicpolicies PresidentTrumpwillputinplace. • However,basedonhiscampaignpromisesandwhat we’velearnedsincetheelec>on,there’srealcausefor concern. • Acombina>onoftaxcuts,increasedgovernment spendingandpoliciesthatcurtailtradewouldbearecipe fordisasterbecauseitwouldpushupinterestratesand crushthehighlyleveragedUSeconomy. • Fivethingswilldeterminewhichwayinterestrateswill move–and,therefore,thedirec>onofallassetprices andtheeconomyoverall. Here’sWhyInterestRates AreSoImportant • Theglobaleconomicbubblecameverycloseto collapsingintoanewGreatDepressionin2008. • ThatdisasterwaspreventedbyultralooseMonetary Policy. • Centralbanksslashedshortterminterestratesto0% andthen“printed”trillionsofdollarsworthofnew moneyandusedittobuyfinancialassets. • Thatstrategyallowedcredittoexpandandcaused assetpricestosoar,therebyrefla>ngtheglobal economicbubbleandstavingoffeconomiccollapse. • Whathappensnextwilldependoninterestrates. 10-YearUSGovernmentBondYield vs.CredittoGDPRa\o 1980topresent 16.00% 400% 14.00% 350% 12.00% 300% 10.00% 250% But,now,ifinterestrates rise,creditwillcontract andtheeconomywillcrash. 8.00% 6.00% Asinterestratesfell,creditbecame moreaffordable.Creditexpandedand CreditGrowthdroveEconomicGrowth. 4.00% 2.00% 2016Q1 DebttoGDP(rightaxis) 2014Q1 2012Q1 2010Q1 2008Q1 2006Q1 Source:TheFed 50% 2004Q1 10-YearUSGovernmentBondYield(le^axis) 150% 100% 2002Q1 2000Q1 1998Q1 1996Q1 1994Q1 1992Q1 1990Q1 1988Q1 1986Q1 1984Q1 1982Q1 1980Q1 0.00% 200% 0% USTotalDebt=TotalCredit US$millions,1952to2016 70,000,000 $65Trillion 60,000,000 $10trillionhigherthan thepre-crisispeak. 50,000,000 40,000,000 CreditGrowthDrives EconomicGrowth. 1964=$1trillion 2016=$65trillion 30,000,000 20,000,000 10,000,000 Q22016 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 1978 1976 1974 1972 1970 1968 1966 1964 1962 Source:TheFed 1960 1958 1956 1954 1952 0 HouseholdNetWorth US$Billions,1980toQ32016 $90Trillion 90,000 And,asInterestRatesfell, AssetPricesrose.A^er2008, QEpushedupNetWorthby $35trillion(+60%).Rising assetpricecreatedaWealth Effectthatboostedconsump\on andeconomicgrowthintheUS. 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 2016 2014 2012 2011 2009 2007 2005 2004 2002 2000 1998 1997 1995 1993 1991 1990 1988 1986 1984 1983 1981 1979 1977 1976 1974 1972 1970 1969 1967 1965 Source:Fed 1963 1962 1960 1958 1956 1955 0 HouseholdNetWorth asa%ofDisposablePersonalIncome %,1951to2016 700 Thisra\oofWealthtoIncomeisnear recordhighlevelsbecauseverylowinterest ratesandQEhavepushedupassetprices. 650 600 550 500 450 Ifinterestratesnowrise,assetpriceswillspiralbackdown,crea\ng anega\veWealthEffectthatwillpushtheeconomyintocrisis. 400 2015-10-01 2013-10-01 2011-10-01 2009-10-01 2007-10-01 2005-10-01 2003-10-01 2001-10-01 1999-10-01 1997-10-01 1995-10-01 1993-10-01 1991-10-01 1989-10-01 1987-10-01 1985-10-01 1983-10-01 1981-10-01 1979-10-01 1977-10-01 1975-10-01 1973-10-01 1971-10-01 1969-10-01 1967-10-01 1965-10-01 1963-10-01 1961-10-01 Source:Fed 1959-10-01 1957-10-01 1955-10-01 1953-10-01 1951-10-01 350 TheFiveFactors ThatWillDetermineInterestRates 1. 2. 3. 4. 5. TheGovernment’sBudgetDeficit. TheUSCurrentAccountDeficit Quan>ta>veEasingbycentralbanksoutsidetheUS. TheInfla>onRate TheChineseRMBExchangeRatevs.theUSDollar. 1.TheBudgetDeficit • PresidentTrump’splanstocuttaxesandincrease governmentspendingonthemilitaryand infrastructurearequitelikelytocausethe government’sbudgetdeficittoincreasevery significantly. USGovernmentBudgetSurplusorDeficit(–) US$Millions,1960to2021es\mates,(FiscalYearsendingSept30) 400,000 200,000 Es\mates 0 -200,000 -400,000 Thebudgetdeficitsarecurrently projectedtoaverage$519billionayear from2017to2021.Thoseprojec>ons don’tincludethelargeincreaseinthe annualdeficitsthatislikelytoresult fromPresidentTrump’sproposed taxcutsandincreasedgovt.spending. -600,000 -800,000 -1,000,000 -1,200,000 -1,400,000 2020est 2018est 2016 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 Source:OfficeOfManagement&Budget 1980 1978 1976 1974 1972 1970 1968 1966 1964 1962 1960 -1,600,000 2.CapitalInflows • BeforeBre-onWoodsbrokedown,tradeimbalances andcapitalflowsbetweenna>onswereverylimited. • Butnowtheyhavebecomeverylarge. • CapitalinflowsintotheUnitedStateshavebecome anenormouslyimportantsourceoffundingforthe USBudgetdeficit. • Thelargerthecapitalinflowsare,theeasieritisto financethegovernment’sbudgetdeficitatlow interestrates. TheUSFinancial&CapitalAccount US$millions,1960to2015 900,000 $807bn 800,000 CapitalInflowsinto theUnitedStates. 700,000 600,000 $463bn 500,000 400,000 300,000 200,000 100,000 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 Source:BureauofEconomicAnalysis 1978 1976 1974 1972 1970 1968 1966 1964 1962 -100,000 1960 0 MirrorImage • TheCapitalInflowsarethemirrorimageofthe CurrentAccountdeficit. • WhentheCurrentAccountDeficitgrowslarger,the CapitalInflowsalsogrowlarger,makingiteasierto financethebudgetdeficit. • But,whentheCurrentAccountDeficitshrinks, CapitalInflowsalsoshrink,makingitmoredifficultto financethebudgetdeficitatlowinterestrates. TheCurrentAccount=TheFinancialandCapitalAccount US$millions,1960to2015 1,000,000 Property Bubble MirrorImage 800,000 600,000 400,000 200,000 2014 2012 Source:BureauofEconomicAnalysis CurrentAccount 2010 Financial&CapitalAccount 2008 -1,000,000 2006 CapitalInflowshaveapowerfuleffectonUSassetprices. 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1987Stock MarketCrash -600,000 -800,000 1980 -400,000 1978 1976 1974 1972 1970 1968 1966 1964 1962 -200,000 1960 0 CapitalInflowsMayShrink • Trump’splanstoforceUScompaniestobringtheirfactories backtotheUS,torenego>atetradedealsand/ortoimpose tradetariffsonChinaandMexicowouldallcausetheUS CurrentAccountdeficittoshrink. • AsmallerCurrentAccountdeficitwouldcausethecapital inflowsintotheUnitedStatestoshrink,too. • LesscapitalinflowswouldmeanlessdemandforUS governmentbonds. • Thatwouldpushupinterestratesandpoptheassetprice bubble. • So,wemustkeepacloseeyeontheUSCurrentAccount Deficitbecauseitwilldeterminethesizeofthecapital inflows. 3.Quan\ta\veEasing • Quan>ta>veEasingisthethirdfactorwemust watch. • Clearly,whentheFedprintsmoneyandbuys governmentbonds,thatpushesupthepriceofthe bondsandpushesdowntheiryields. • Addi>onalQEfromtheFednowlooksunlikely,at leastinthenearterm.(We’regoingtohavefiscal s>mulusinsteadofmonetarys>mulus.) OtherCentralBanks • However,wemustalsomonitortheQuan>ta>veEasingbeing carriedoutbyothercentralbanksaroundtheworldbecause QEoverseasimpactsUSinterestrates,too. • Currently,theECB,BOJandBOE(combined)areprin>ngthe equivalentofroughly$500billioneverythreemonths. • Theyusethatnewmoneytobuytheirgovernments’bonds. Thatpushesupthepriceoftheirbondsandpushesdown theiryields. • LoweryieldsinEurope,JapanandtheUKarenowpunng downwardpressureonUSgovernmentbondyields. • However,ifthosecentralbanksprintlessmoneyinthe future,USinterestrateswouldprobablyrise. HalfATrillionDollarsPerQuarter TheBOJandtheECBarenowcarryingout Quan\ta\veEasingonaverylargescale. Herearethedetails: Global QE Per Month US$ Exchange Rate US$ billion per Month US$ billion per Quarter BOE £70 billion over 8 months £8.75 billion 1.3 11.4 34.1 BOJ Yen 80 trillion per year Yen 6.67 trillion 100 66.7 200.1 ECB Euro 80 billion per month Euro 80 billion 1.13 90.4 271.2 168.5 505.4 Total Source:CentralBanks US$8.15trillion GovernmentDebtCancelledThusFar Central Bank Holdings Of Government Debt Converted into US Dollars, billions US$ Exchange Rate US$ billions BOE £375 billion 1.3 488 BOJ Yen 368 trillion 100 3,700 ECB Euro 1,326 billion 1.13 1,500 Fed $2,462 billion Total 2,462 8,150 ThistotalisscheduledtoincreasebyUS$1trillionoverthenext6months. Source:TheBOE,BOJ,ECB,Fed TheAmountOfGovernmentDebtCancelled*SoFar CentralBankHoldingsOfGovernmentDebt Asa%ofTotalGovernmentDebt: BOE 25% BOJ 35% ECB 12% Fed 13% Source:RDes>mates *Effec>velyCancelled Note:ThenumbersfortheBOJandECBareslightlyoverstatedbecausesomeof theassetstheyhaveacquiredarecorporatebonds(butonlyasmallpart).The importanceoftheFed’sQEisunderstatedbecauseinaddi>ontoowningUS$2.5 trillionofgovernmentbonds,theFedalsoowns$1.7trillionofasset-backed mortgagedebt. 4.Infla\on • Infla>onalsoaffectsinterestrates. • Iftheinfla>onrategoesup,thedemandforbonds willgodown–unlesstheyieldofferedonthose bondsincreases. • Noonewilllendmoneyfor3%iftheinfla>onrateis 5%. • InrecentyearstheInfla>onRatehasbeen excep>onallylow–despiteallthemoneythatthe centralbankshavebeenprin>ng. 1.6%in Oct.2016 Source:StLouisFed WhatCouldCauseInfla\onToRise? • Infla>onhasfallensincetheearly1980sbecause increasingtradewithlowwagecountrieshaspushed downUSwagesandthepriceofconsumergoods. • Now,however,iftheUSimportslessfromlowwage countries,thepriceofmanufacturedgoodswillrise,US wageswillrise,andinfla>onwillrise. • Forcingcompaniestobringtheirfactoriesbacktothe UnitedStatesorimposingtradetariffsonimported goodswouldcauseinfla>ontoincrease. • Increasedgovernmentspendingcouldalsocause infla>ontopickup. 5.TheChineseRMB • Finally,thevalueoftheRMBcouldalsoimpactUSinterestrates. • TheUnitedStateswillimportnearlyHalfATrillionDollarsworthof goodsfromChinathisyear. • IftheRMBcon>nuestoweakenagainsttheDollar,thoseimports willbecomecheaperandputdownwardpressureonUSinfla>on rates. • IftheRMBweretostrengthen(whichisunlikely),thenthatwould putupwardpressureonUSinfla>on. • Ofcourse,iftheUSputstradetariffsonChinesegoods,thatwould causeaspikeintheUSinfla>onrate,whichwouldpushupUS interestrates. • Bytheway,in2015theUSimported$483billionofgoodsfrom Chinaandexported$116billionofgoodstoChina,resul>nginaUS tradedeficitwithChinaof$367billion-orroughly$1billionaday. ChineseRMBperDollar 1980toDecember2016 10.0 TheGreatChinaBoom wasfuelledbyavery weakcurrency.It fellfordecadesun\l 1994. 9.0 8.0 7.0 6.0 From2006to2013, theRMBappreciated. But,now,itisfalling again. 5.0 4.0 3.0 2.0 1.0 01/2016 01/2014 01/2012 01/2010 01/2008 01/2006 01/2004 01/2002 01/2000 01/1998 01/1996 01/1994 01/1992 01/1990 01/1988 Source:CEIC 01/1986 01/1984 01/1982 01/1980 0.0 TheUSTradeDeficitIsToBlame • PresidentTrumpbelievestheUStradedeficithas beenresponsibleforthelossofmanufacturingjobs intheUnitedStatesandthedownwardpressureon USwagesthathasoccurredoverthelastseveral decades. • Iagree. • I’vewri-enabouttheharmtheUStradedeficithas donetotheUnitedStatesandaboutthe destabilizingimpactit’shadontheglobaleconomy inallthreeofmybooks. TheDollarCrisis Herearetheopeninglinesfrommyfirstbook,The DollarCrisis: “Theprincipleflawinthepost-Bre-onWoods interna>onalmonetarysystemisitsinabilityto preventlarge-scaletradeimbalances.Thethemeof TheDollarCrisisisthatthoseimbalanceshave destabilizedtheglobaleconomybycrea>ngaworldwidecreditbubble.” NotEasy • However,unwindingtheUStradedeficitisgoingto beverydifficult. • Overthepast35years,thatdeficithasbecomeTHE driverofglobaleconomicgrowth. • Infact,theen>reglobaleconomyhasbeen constructedaroundunbalancedtrade. • Atthispoint,thea-empttoeliminatetheUStrade deficitcouldveryeasilycausetheglobaleconomyto collapseintoanewGreatDepression. USCurrentAccountBalance 100,000 US$Millions,1960to2015 0 -100,000 -200,000 -300,000 -400,000 -500,000 -600,000 -700,000 -800,000 Source:BureauofEconomicAnalysis 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 1978 1976 1974 1972 1970 1968 1966 1964 1962 1960 -900,000 Fromtheearly1980s, theUSCurrentAccount Deficitbecame THEdriverofglobal economicgrowth.Aslong asthedeficitexpanded, theglobaleconomy prospered. TheUndesirableConsequences ofElimina\ngTheTradeDeficit 1. IftheUSreducesitsimports,theglobaleconomywillshrink. 2. IftheUSeliminatesits$1billionadaytradedeficitwith China,China’seconomycouldcollapseintoadepression thatwouldseverelyimpactallofChina’stradingpartners, andpoten>allyleadtosocialinstabilitywithinChinaandto militaryconflictbetweenChina,itsneighborsandtheUS. 3. IftheUSCurrentAccountdeficitreturnstobalance,the globaleconomywillsufferfrominsufficientDollarliquidity, whichcouldcauseeconomicstagna>onorworse. 4. Areduc>onofimportsfromlowwagecountrieswould causeUSinfla>ontorise,whichwouldpushupUSinterest rates. USImports&Exports US$Millions,1990to2015 3,000,000 WhentheUSbuyslessfrom therestoftheworld,the restoftheworldbuysless fromtheUS. 2,500,000 2,000,000 1,500,000 1,000,000 IfUSImportsfall, USExportswillfall,too. 500,000 2015 2014 2013 2012 Importsofgoodsandservices 2011 2010 2009 2008 2007 2006 2005 2004 Source:BureauofEconomicAnalysis 2003 Exportsofgoodsandservices 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 0 TheUndesirableConsequences ofElimina\ngTheTradeDeficit 1. IftheUSreducesitsimports,theglobaleconomywillshrink. 2. IftheUSeliminatesits$1billionadaytradedeficitwith China,China’seconomycouldcollapseintoadepression thatwouldseverelyimpactallofChina’stradingpartners, andpoten>allyleadtosocialinstabilitywithinChinaandto militaryconflictbetweenChina,itsneighborsandtheUS. 3. IftheUSCurrentAccountdeficitreturnstobalance,the globaleconomywillsufferfrominsufficientDollarliquidity, whichcouldcauseeconomicstagna>onorworse. 4. Areduc>onofimportsfromlowwagecountrieswould causeUSinfla>ontorise,whichwouldpushupUSinterest rates. China'sExports&Imports US$Millions,1990to2015 2,500,000 2,000,000 1,500,000 1,000,000 WhenChinaExportsless, itImportsless.Andwhen Chinaimportsless,commodity pricesfall,hur\ngthe economiesandcurrenciesofthe commodityproducing countriesallaroundtheworld. Exports Imports 500,000 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 Source:CEIC 1994 1993 1992 1991 1990 0 IfChina’sEconomyImplodes • China’seconomyisalreadyvergingoncrisis.Ithasmassive excesscapacityacrossprac>callyeveryindustry.So,product pricesarefalling,companiesareloss-makingandthebanking systemisstuffedwithunrecoverableloans. • IfChina’stradesurpluswereeliminated,thenega>veimpact onChina’seconomywouldbedevasta>ng. • Inalllikelihood,Chinawouldexperienceaseveredepression, thatcouldthreatentheruleoftheCommunistParty. • Chinamightrespondmilitarily–justasJapandidatPearl HarborarertheUSimposedanoilembargoonJapanin1941. • Nooneshouldunderes>matethedamagethatcouldresult fromaneconomiccrisisinChina. TheUndesirableConsequences ofElimina\ngTheTradeDeficit 1. IftheUSreducesitsimports,theglobaleconomywillshrink. 2. IftheUSeliminatesits$1billionadaytradedeficitwith China,China’seconomycouldcollapseintoadepression thatwouldseverelyimpactallofChina’stradingpartners, andpoten>allyleadtosocialinstabilitywithinChinaandto militaryconflictbetweenChina,itsneighborsandtheUS. 3. IftheUSCurrentAccountdeficitreturnstobalance,the globaleconomywillsufferfrominsufficientDollarliquidity, whichcouldcauseeconomicstagna>onorworse. 4. Areduc>onofimportsfromlowwagecountrieswould causeUSinfla>ontorise,whichwouldpushupUSinterest rates. GlobalLiquidityWouldDryUp • Whentheworldwasonthegoldstandard,“globalliquidity” dependedonthediscoveryofnewgoldmines.Some>mes therewastoomuchgold(16thCenturyEurope,whichcaused infla>on)andsome>mesnotenough(late19thCentury America,whichcauseddefla>on). • ButunderTheDollarStandard,globalliquidityisdetermined bythequan>tyofDollarsintheglobaleconomy;andthe principalwayinwhichDollarsareinjectedintotheglobal economyisthroughtheUSCurrentAccountdeficit. • IftheUSCurrentAccountDeficitwereeliminated,thesupply ofDollarliquiditywouldbetoo>ghttosupporteconomic expansion. • Thatwouldprobablyresultinglobaleconomicstagna>onor worse. TheUndesirableConsequences ofElimina\ngTheTradeDeficit 1. IftheUSreducesitsimports,theglobaleconomywillshrink. 2. IftheUSeliminatesits$1billionadaytradedeficitwith China,China’seconomycouldcollapseintoadepression thatwouldseverelyimpactallofChina’stradingpartners, andpoten>allyleadtosocialinstabilitywithinChinaandto militaryconflictbetweenChina,itsneighborsandtheUS. 3. IftheUSCurrentAccountdeficitreturnstobalance,the globaleconomywillsufferfrominsufficientDollarliquidity, whichcouldcauseeconomicstagna>onorworse. 4. Areduc>onofimportsfromlowwagecountrieswould causeUSinfla>ontorise,whichwouldpushupUSinterest rates. TheUndesirableConsequences ofElimina\ngTheTradeDeficit 5. Theelimina>onoftheCurrentAccountdeficitwould causeasharpreduc>onincapitalinflowsintotheUS, whichwouldalsocauseUSinterestratestorise. 6. Higherinterestrateswouldcausecredittocontractand theUSeconomytogointorecession. 7. HigherinterestrateswouldalsocauseasharpfallinUS assetprices.That,too,wouldalsocausetheeconomy togointorecession. 8. Higherinterestratescouldcauseawaveofcredit defaultsintheUSandaroundtheworld,poten>ally leadingtoanewsystemicfinancialsectorcrisis. ABe5erWay • Forallofthesereasons,I’mveryconcernedthatit willnotbepossibletoeliminatetheUStradedeficit withoutcausingtheglobaleconomicbubbleto implodeintoanewgreatdepression. • Ratherthana-emp>ngtoeliminatethedeficit,it wouldbewiserfortheTrumpAdministra>onto allowthedeficittopersist,buttopursuepolicies thatwouldincreaseaggregatedemandinthe countriestheUStradeswithandalsointheUnited Statesitself. ABe5erWay • Forinstance,theUScouldenactpoliciesthatwould forceChinatoincreasewagesinitsmanufacturing sector.ThatwouldincreaseChina’sdemandforUS goodswithoutcausingacrisisinChina. • Athome,theUSgovernmentcouldsharplyincrease itsinvestmentinnewindustriesandtechnologies. ThatwouldboostUSpurchasingpowerandgrowth– and,thatinvestmentcouldbefinancedatverylow interestratesthankstothedefla>onarypressures andthecapitalinflowsresul>ngfortheUStrade deficits. Conclusions • TheproposalsoutlinedthusfarbyPresidentTrump suggestthat: 1. Thebudgetdeficitwouldgrowlarger(duetotax cutsandincreasegovernmentspending); 2. Thecurrentaccountdeficitwouldshrink(dueto renego>a>ngtradedeals,bringingUSfactoryjobs backtotheUSandpossiblytradetariffs); 3. Andinfla>onwouldpickup(duetoincreased governmentspending,higherUSwages,pressure onChinatopushuptheRMBand,possibly,tariffs). ARecipeForDisaster • Ifthosepoliciesreallyareadopted,theywouldbea recipefordisasterbecausetheywouldpushUS interestratessignificantlyhigher–andthatwould poptheglobaleconomicbubble. • Ifitpops,itmaybepossibletoreflateitagainwith evenlargeramountsofQuan>ta>veEasing. • Ontheotherhand,itmightnotbe,inwhichcasethe worldcouldbeplungedintoanewGreatDepression. • Inthatscenario,massivewealthdestruc>onwould onlybethebeginningofourproblems.Ourpoli>cal ins>tu>onswouldprobablynotsurvivethestrain. MACROWATCH Avideo-newsle-eranalyzingtrendsinCreditGrowth,Liquidity andGovernmentPolicytoan>cipatetheirimpactoneconomic growthandassetprices h-p://www.richardduncaneconomics.com ToSubscribetoMacroWatchata50%discount,visitthe MacroWatchwebsite,clicktheSubscribetaband,when prompted,usethediscountcouponcode:financial
