A few months ago many of us read about the conspiracy theory of “the nuclear option”, according to which China could generate a huge debt crisis in the United States and destroy the US economy if it sold its treasury holdings. Read More
Market strategists and policymakers are putting too much emphasis on a trade deal between the United States and China, and it’s quite likely that whatever is agreed will disappoint. Read More
In these weeks we have read a lot about the so-called trade war. However, this is better described as a negotiation between the largest consumer and the largest supplier with important political and even moral ramifications. This is also a dispute between two economic models.
Nobody wins in a trade war, and tariffs are always a bad idea, but let’s not forget that they are just a weapon. Read More
In this fifth episode of my video-blog, we discuss the mistake of believing GDP as the key driver of economic growth, as it is not difficult to inflate via debt.
We also discuss the differences between the US, China and EU, and why the slowdown in the Eurozone should concern us more.
Talking in CNBC about the 2019 outlook
The central idea is that we are in the process of a change of cycle that central banks and governments are unlikely to disguise because both monetary tools and fiscal space have been exhausted. This change of cycle may not lead to a 2008-style recession, but more likely to a Japanese-style stagnation as debt continues to rise while economic and productivity growth weaken. As such, we as investors may believe the mirage of a chain of “bullish” headlines in the first part of 2019: a trade deal between the U.S. and China (likely), a large China stimulus (very likely) and central banks’ relative dovishness (highly likely). This may create short-term bounces, but the euphoria effect many quickly fade because even with a bounce in global liquidity, net financing needs may exceed real growth. If markets react quickly and aggressively to these “false” bullish signals increasing risk and leverage, the probability of falling into a 2008-style crisis increases. Liquidity is falling, and this may reduce this risk of abnormal bullishness.
- Eurozone slowdown worsens. After a moderate slowdown in 2018, the Eurozone economy is likely to enter a period of stagnation as France, Italy, Germany and Spain post weaker growth figures than expected. The likely rise in bond yields may also affect credit growth. Governments have completely abandoned any reform agenda and the rise in public spending combined with lower tax revenues and growth might erode the confidence in the solvency of the Eurozone major economies. Brexit is likely to be a minor factor in this slowdown. The largest impact is probably going to come from weakening consumption and industrial output. Weak commodity prices may help the Eurozone avoid a recession, but credit risks will probably intensify as the effect of ECB purchases ends and political unrest rises.
- Brexit impact becomes negligible on the UK economy. The process of exit from the EU is unlikely to create the doomsday scenario announced by many as the dynamism of the exporting industry, the strength of the labour market and the comparatively attractive taxation versus global peers generate a better growth environment for the UK.
- Commodities rebound only to fall again on China failed stimulus. There will likely be a trade agreement between China and the U.S. that may help energy commodities as well as base and industrial metals short-term. However, markets focusing on this trade agreement catalyst are likely to be disappointed into the end of the year as the evidence of debt saturation and structural factors behind the economic slowdown of China become more evident. The headlines of a massive stimulus and a trade agreement will probably drive growth estimates to overoptimistic levels that may need significant downgrades as the reality of disinflation and global slowdown becomes more apparent.
- Gold rises as liquidity dries up and currencies weaken. Emerging market concerns are likely to rise again as the recent calm is tested by large U.S. dollar denominated maturities. Emerging economies have increased their imbalances—both fiscal and trade deficits in many countries—throughout 2018. There is very little that most governments want to do to avoid the increasingly demanding net financing needs. As the optimism about growth and Federal Reserve dovishness fades, we are likely to see the central banks of most emerging economies letting their currencies devalue in order to maintain foreign exchange reserves.
- U.S. economy avoids recession but slows down. The government shutdown will not generate a massive impact on the economy, and steady flow of capital into the U.S. economy is likely to drive a moderate slowdown that avoids recession thanks to a stronger and more dynamic economy than the European, Japanese and Chinese. Low oil prices and a strong dollar are needed to avoid recession. If the Fed capitulates and halts the announced rate hikes, we might see a temporary bounce in risky assets and investors retrying the reflation trade, but only to see another year of two halves where flight to U.S. assets is likely to accelerate once investors find that the headlines of trade agreement, Fed dovishness and Chinese stimulus are not as bullish in terms of growth and global demand as needed to keep the U.S. dollar carry trade ongoing.
- The biggest positive scenario for 2019 would be that central banks maintain their promises of normalization and the economies gradually strengthen driven by savings and productive investment.
- The biggest negative scenario for 2019 is that economies believe that 2018 was an anomaly and fall into the trap of believing, like in 2008, that a China stimulus will prevent the change of cycle.
The G20 meeting in Buenos Aires had a primary objective. To reach an agreement between the United States and China.
However, the announced agreement is more a “diplomatic truce” than a real agreement.
The United States commits to delaying tariffs against China that would start on January 1st, 2019 and China commits to purchase more agricultural and energy products (LNG, liquefied natural gas) in addition to promising to advance in legal security, compliance with contracts, the opening of capital markets and protection of intellectual property.
However, the wording is vague, the commitments are conditional and the time is limited.
When we talk about trade wars as if they were something new, we make a diagnosis mistake. We’ve been in a trade war for years. The United States has been denouncing trade barriers imposed by China and other countries directly and indirectly for years, with a World Trade Organization that did nothing about it.
The United States acted in the wrong way, and between 2009 and 2016 introduced more protectionist measures than any other G-20 country. The World Trade Organization warned on several occasions before the Trump administration took office of the increase in protectionism since 2011.
China desperately needs to keep the trade surplus with the United States to maintain its extremely indebted growth model. More than the United States needs China to purchase its debt.
China is not the main holder of US bonds (not even the largest foreign buyer). The largest holders are North American institutions and investors in their vast majority.
The United States has seen demand for its bonds remain robust and yields have not soared even with China and the Fed selling. Meanwhile, China’s foreign exchange reserves have fallen.
China’s foreign currency reserves fell to the lowest level in 18 months in October. A reduction of $ 33.9 billion in October, the worst since December 2016 and the lowest level since April 2017.
China cannot maintain its growth – based on a huge debt bubble – if its exports to the US fall. There is no other market that can offset its exports to North America. And its trade surplus with the United States is already over 275 billion dollars per year, the biggest contributor to the Chinese GDP from the external sector.
A drop in the growth of China’s exports would mean a much larger collapse of its foreign exchange reserves, which are down 30% since the 2014 highs.
A collapse in foreign exchange reserves also accentuates the already existing capital flights, which in turn would lead to more capital controls and, with it, three effects. Lower growth, an increase in the already high debt and the risk of a very important devaluation of the yuan.
These three effects have already happened in 2018.
In summary, for China, the trade war is devastating. For the US it is negative, but for China it is a disaster.
The United States exports very little (11% of GDP), so any threat that leads to an agreement is good.
A trade war can generate higher costs of goods and services for Americans, but the reality is that China exports disinflation and, if any, inflation expectations are falling, not rising.
This does not mean I support trade wars. It means that the idea that both sides are equally negatively impacted is simply empirically incorrect.
As such, the agreement announced between the US and China in the G20 is nothing more than a “conditional ceasefire”.
China has little intention of guaranteeing intellectual property and eliminating capital controls or the immense interference between political and legal power.
The increase in purchases from China to the United States announced is likely to have a very low impact on the trade surplus . China’s trade surplus with the US has skyrocketed in 2018 from 21.9 billion dollars in January to 34.1 billion in September. If China doubles its purchases of agricultural and energy products from the United States, something very difficult to achieve, this surplus would only fall by a maximum figure of 3 billion US dollars.
This agreement is only a pause, and the announced tariffs would be recovered if improvements are not evident. The tariffs announced for January 1st would be increased to 25% if China does not comply in 90 days.
The differences in the interpretation of the agreement between the Chinese and US administrations can be seen in their official statements.
While the US says that China will change its policy with respect to intellectual property, capital control and legal security, China only says that they “will work together”. While the US states that the agreement is invalidated after 90 days, China does not mention the deadline. While the US mentions that the purchases of North American products will increase in specific sectors, China only talks about buying more products.
This agreement does not change the trade and policy differences of both countries, but it is very similar to the failed agreement reached with China in May that ended in nothing. We have to be very cautious and wait to see if real economic data improves. If China continues to devalue the Yuan and inject capital into its financial and corporate sectors it will be a sign that the agreement has no credibility for the Chinese government itself. Furthermore, as leading indicators show, the global slowdown is much deeper and complex than the differences between China and the US on trade. If the global economy recovered the trade growth levels of 201, global GDP slowdown would still be evident, and more pronounced than consensus currently estimates.
This trade deal is not only vague, conditional and temporary… It does not disguise the slowdown of major economies, which had nothing to do with trade wars and a lot to do with debt saturation.
Be careful thinking that this is a catalyst that puts the world back in growth and multiple expansion modes. The reality is that this deal is not a catalyst for the global economy.
