Dr. John Rutledge: Far from Equilibrium Economics, Finance and Investing

Summary: I spoke with Tyler Mathisen and Seema Mody yesterday on CNBC’s The Exchange about the flurry of confusing messages around the first day of the trade talks. You can see a short video of the interview by clicking this link.

Steve Mnuchin and Bob Lighthizer have the hardest assignment in the world. Yesterday, while they were meeting with the Chinese delegation in Shanghai, Pres. Trump was using the meetings to play election politics, launching a flurry of offensive, erroneous, and self-contradicting Tweets. Someone should tell him that the Chinese delegation all have (Huawei) Smart phones in their pockets. And they all read English.

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Among the Tweeted messages flying around were:

• “Trade talks are going well.” (I hope so.)
• “We are raking in billions of dollars in tariffs.” (No, you are raking in billions of dollars out of the pockets of US consumers. Tariffs are, essentially, an excise sales tax on selected Chinese goods collected by raising prices for consumers.)
• “China is doing very badly, worst year in 27.” (Their annual growth rate starts with a 6; ours starts with a 2.)
• “That is the problem with China, they just don’t come through.” (insulting much?)
• “…they always change the deal in the end to their benefit.” (see above.)
• “our economy has become MUCH larger than the Chinese economy in last 3 years….” (Wrong, their economy has grown by almost 20% over the last 3 years, 3x as much as ours.)
• “they should probably wait out our election to see if we get one of the Democrat stiffs like Sleepy Joe. Then they could make a great deal…” (in that case, let’s all go to lunch.)
• “we have all the cards…”

Why on earth would Liu He, reading the Tweets, think it is a good idea to try to work out a trade deal today?

What we do know is that the trade war has cost the global economy roughly $1.2 trillion in lost output so far, that it has disrupted supply chains everywhere, that it has produced a precipitous drop in capital spending, that it has induced global investors to pull capital out of China and driven the RMB down by some 10% against the dollar (making Chinese goods cheaper in the US!), and that it has forced central banks to shift policy toward lower rates–as the Fed did today–which further inflates sky-high asset prices and increases the likelihood of a financial infarction (technical term.).

My conclusion is Pres. Trump is using the trade war as a political asset for his 2020 campaign, not as an economic event of massive importance to the US and the world economies. It is looking more and more like he will keep it alive through the next election. It is simply too valuable a marketing asset to lose. 

JR

Summary: This week the US and China re-booted the trade talks, which occasioned a 2:30AM Monday morning live hit on CNBC’s Worldwide Exchange to talk with anchor Brian Sullivan about what to expect. You can see a short video of the interview by clicking this link. I have copied the talking points, below, that I sent to the producers to brief Brian before the show.

The trade team, headed by Steve Mnuchin and Bob Lighthizer, is heading to China today for Tuesday/Wednesday meetings with their Chinese counterparts. T hey are the right 2 guys for the job. Steve understands all the economics and finance issues; Bob is the leg-breaker who will negotiate the terms of the deal. They are meeting in Shanghai this time (way better hotels, food, and wine than in Beijing). Shanghai is also symbolic, as Xi Jinping’s power arose from the political clique known as The Shanghai Gang, associated with Jiang Zemin.

It is good that they are meeting again but we shouldn’t expect any big announcements this week. Think of it as CTRL+ALT+DEL, an attempt to re-boot the conversation that blew up in May, kind of a “don’t you think we should talk?” dinner with your former spouse where the best you can hope for is no loud noises and that nobody throws food.

It is good that they are getting together, though. When the trade war started the biggest weakness on the US side was a trade team with no real experience in China. After two years and many trips, they should now at least be getting to know their opponents and have an understanding of just what the other side wants.

I expect this week’s meetings to focus on small, tactical matters so that both sides have some wins they can report in the Wednesday press releases. I say releases (plural) because each side will make a separate press release in their own language. This allows the two sides to write very different accounts of the talks for their home audiences. In particular, the US side can write about how they annihilated the opposition without flashback because, with few exceptions, nobody in the US has invested the time to learn Mandarin.

So, what will they announce? They will announce that the talks were productive, that China is going to buy more soybeans, that the US is going to allow US tech companies like Qualcomm and Intel to sell some components to Huawei, and that the Chinese team is going to schlepp back to Washington for the next meetings later this month.

I have met privately with our trade team to discuss both the Chinese economy and what a deal might look like that would be acceptable to both sides. The core items–the 90% done that Steve Mnuchin talked about a few months ago—-are both obvious and achievable. Both sides can reduce tariffs and promise to buy a lot more of each other’s stuff. China can agree to improve protections for Intellectual Property (IP), further open markets to US firms and investors, and not impose regulations that make doing business in China difficult for US companies. And you can agree to treat each other with respect in public, i.e., to stop Tweeting rude threats in the middle of the night.

As I told the trade team, however, there are two things that you will never get:

1. They are not going to agree to change the entire structure of their economy, shut down their state-owned companies, or stop investing in technology. They are irreversibly committed to going from a low margin assembler of iPhones to a global, high margin, branded producer of high tech products.
2. As a sovereign nation, they are not going to allow you to wander around China with a clipboard to verify that you are following the agreement, any more than you would allow them to do the same thing here. (Note: I advised the team to drop demands for invasive ‘verification’ and to use the collective 110,000 Americans living and working in China as their information network on compliance.)

Meanwhile, Pres. Trump has hinted that we should expect the trade war to go on through the 2020 elections. Why? There are only two strings on the election banjo to pluck, 1) hating immigrants, 2) hating China. He is not about to let one of them go before November 2020.

JR