Notes From Underground: Things to Contemplate

Let’s discuss the concept of tariffs with a wider historical perspective:

The Bretton Woods system crafted at the end of World War II provided the U.S. with both an enormous privilege and an enormous burden (a blessing and a curse, if you will). The U.S. acted as the provider with massive amounts of global liquidity but it also became the repository of the FREE world’s excess capacity. The Marshall Plan and the Alliance For Progress acted to spread dollars to our allies in an effort to counteract COMECON and the influence of the Soviet Empire.

Until the 1960s, the U.S. was the sole provider of many important goods for the rebuilding of Europe and Asia since the war destroyed so much of the world’s industrial capacity. Bretton Woods fixed the world’s currencies against the dollar at levels that provided a competitive advantage to Germany and Japan in an effort to stimulate growth to keep them out of the Soviet camp. The advent of the Vietnam War brought about the rise of Japan as its industries supplied the U.S. military with many of its needs. As Europe recovered, the Germans, French and Italians were able to compete with a built-in advantage of heavily undervalued exchange rates.

The Vietnam war led to an explosion in U.S. trade and budget deficits, resulting in the demise of the fixed exchange rates created by the Bretton Woods agreement. Currency rates were floated, which reestablished a semblance of sanity in the post-World War financial and trade realities heading into the 1970s. The U.S. was disadvantaged by design as the use of the DOLLAR as the world’s reserve currency anchored New York and the London eurodollar market as the bastion of global finance. The world’s acceptance of dollars has meant that the U.S. has benefited by living way beyond its means for many years: large current account deficits, budget and trade deficits were the trade-off for what the French leaders in the 1960s termed an exorbitant privilege. The rise of global competition from quality manufacturers and the bastions of cheap labor have resulted in what Michael Pettis refers to as an EXORBITANT BURDEN.

What the Trump administration is trying to do is diminish the exorbitant burden by rectifying the massive changes in the global trading system. But if the role of Pax Americana is to evolve to reflect the new reality then it may take a change in policy. If the world DOES NOT DESIRE A TRADE WAR THEN THE TRUMP ADMINISTRATION MAY DESIRE A DEPRECIATION OF THE U.S. DOLLAR. It was FORD CEO MARK FIELDS THAT CITED CURRENCY MANIPULATION IS THE MOTHER OF ALL TRADE BARRIERS. THE BASTION OF GLOBALISTS WILL HAVE TO EITHER COUNTENANCE TARIFFS OR DOLLAR DEPRECIATION. The classic case would be a return to examining the extreme undervaluation of the Mexican peso. If the world doesn’t desire an ostensible TRADE WAR it may have to tolerate a market induced dollar depreciation in which currencies continue to adjust to a changing global financial environment.

***While it has been Mexico/Canada and NAFTA that has borne the brunt of the steel and aluminum tariffs I SUGGEST PAYING CLOSE ATTENTION TO CHINA. A brief summary of why China is critical to watch here as to where the this whole concept of a trade war goes. An important piece of history:

On January 1, 1994, the Chinese DEVALUED the CHINESE YUAN 50% to 8.7/dollar from 5.8/dollar. It was also the beginning of NAFTA. The Chinese were aware that NAFTA was a direct shot at the coming rise of China and the entrance of over a billion Chinese into the global economy, a dual role of worker and consumer. Mexican workers were to provide a counterforce to U.S. unions  in an effort to keep wages under control as the global economy was undergoing massive changes due to the rise of China, the impact of the Asian Tigers and of course the fall of the Berlin Wall, collapse of the Soviet Economy and Eastern Europe entering the capitalist system.

China stole the thunder of Mexico and the Asian tigers because by 1995 we had the tequila crisis followed by the THAI BAHT crisis on July 2, 1997, which led to the collapse of the Asian miracle as global overcapacity led to money fleeing the developing Asian economies. History has shown that there are no winners in a beggar thy neighbor trade battle but if the global economy undergoes a reset of certain valuations short-term pain may result in a better system. Where this goes I have no idea but I will certainly be watching China for its response to the Trump initiatives. A reset of the U.S. currency valuation will be a far better tactic than the imposition of tariffs. I think I will rent a room at the PLAZA Hotel.

***The Bank of Canada meets tomorrow followed by the European Central Bank on Thursday and the BOJ on Thursday night. In these turbulent times I would expect no change from any of the central banks. The Bank of Canada has room to raise rates as unemployment has dropped and the Canadian economy had a robust PMI today, but with the talk of tariffs the BOC will be very cautious. The Italian elections will prevent President Draghi from making any changes to the current ECB policy, and, as usual, the press conference following the meeting will result in the most interesting piece of the day’s trading activity. The BOJ will stand firm as Governor Kuroda and his new members have been dovish of late and the YEN has been firm against a wide array of currencies. The BALL OF CONFUSION ROLLS ON.


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21 Responses to “Notes From Underground: Things to Contemplate”

  1. Mike Temple Says:

    Sounds like a good time to buy some gold. Even better value is silver at 1:80 ratio to gold
    Trump’s business profile is one in which he was never bothered by carrying huge debt loads and threatening his creditors what he would do to them
    Cannot rule out a Sat am tweet in which Trump throws out a trial balloon about hair cutting UST debt or calling his new Fed Chief a “Magoo” as markets grow twitchier.

    If you were a foreign money manager, would you really want to be holding USD these days?

    I think gold/silver are going to be in demand very very soon

  2. rld Says:

    Terrific back round info on a complicated subject. Our “change agent” President loves to poke eyes, and shake it up.

  3. Stefan Jovanovich Says:

    Trump’s tariff policy is the devaluation. It rewards U.S. based multinationals (whose foreign earnings can ride the up escalator) and US workers and owners of export businesses. It punishes Amazon. What’s not to like – from Trump’s point of view.

    • David Richards (@djwrichards) Says:

      From the perspective of the average joe who doesn’t own a large foreign investment portfolio, what’s “not to like” is his collapsing standard of living as his purchasing power has eroded 20% in one year due to the average 20% depreciation of the dollar in a year. And worse, adding on rising inflation and sub-federal taxes, and recently tariffs (eg., lumber & housing costs) with apparently much more tariff-induced price inflation to come.

      Then how is he maintaining his standard of living? Debt. Bad.

      Joe will feel the pain but not necessarily understand its cause. So he thinks that come election time, maybe the Marxist/socialists are correct that free market capitalism is to blame (increasingly the sentiment of many including the vast majority of voters under age 40). A big lurch to the far left probably beckons in the US for 2018 and especially 2020.

      • Chicken Says:

        I can still buy tooling and parts delivered from China for less than the US shipping charges alone. Not sure how long that lasts or who’s subsidizing it exactly, but I figure it can’t last forever.

  4. Bob Zimmerman Says:

    I guess we will go back to adding duty to the cost of goods. It’s been forever!

  5. David Richards (@djwrichards) Says:

    “Trade wars are good and winnable” should prove even more misguided than “the Iraq war will pay for itself” mantra of the last Republican administration.

  6. Bob Zimmerman Says:

    I am the Egg man, They are the Egg men I am Walrus, Goo Goo Goo Joob.

  7. Ronald Ferrill Says:

    There are a couple of ageless points in this thath I noted (perhaps because I was trying to digest it very quickly?) .

    1. Hearkening to Bretton Woods, made me scan 20th century history, and the U.S. while under the same constitutional basis, was primarily a country with a value system, non-relativistic based upon Judeo-Christian principles of what is right and wrong. Since, we chose, thinking we were being inclusive and enlightened, to allow relative moral and ethical values to have a say. It opened a door to a price we have and are paying with decay that incipient destroyer of individual, family, community, country. Instead of seeing any blessing of wealth and health as a responsibility to others, we dwell in the darkeness of the dungeon of greed and self approbation.

    2. read the second half of 1.

    So, our (U.S.) material success in the first 2/3 of 20th century has served as a lesson for the rest of the world. But, they come after we began the decay part. Are they emulating only the worst?

    Do not get me wrong. I am not accusing every person, family, community of jumping into the torrent of relativistic morality. In fact I am optimistic that through a rediscovery of the principles, and fairly open access to great thinkers throughout history, we will slowly find our way back to a simpler life and focus on using our blessings for the uplifting of all people, one at a time, but each helping one – at a time. This will spread the acceptance of the immutable principles.

    Good Morning, Y’all!

  8. David Richards (@djwrichards) Says:

    Yra, I’m skeptical that the dollar is still overvalued since its collapse last year against almost everything. For example, using the imperfect but infamous Big Mac index, USD is currently the cheapest currency in the developed world. The presumably more sophisticated bank economists typically consider fair market value of the Euro to be about 1.20, so the Euro has actually been overvalued throughout 2018 (apparently taking its toll now as Europe has recently suffered a plunging Citi Economic Surprise index amidst a big string of disappointing economic data including again today, with Germany factory orders 35% below expectation).

    With the European economy showing early signs of a renewed slowdown and the Euro already up from 1.034 to 1.256, fat chance the EU or ECB will discuss an upward adjustment to the Euro. Not a fan of the ECB, but Draghi was masterfully dovish today by removing accommodative language whilst slamming the Euro’s intraday spike (which came within a whisker of a major breakout) by hammering away that Eurozone inflation will fall in 2019-20, as if he or anyone really has a clue what inflation in 2020 will be like. Drawing a key reversal on the chart for the day. Perfectly played! (Take that, Mr Trump; you’re no match for super-Mario)

    Apparently, the current ECB will not tolerate any further Euro appreciation. Especially with the majority of Italy’s seats now held by Euro-skeptic parties? So whatever it takes. Perhaps including buying of foreign equities with newly printed Euros if necessary?

    • David Richards (@djwrichards) Says:

      Just to point out another, different CB decision today in contrast to the dovish ECB and BOC… Bank Negara Malaysia in southeast Asia, which has hiked its bank rate once in 2018 already, today stated it wants to see a *stronger* currency – even thought the MYR/USD is already up by 30% from 0.20 last year to 0.26 now. They are lauding the positives of the stronger currency because of the increasing investment, jobs and household wealth it’s bringing to this growing, middle-income nation. How refreshingly different! The road less traveled, like from another era. Maybe it even works?

  9. GreenAB Says:

    So Canada (No.1 Steel Exports to the US) and Mexico (No.4) are excluded from the tarriffs.

    What does the president think is going to happen? Let´s say you are a large automobile manufacturer and you source part your steel from South Korea. Hit by the tarriff their steel prices go up. So what do you do? Switch to equally expensive US steel? Or do you call a Canadian steel mill, which can still offer low prices?

    What in the world prevents Canada/Mexico from taking advantage of this opportunity, INCREASE their exports and take share from the rest (Korea, Brazil…)?

    • David Richards (@djwrichards) Says:

      True, but it’s contingent on NAFTA continuing. And the US steel tariff on Canada for national security reasons was a blow to US credibility because, as US Defense Secretary James Mattis has said, the main reason steel making exists in Canada is because the US pushed for it in the first place for US national security reasons.

      Looks like the next main target for Mr Trump might be the EU with its big, record-high current account surplus in the news while he’s paying handsomely to defend EU. This is a top fundamental dynamic that buoys the value of the Euro. If that ever fundamentally changes, then watch out below. Just saying, as I have no dog in that fight, except for periodic currency positions.

    • David Richards (@djwrichards) Says:

      And on another topic, that March low that I subsequently warned before might instead lead to new stock highs (technically called a cycle inversion) is a possibility to monitor, should the March high in the Dow exceed February’s, and then if April high exceeds March. In which case we’d expect the advance to continue to new record highs in May, which is the target month that you identified (and I agree with)…
      So May should either see all-time record highs or else deeper lows than February, depending on whether the cycle inverts as described. Hope that’s comprehensible.

    • Chicken Says:

      IMO, we should go easy on SK, but that’s my personal feeling. Perhaps POTUS meets with Kim and something comes of it….

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