Kinky Money Makes the World Go ’Round

By David Stockman  |  March 5, 2019

Confucius said, ‘The gentleman understands integrity; the petty person knows about profit.’

– Confucius, Analects (551 – 479 B.C.E)

Yesterday, we talked about the fact that America’s trade deficit with China is not the result of bad trade deals or the nefarious doings of the communist state.

Here’s the math.

Since 1992, the weighted average tariff on China’s imports plunged from 32% in 1992 to 3.8% in 2017. That’s an 88% drop. During the same 25-year span, the already low 3.9% average U.S. tariff shimmied down to just 1.7%.

The once yawning U.S.-China tariff gap has completely disappeared.

Let’s say China was at complete parity. The implied $2.7 billion reduction in the landed cost of U.S. goods in China wouldn’t amount to a hill of (soy)beans in the great scheme of things.

Still, during the same quarter century, the greatest trade imbalance aberration in history materialized. The trade deficit with China soared from $20 billion in 1992 to $375 billion in 2017.

That means it grew by 19 times.

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This imbalance isn’t due to classic, tariff-based protectionism.

Trade negotiators couldn’t touch the underlying causes with a 10-foot pole. And that’s even if they were competent and on the same page… and the Donald’s gang of protectionists, Wall Street shills, K-Street errand boys, and free trade hypocrites clearly are not.

It’s structural, and it’s rooted in bad money on both sides of the Pacific.

The Chinese economy has been transformed into the Red Ponzi. Its growth is based on an eruption of debt, speculation, malinvestment, and statism with no parallel in economic history.

Meanwhile, costs, prices, and wages in the U.S. have been relentlessly inflated. Corporate cash flows and balance sheets have been strip-mined by Wall Street’s financial engineers. And much of America’s industrial economy has been hollowed-out and debilitated.

The villains of the piece are monetary central planners on both ends of the trade.

In the U.S., the Fed’s foolish pursuit of 2% inflation has caused households to earn less in real terms. At the same time, it’s repression of interest rates has induced them to spend by piling up debt.

During the past three decades, the household debt-to-income ratio has soared from an already high 130% in 1987 to a peak of 220% in early 2008. It’s still historically aberrant at 175%. Prior to 1971 it was about 80%.

Fueled by cheap debt and inflating financial asset prices, the U.S. economy has been living way beyond its means, i.e. production.

We’ve imported the balance from low-wage, low-cost exporters, led by China.

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Meanwhile, China depreciated its currency by 60% in the early 1990s. And then it pegged the Chinese yuan to the U.S. the dollar.

Its innocent sounding peg to the dollar in the range of CNY6 to CNY7 to the USD since the turn of the century reflects an extremely “dirty float.”

It’s the consequence of the Peoples Bank of China defending its burgeoning export economy from the Fed’s tsunami of excess dollar liabilities by capping its foreign-exchange rate and buying in massive amounts of dollars in the form of U.S. Treasury debt and other securities.

It swapped the labor and savings of its people for Uncle Sam’s debt emissions. That enabled America to keep buying what China had on offer.

And those surging export earnings and capital inflows led the Chi-coms to crank up debt-fueled over-investment to even more egregious extremes.

A sound money regime would have produced persistent deflation in the U.S. in the face of the Red Ponzi and its explosion of subsidized production capacity and labor-intensive exports.

It would have also caused high domestic interest rates and reduced borrowing and consumption spending for imports by U.S. households.

Sound money causes trade imbalances to self-correct. That happens through adjustments in relative prices, costs, and wages on the free market.

Bad money tends in the opposite direction. It reinforces and aggravates imbalances… until we reach the point of metastatic crisis…

A Sound Model

Everywhere you look, there are signs of weakness.

The Great Disruptor may indeed succeed in right-sizing the American Empire – but it’s through no intentional effort of his own.

You see, the world is tiring of the “Indispensable Nation.” It’s starting to suffer too much the costs of “Team America: World Police!”

That doesn’t mean, however, that Imperial Washington is on board to end Forever War… far from it. Neocons are ginning up the old martial spirit against Iran, and Very Serious People on both sides of the Duopoly are eyeing Venezuela for intervention.

The Warfare State will metastasize until something bigger stops it. AOC-and-MMT-style socialism plus the Green New Deal promise the same for the Welfare State.

What it does mean – and this is the short version – is “easy money as far as the eye can see.”

The inability of our monetary central planners to do anything but feed Leviathan and appease Wall Street is the focus of the March issue of The Stockman Letter.

Appeasing Wall Street is, of course, critical to maintaining the status quo. The Fed is therefore merely an instrument of Imperial Washington.

So, we’re stuck abroad… And Main Street is stuck in stagflation… The fundamentals are terrible… All we have is debt to sustain us.

But our monetary central planners will test the absolute limits of U.S. hegemony – including the durability of the dollar as the global reserve currency – to nourish the Acela Corridor.

That’s the way it is in the March issue of The Stockman Letter.

As always, I’ve included “tactical” notes based on The Stockman Model throughout the issue.

The Model is built precisely for the type of disruption that comes with the ends of empires…

To common sense,

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David Stockman

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR