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The Consequences of Budget Deficits For International Trade

In all the economic mayhem ahead, no one is yet thinking of the consequences for trade imbalances. The twin deficit hypothesis informs us that skyrocketing US budget deficits will lead to increasing trade deficits, a situation with serious political consequences. Furthermore, with foreign interests already saturated with dollars and financial assets denominated in them, far from investing their growing surpluses in yet more dollars and dollar-denominated investments, they will become increasingly aggressive sellers.

This article walks the reader through the main issues of international trade in a developing slump and finds worrying parallels with the Wall Street crash and subsequent events. While the parallels are worrying, the major differences between then and now suggest that this time outcomes could be even more economically challenging.

Introduction

Following the presidential election this week, the new President of the United States will face an economic slump. Long before the covid-19 lockdowns, economic and financial developments threatened to undermine both the US economy and the dollar.

The similarities between the situation today and the end of the roaring twenties, and the depression that followed, are enormously concerning. Both periods have seen a stock market bubble, fuelled by bank credit and an artificial monetary stimulus by the Fed. Both periods have experienced an increase in trade protectionism:  In October 1929, the month of the crash, after debating it for months Congress finally passed the Smoot Hawley Tariff Act, raising tariffs on all imported goods by an average of about 20%. In 2019, US trade protectionism against China put a stop to the expansion of international trade. These facts, which should continue to concern us, have been buried by the immediacy of the coronavirus crisis, which is an additional burden for the global economy today compared with the situation ninety years ago.

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What? Default? Where? Dollar?

What? Default? Where? Dollar?

It won’t come as a surprise to anyone that the first half of 2020 has brought, among many other things, renewed calls for the demise of the US dollar. It’s been pretty much a non-stop call for over a decade now, and longer. But this time, like all previous ones, I’m thinking: I don’t see it. I guess my first question is always: please explain why the dollar would collapse before the euro does.

For one thing, the dollar would have to collapse/default against one or more “entities”. The dollar is not like one of those highrises that collapse upon themselves. It will have to default or collapse against something(s) else. Since it is the world reserve currency, that means there would have to be a replacement reserve currency. Yes, that could also be for example gold or SDR’s, or even a basket of currencies, and something like that may happen eventually, but it doesn’t appear in the cards in the short run.

There are really only two candidates for the role, and neither looks at all fit to play it. The euro may have some ambitions in that direction, but it has far too many problems still. The yuan/renminbi certainly has such ambitions, but the Communist party refuses to let it get on stage to show what it’s got. As I recently wrote:

The main sticking point for Beijing is a conundrum it cannot solve. The CCP wants to have BOTH a global currency AND total control over that currency. It will have to choose between the two, and cannot make up its mind. So it pretends it doesn’t have to choose.

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The Weaponization of the Dollar

The Weaponization of the Dollar

The Uncivil Civil War discussed the sanguine approach many investors take towards equity risk despite clear signs of domestic political turbulence. The article put the upcoming elections and the growing political divisions amongst the populace into context with market risks.

While we read plenty of politically related articles and many more investment related articles, we have found precious few that bridge the gap and gauge the effect politics has on markets. The intersection of markets and politics is important and should be followed closely, especially with a mid-term election months away. As so eloquently described by the late Charles Krauthammer, “You can have the most advanced and efflorescent cultures. Get your politics wrong, however, and everything stands to be swept away. This is not ancient history. This is Germany 1933.

In this article, we readdress politics and markets from an international perspective. In particular, we focus on suspicions we have regarding Donald Trump’s negotiation tactics and goals for the U.S. relationship with Turkey.

Emerging Markets and the Dollar

China, Turkey, and Iran are all classified as emerging markets. While the classification is broad and includes a diverse group of countries, these countries have many things in common. One is that their currencies, for the most part, are not liquid or highly valued. Thus, they heavily rely on the world’s reserve currency, the U.S. dollar, to conduct international trade.

As an example, when Pakistan buys oil from Qatar, they transact in U.S. dollars, not rupees or riyals. To facilitate trade efficiently, these countries must hold excess dollars in reserve. In almost all cases, emerging market nations rely on U.S. dollar-denominated debt for their transactional needs.

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The End Is Nigh

The End Is Nigh

The End Is Nigh
Recently, US Secretary of the Treasury Steve Mnuchin stated, “If China doesn’t follow these sanctions [against North Korea], we will put additional sanctions on them and prevent them from accessing the US and international dollar system.”

This is astonishingly shortsighted, as the US can no more do without trade with China than China can do without trade with the US. Further, the US will unquestionably pressure its other trading partners (particularly the EU) to endorse and follow the sanctions. This they will not comply with, as it would serve to cut their own economic throats. The relationships between the US and their partners have been wearing thin in recent years, and the present threat against China is very likely to prove to be the final straw. The net effect would be to place the US out on an economic limb, alone.

There may be those who disagree with this premise, under the assumption that, to cut China out of the SWIFT system would destroy China’s ability to make international transactions, forcing them to cave to US demands.

However, China, Russia, and others have seen this day coming and have created their own SWIFT system, world cable network, and world banking system. All that’s needed to kick it all into gear is a major international need to bypass SWIFT. The US government has just provided that need with this threat. There would certainly be teething pains in getting the new system running on a massive scale, but the sudden worldwide need would drive the implementation.

This threat by the US at a time when it’s broke is, in effect, economic suicide.

But, just as the ink is drying on this announcement, the increasingly impetuous US president has cracked a deal with Democrats to permanently abolish the US debt ceiling. As the debt ceiling was the last safeguard in governmental fiscal responsibility, he’s effectively chosen to assure that the US will experience economic collapse.

…click on the above link to read the rest of the article…

The Fed’s Dollar Distraction

The Fed’s Dollar Distraction

In its September policy statement, the US Federal Reserve took into consideration – in a major way – the impact of global economic developments on the United States, and thus on US monetary policy. Indeed, the Fed decided to delay raising interest rates partly because US policymakers expect dollar appreciation, by lowering import prices, to undermine their ability to meet their 2% inflation target.

In reality, while currency movements can have a significant impact on inflation in other countries, dollar movements have rarely had a meaningful or durable impact on prices in the US. The difference, of course, lies in the US dollar’s dominant role in the invoicing of international trade: prices are set in dollars.

Just as the dollar is often the unit of account in debt contracts, even when neither the borrower nor the lender is a US entity, the dollar’s share in invoicing for international trade is around 4.5 times America’s share of world imports, and three times its share of world exports. The prices of some 93% of US imports are set in dollars.

In this environment, the pass-through of dollar movements into non-fuel US import prices is one of the lowest in the world, in both the short term (one quarter out) and the longer term (two years out), for three key reasons. First, international trade contracts are renegotiated infrequently, which means that dollar prices are “sticky” for an extended period – around ten months – despite fluctuations in the exchange rate.

Second, because most exporters also import intermediate inputs that are priced in dollars, exchange-rate fluctuations have a limited impact on their costs and thus on their incentive to change dollar prices. And, third, exporters who wish to preserve their share in world markets – where prices are largely denominated in dollars – choose to keep their dollar prices stable, to avoid falling victim to idiosyncratic exchange-rate movements.

…click on the above link to read the rest of the article…

 

Exorbitant Privilege: “The Dollar is Our Currency but Your Problem”

Exorbitant Privilege: “The Dollar is Our Currency but Your Problem”

The Global Monetary Architecture: Change is on the Horizon

There is no better way to descibe the international monetary system today than through the statement made in 1971 by U.S. Treasury Secretary, John Connally. He said to his counterparts during a Rome G-10 meeting in November 1971, shortly after the Nixon administration ended the dollar’s convertibility into gold and shifted the international monetary system into a global floating exchange rate regime that, “The dollar is our currency, but your problem.” This remains the U.S. policy towards the international community even today. On several occasions both the past and present chairpersons of the Fed, Ben Bernanke and Janet Yellen, have indicated it still is the U.S. policy as it concerns the dollar.

vyingTwo empires vying for supremacy?

Is China saying to the world, but more particularly to the U.S., “The yuan is our currency but your problem”? China’s move to weaken the Yuan against the US dollar is in fact a huge response to America’s resistance to reforming the international monetary framework. It’s telling American policy makers that the longer they delay acting on reforming the international monetary system, the harder and longer they are going to make it for the U.S. to climb out of their trade deficit and depreciate their currency to where they need it to be.

China has been preparing for this moment for several years by accumulating gold through its central bank but also by using banks/corporations and individuals. It has in recent years signed several international agreements to bypass the US dollar in international trade and use preferably the Yuan. It has created an alternative World Bank (Asian Infrastructure Investment Bank) and a gold fund to invest in gold mining in more than 60 countries.

…click on the above link to read the rest of the article…

 

 

Global finance and the privatization of rural livelihoods | ROAR Magazine

Global finance and the privatization of rural livelihoods | ROAR Magazine.

A big piece of news for food politics enthusiasts this summer was India’s veto over a proposed agreement — to be concluded within the legal framework of the World Trade Organization — on ‘trade facilitation measures’. The agreement was meant to regulate a number of sensitive issues, mostly related to customs infrastructure and procedures, which are liable to affect trade between WTO members. As it often happens with international agreements, however, exceptions and exemptions are as important as the rules being agreed. In Bali, which is where the ‘trade facilitation’ negotiations were happening, the bone of contention happened to be India’s request for a permanent exemption from further trade liberalization of its public stockpiling and distribution system for food staples.

In fact, the centerpiece of India’s food security infrastructure is the Food Corporation of India (FCI). This is a public body, established in 1964, that acts like a hybrid between a marketing board, a food bank and a subsidy scheme. It stockpiles grains and other food staples (which it buys at controlled prices that give farmers some protection against fluctuations). It then uses this reserve to distribute grains at times when market prices become too high, both as a way to bring those prices down (this is what a marketing board does) as well as to ensure access to essential dietary staples (the ‘food bank’ aspect of the FCI). In other words, the FCI is like a public insurance mechanism against the fluctuation of food prices. The issue in Bali, then, was whether India should be allowed to ‘keep’ the FCI indefinitely, or whether it should gradually phase it out, in order to leave free reign to private actors.

…click on the above link to read the rest of the article…

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