@theMarket: The Summer of Financial Discontent
As we close out the summer, investors have had anything but a sleepy three months. The volatility caused by the Fed's actions, Donald Trump's tweets, Brexit, and tariff threats had markets gaining and losing billions — if not trillions — of dollars in assets on a weekly, and sometimes, daily basis.
The question you might ask is "Will it continue?" The short answer is yes, at least into October, unless a trade deal is signed. And what are the chances of that happening? Not very high, if you listen to the experts who profess to know and understand China.
A respected Deutsche Bank economist, Yi Xiong, wrote in a recent report that China has made up its mind to play the long game, something I have been warning investors might happen. Rather than come to the table, China will look to strengthen their domestic economy, while enduring any tariffs the Trump Administration might inflict upon them.
In order to understand their decision, you need to realize that China has been working for almost a decade to transform their economy from an export-led economy to a consumer-driven domestic powerhouse. As a result of this transition stage, China's GDP has been cut roughly in half from 12 percent annually to 6-6.5 percent today. The government hopes to complete the transition by 2025 or so.
As such, external trade makes up a small portion of their economy, no more than 20 percent of GDP and this percentage keeps shrinking. Contrary to the rhetoric you may be hearing or reading on Twitter, the majority of that trade is not with the U.S. As much as 80 percent of China's exports have gone to other countries, rather than the United States.
As a result, the trade impact thus far on China has barely dented economic growth, contrary to claims made by others. While the overall economy has slowed, most of the decline can be accounted for by China's own actions. In their stated desire to reduce national debt, government investment has declined, as has consumer spending, which accounts for most of the shortfall in their economic growth.
In response to the expected levy of U.S. tariffs on all their exports, China plans to adopt measures to grow their domestic economy. Additional spending on infrastructure and measures to boost domestic consumption have already been announced and are being implemented today.
At the same time, the government is diversifying its supply chain. It is accelerating efforts to open up their economy to other countries, while reducing reliance on the U.S. over the longer term. And as for combating the tariff hit to the price of their export goods to the U.S., China will most likely continue to devalue their currency, the yuan. This last month, the yuan has lost about 3.7 percent against the greenback, the biggest monthly decline since 1994.
What will all this mean for our markets and economy? More of the same, in my opinion. Without a trade deal, U.S. companies will continue to put off investment, which will, in turn, slow our economy (and earnings). Most other regions of the world are already in worse economic shape than we are, so don't count on any spill-over in growth from elsewhere. Interest rates should continue to slide, sparking more and more calls for an imminent recession.
Our side will continue to raise, and lower hopes of a deal (most of which will be simple fabrication), while blaming the Fed for any shortfall in growth. The president will deny that his tariff war has any impact on the economy, while desperately seeking ways to shore up the economy by more tax cuts, etc. If he fails, I expect he can always blame the Fed.
The only saving grace out of all of this may be the central bank and what it decides to do in two weeks. If they cut rates (and by how much), it may give the financial markets some support. In which case, you could see a big spike up as a result. Otherwise, expect more volatility while being trapped in a wide trading range.
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The Independent Investor: The Rising Costs of Hurricanes
Over the last few decades, hurricanes have wreaked havoc on this country. Hurricanes have caused the most deaths, the greatest damage, and cost the most money of any weather or climate-related disasters in U.S. history. Some say we're just getting started when it comes to the intensity and frequency of these super storms.
The frequency of hurricanes (like just about any other subject you can think of in this country these days) can be a political football depending on who you talk to. Environmentalists blame a warmer climate and rising sea levels, caused by greenhouse gas emissions, for the rise in super storms. If you are in the Trump camp, the tendency is to deny that there is such a thing as global warming, let alone increased hurricane intensity. As such, I will steer clear of causes and simply state the facts.
The expected costs of damage from hurricane winds and storm-related flooding is expected to total $54 billion this year. Breaking down that figure, we have $34 billion in losses to U.S. households, $9 billion to commercial businesses, and $12 billion to the public sector. These figures are derived directly from the Republican-controlled Congressional Budget Office (CBO).
The expected annual losses would amount to roughly 0.3 percent of the country's current gross domestic product. The CBO's estimate is somewhat understated, since it does not include losses to assets that the federal government would not fully repair as well as losses to parts of the private sector other than commercial businesses. Damage in areas such as the industrial, agricultural and energy sectors could increase the losses substantially.
Since 1980, the United States has endured 40 hurricanes that have been tagged as billion-dollar disasters with cumulative damage being an estimated $862 billion, according to National Oceanic and Atmospheric Administration. Hurricanes Harvey, Maria and Irma, all occurred in (2017), accounted for 31 percent of the total damage, making it the most expensive season out of the last 38.
One big reason that hurricane costs are rising has nothing to do with the environment. Americans have had an increasing love affair with living along the U.S. coastline where hurricane-strength winds and floods cause the most damage. From 1980 to 2017, the population density of our shoreline has more than doubled. Gulf and East Coast shoreline counties, for example, increased by 160 people per square mile, compared to just 26 per square mile in the remainder of the mainland over the same period.
As Dorian, the first potential hurricane of the season takes aim at the Florida coastline this weekend, the CBO has offered some suggestions to reduce the future losses to the country, if anyone in Washington were to actually read the report. Limiting greenhouse gas emissions, they believe, would reduce projected increases in sea levels and could lessen the severity of these storms. Of course, under the present administration, greenhouse gas emissions have taken a great leap forward as the president, who discounts their impact on the environment, relaxes all sorts of rules and regulations on emissions.
The CBO also suggests expanding the federal role in risk reduction efforts such as better analysis of flood-prone areas and spending more on pre-disaster activities that would reduce damage in the face of future storms.
Instead, as hurricane season bears down on us, President Trump just took $155 million of sorely needed funds from the Federal Emergency Management Agency's Disaster Relief Fund to pay for 6,800 beds in his immigrant "detention relief space" (a type of concentration camp for illegal immigrants). Since most of the East Coast is not part of the Trump camp, any damage to these mostly-blue states is none of his concern.
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The Independent Investor: Will We race to the Bottom?
Financial markets are in turmoil. President Trump's trade war is escalating, and with it, fears that both China and the U.S. will employ a new weapon, currency devaluation, to win the war. Is that a wise move?
The last time the country devalued the dollar outright was on Dec. 18, 1971, when President Nixon took the country off the gold standard. Since then, there have been times when various administrations have nudged the dollar down, but most American presidents have maintained a strong-dollar policy.
However, over the course of the last two years, President Trump has increasingly complained that the United States is at an unfair advantage versus other countries that are deliberately devaluing their currencies in order to increase their exports. As most readers understand, the cheaper your currency, the cheaper the price of your exports.
This week, however, the question of currency manipulation moved front and center. In response to the president's decision to place a 10 percent tariff on an additional $300 billion of Chinese exports on Sept. 1, China ordered its companies not to purchase any additional food stuffs from the U.S. The government also allowed its currency, the renminbi, to drop below the seven to one U.S. dollar valuation, the lower end of the official exchange rate range.
The Chinese currency does not trade freely but is instead managed by the government. Its value is allowed to trade within a range with the 7-to-1 level being the lower end of that band.
Up until this week, the Chinese government had been attempting to stabilize their currency despite the accusations from the administration. Outside economists as well as the IMF, believe at this level the Chinese currency accurately reflects the fundamentals of their economy.
But when have facts and figures ever influenced the Trump administration? On Monday, under orders of the president, the U.S. Treasury designated China a "currency manipulator."
Financial markets, at first, swooned, fearing that the trade war was about to get far more serious. Investors fear that by naming China a currency manipulator, President Trump can now open the door to a currency war and justify some kind of devaluation of the dollar. It is a move that his trade adviser, Peter Navarro, has been urging on the president as recently as two weeks ago. Trump dismissed his proposals at the time, but said later, according to the Wall Street Journal, that it was still an option.
A currency war is one where one country devalues or weakens their currency, which leads the impacted country to do the same. It may also evoke a similar response by other nations (think the EU), which could set off a domino effect and a race to the bottom as countries continually devalue their currencies. The end result would not be pretty for anyone, since there are no winners in a currency crisis.
A dollar devaluation would, in the short-term, increase U.S. exports and decrease imports. It would also help Trump's most important supporters in the Great Plains, the South and Midwest that make up the farm belt, coal and energy sectors. A weaker dollar would also make it easier to pay down our public debt that has skyrocketed under the Trump administration.
Of course, all of the above comes to naught if others also join the currency war. For the world overall, it would most likely mean stagnation and possibly the match that could ignite inflation that has long been slumbering under the surface.
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@theMarket: Tariff Threat Unsettles Markets
Donald Trump's announcement on Thursday that an additional 10 percent tariff will be levied on the remaining $300 billion in Chinese exports to the U.S. on September 1 did not sit well with investors. The news could very well trigger the stock market decline that I have been expecting.
Regular readers know that I have been waiting for a 5-7 percent pullback in the markets fairly soon. Since the first two weeks of August are usually a bad time in the markets, the pullback this week might be right on cue.
In my last column, I also explained in some detail how it appeared that Donald Trump had no intention of negotiating in good faith with the Chinese this past week during meetings in China. The Chinese, evidently, felt the same way. Nothing was offered to move the negotiations forward by either side.
That suited the president just fine because he was using the potential of a deepening trade war, in my opinion, to pressure the Federal Reserve Bank into a series of interest rate cuts. However, Jerome Powell, the chairman of the Federal Reserve Bank, failed to deliver what he wanted on Wednesday.
Powell is stuck between a rock and a hard place. He did acquiesce (to some degree) to Trump's demands, while attempting to preserve his and the Fed's historical and legal independence. He cut rates by one quarter of one percent, but then left the impression, while talking to reporters in a press conference, that the cut was simply a "mid-cycle adjustment" rather than the beginning of a series of further interest rate cuts.
That disappointed the financial markets. Some investors hoped to have seen even further easing in the months ahead. It also angered the president, who made his displeasure known through his usual channel on Twitter. "What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle, which would keep pace with China, The European Union and other countries around the world," Trump tweeted after the Fed FOMC meeting.
None of this should come as a surprise to you, if you have been reading my columns. Last week I wrote "If the Fed does cut rates, we will see what the president's next move will be. Of course, that is not entirely within his control, since China will have an equal say in what kind of deal is struck and when."
Thursday afternoon, Trump announced that next move by threatening to levy a 10 percent tariff on all the remaining Chinese export goods to the U.S. It was a completely predictable and expected response from the president, given his character. While the markets swooned focusing on the impact of these new potential tariffs on the U.S. and world economy, I've taken a different view.
To me, Trump is simply doubling down on his demand for more rate cuts. Slapping tariffs on the Chinese, he is hoping, will tip the Fed's hand into doing exactly what he wants. And believe me, he will do all he can to institute those tariffs.
It seems clear to me that the Chinese have given up working toward a trade solution with Donald Trump. They realize (according to the official Chinese news agencies) that no deal will be struck any time soon, or at least not until after the 2020 election. They are probably right, unless Trump perceives that he needs a deal to get re-elected.
Instead, their plan is to hunker down, alleviate the impact of these costly tariffs on their economy, and wait it out. They are very good at that. And who knows, Trump might actually lose in 2020, setting the stage for possibly better terms from a future administration.
In the short-term, Trump's willingness to disregard the independence of the Fed, and postpone a U.S./China trade deal, while manipulating financial markets for his own apparent political gain sets a dangerous precedent. Markets, therefore, will continue to gyrate but it is what it is.
So how do you take advantage of all this market noise and manipulation? Stay invested. If I am right, simply wait for the Fed to cut interest rates again in September, (regardless of economic necessity) thanks to Trump's shenanigans, and watch the markets come roaring back.
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The Independent Investor: Brexit: The Never-Ending Story
Back in 2018, the government of the United Kingdom and the European Union reached an agreement on exactly how the British exit (Brexit) would occur. Since then, despite countless meetings, discussions and votes, the UK Parliament has failed to approve that process. The new date for an exit is Oct. 31. Will this really be the end of the story?
The October extension was really a compromise negotiated by former Prime Minister Theresa May of Britain's Conservative Party. Some European countries were offering a much longer delay for as much as one year. However, Emmanuel Macron, the French President, insisted on a much shorter time period.
Macron and some other European leaders are worried that the toxic atmosphere within Britain, which has been building ever since the exit vote back in 2016, could spill over and infect sentiment within the populations of other European countries. The longer these exit negotiations go on, the more likely other European countries might be persuaded to follow the UK's lead and announce their own exit plans.
To further complicate matters, Boris Johnson, an outspoken critic of the negotiations (and a leading pro-exit populist), took over as prime minster from May for Britain's Conservative Party this month. One of his first promises was to accomplish the exit with "no ifs, ands, or buts."
Johnson has vowed to leave the EU by Oct. 31, regardless of whether or not a deal with the EU can be inked. In addition, he and his cabinet have demanded a change in the terms of the negotiated deal, which have surfaced before, and were rejected repeatedly by the EU.
Many Brexit watchers believe Jonson's tactics are simply a ploy to bring a no-deal Brexit plan to a vote in Parliament where it would be rejected. That's a safe bet, since the majority of MPs (Members of Parliament) are adamantly opposed to a no-deal departure. At that point, Johnson could then call for new elections, positioning himself as the self-styled champion of Brexit.
If Johnson's threat was to be taken seriously and the UK actually exited the EU on Halloween, the impact could be devastating. All the arrangements, pacts, treaties and trade agreements with the EU would come to an abrupt end. Everything from the free movement of people to policing and security would be called into question. Food, drink, data, finance, aviation, even the supplies of medicine as well as countless other day-to-day items would need to be re-examined.
There would be need for a great deal more government spending and planning immediately to deal with the short falls in all these areas if the exit were to occur over the next three months. Some of this preparation has already begun, but there is far more spending and planning required than time to implement it.
And even if a large and vocal segment of the population simply wants to "get it over with," regardless of whether or not a deal can be negotiated, that does not end the problem. In the immediate aftermath of a no-deal exit, the UK would be able to continue trading with the EU under the terms of an existing default agreement governed by the World Trade Organization (WTO).
Under the default agreement, tariffs on such things as agricultural goods would be able to continue for a limited time, but the UK would still need to negotiate a permanent deal with the EU. That would involve all the same issues that the UK Parliament is already facing (and failing to pass). The issue would be that a no-deal exit would require decisions on all of the above to be made quickly; something parliament and the country overall has proven to be incapable of doing. Given all of this, I believe the October deadline will come and go so the Brexit story will continue and continue and continue.
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