Links of Interest 2019.Jun.29

Links of Interest is a weekly email that covers interesting links from the week and any news I find of interest to investors. You can subscribe to the Links of Interest newsletter here.

Greetings,

Trump and Xi will be meeting over lunch tomorrow in Osaka. Many hope to see a significant x.0 upgrade in the G2 relationship, a G2.0 if you will. The big news (so far): SCMP is reporting a tentatively agreed truce and joint press releases to be out before the meeting. The report also says a delay in additional tariffs was Xi’s price for the meeting. On to the note.

First off, my apologies for a relatively long note. I take a look at 4 economists’ comments on global trade tensions around what I believe is an underlying cause. I hope you find it useful or helpful. Feel free to forward.

A few Economists’ view of Trade Tensions & US-China Relations

Imagine someone asked you, where will future global demand come from? You might think demand should be created from globalization spreading and lifting people out of poverty.

This week Catherine Mann was on Bloomberg Surveillance (overcast)[2]. Tom Keene asked for her view on inter-dependencies and correlations that lead to a country’s individual policies having little effect. Her response:

“The trade relationship we have right now with China is emblematic of 10 years of stagnation in terms of global integration. Earlier in my career we talked about more deeply integrated global supply chains, a greater variety of products crossing borders, lower prices available to both businesses and consumers. And all that stopped about 10 years ago.”

Demand cannot come from globalization because global integration stopped 10 years ago. What about incremental demand in the form of imports increasing as a country’s GDP increases?

Brad Setser, Council on Foreign Relations, last November wrote a blog post entitled “China should import more.” He included this chart, showing the declining trend in China’s trade in manufactures with the US as a share of GDP.

Setser is still on top of this, he wrote a post this week that argues “China under Xi has deglobalized more than the US under Trump.” And he shows it with his namesake’s indicator, which compares the rate of growth of imports with the rate of growth of GDP. A value below 1 shows imports increase at a slower rate than GDP.

So, incremental demand is not coming from China even though its GDP grew faster than any other nation. You may be wondering why this matters. Let’s turn to Michael Pettis.

Last year as trade tensions were heating up, Michael Pettis discussed the historical significance of the global system we find ourselves in. (A video is on youtube, and I transcribed it.)

“The problem is that the American role in the global economy is to balance the excess demand or excess supply of savings.”

He then explains how this came about after two world wars, countries were destroyed and they desperately needed savings (investment) to rebuild. So in that period the US ran a current account surplus every year. Then it switched.

“Since roughly the 1960s when the world was more or less rebuilt, the problem shifted. The world no longer lacked savings, it lacked demand. The way to grow was with additional demand. And [the world] had excess savings. And I think it’s not a coincidence that during that period, countries like the US with very open, deep, flexible financial markets (including Great Britain) were constantly running capital account surpluses. In other words, the excess savings ended up in those countries. And if you run a capital account surplus, you must run a current account deficit. And I’d say that is why the US has run persistent current account deficits since the 1970s.

Because, given the existing global framework, its been forced to absorb excess savings in the rest of the world. So this has been a problem for a long time. During the Cold War, the US was willing to ignore the problem because, by running large current account deficits, it was able to strengthen its relationships with its allies. But with the end of the Cold War, I think it was inevitable that would become an increasing problem.”

Note: Pettis wrote an entire book on this subject, The Great Rebalancing, which I highly recommend.

The world lacks demand. Pettis clearly states: “The problem is people think all we need are good trade deals. No. All we need is someone willing to run large current account deficits.”

Who is willing to run large capital account surpluses? Let’s turn to Mervyn King, who was interviewed on RealVision, worrying about global imbalances.

“If you actually look at the surpluses deficits around the world today, basically there are four countries or currency blocks that matter. Two surplus and two deficit. The two surplus areas are China and the Euro area. The two deficit countries are the United States and the United Kingdom.”

Mervyn King suggests these four countries get together for private meetings to “explain to each other how we are going to rebalance our own economy” with currency adjustments off the table.

It’s not surprising that Michael Pettis had a similar suggestion, “the best way to do it, is for us all to get together and decide what this new world must look like.”

There’s the economists’ solution: get together and come up with a grand bargain. Why? Because all four of these countries have something to fix.

All four have structural supports for imbalances or structural impediments to rebalancing. Basically, policies in the form of over reliance on consumer credit, capital controls and others [2].

But it’s not just individual domestic policies. Every country is operating inside a global trade “system”. A country’s imbalances are impacted by the policies in other countries.

This means global trade is a complex system. And, in order to understand the system, we must avoid treating the pieces as independent from the system.

We, humans, tend to take an “inside view” on situations, because we rely on our own narrow experiences, emotions and intuitions. It’s easy. It’s more difficult to take an “outside view”, where we (1) see our actions from the view of someone else and (2) seek to understand the other side’s situation. And this is exactly what we need.

It is probably impossible to expect a nation of many voices and views to cultivate an outside view of another nation. Thankfully, there are pockets of people who do such a thing, I include those mentioned above in that category.

This brings us to another problem: if (fingers-crossed) our policy-makers can adopt an outside view and somehow get to a new grand bargain that puts the world on a better path, will our individual nations’ people accept it?

Said another way. Can we look beyond our differences, refrain from placing blame, and, perhaps hardest of all, trust one another?

Thanks for reading. Please feel free to forward to anyone you think may find this interesting. As always, I’m happy to discuss any questions, comments.

Yours truly,
James Hull

Edits: Added inside / outside view comments.

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hullx.com

[1] Catherine Mann had an interesting take on US foreign policy towards China: “There is this disconnect between the objectives: to enhance IP protections, allow for broader joint ownership, allow for protection from technology transfer. That would more deeply engage the US with China. The Tariffs are to divorce our relationship with China, to break up those supply chains and make them go to some other country. There’s a real disconnect between these two different objectives in the current policy set.”)

[2] I reject the cultural reasons for trade surpluses/deficits, such as “thriftiness” or “laziness”. I find the analysis shallow and, if not completely wrong, woefully incomplete.

[3] For more on inside / outside view, see Thinking, Fast and Slow