Category: China & HK

Posted on

4 Key Takeaways for the Week

Key Points

  • Long-term Treasury yields climbed after the Fed kept rates unchanged.
  • The Japanese Yen is weakening as the Bank of Japan slow walks rate hikes.
  • Gold absorbs selling pressure as long-term rates rise.
  • China’s economy is slowing.

Treasury Market

The bond market has been anticipating a rate hike. This has been signaled since the 2-year Treasury yield broke above the Fed funds target range in March 2026.

2-Year Treasury Yield & Fed Funds Target (Upper Limit)

The FOMC voted to keep the Fed funds rate unchanged, with a target range of 3.5% to 3.75%. There were 3 dissenting votes, calling for a rate hike. The new Fed Chair, Kevin Warsh, is encouraging opposing views, and we can expect more dissent in the future. Warsh has also avoided forward guidance, which is likely to increase volatility in the bond market and consequently the term premium.

10-year Treasury yields climbed to 4.745% on Friday, reflecting market concern that the FOMC is not taking a more hawkish stance on inflation.

10-Year Treasury Yield

GDP grew at 6.5% over the 12 months to June, suggesting that the 10-year yield needs to rise by at least 175 basis points if the Fed is serious about containing inflation. Long-term interest rates below nominal GDP growth (the rate of return on new capital investment) encourage rapid credit growth, with demand expanding faster than output.

10-Year Treasury Yield & Nominal GDP Growth

Japan & the Sovereign Bond Market

Japan’s GDP grew by 3.6% over the 12 months to March 2026. The 10-year JGB yield is 2.8%, indicating that monetary policy remains stimulative, but less so than the US.

10-Year Treasury Yield & Nominal GDP Growth

The Bank of Japan kept its policy rate at 1.0% at last week’s meeting despite an upturn in CPI to 1.7%. The weakening Yen drives higher inflation.

Japanese CPI Inflation

The low BOJ policy rate and ongoing bond purchases aimed at suppressing long-term JGB yields undermine the currency. The Yen has steadily weakened, breaking above 160 against the Dollar in June 2026 to reach its highest level in 39 years. Japan’s Ministry of Finance intervened on Thursday to support the Yen, driving the exchange rate to 157 against the Dollar. However, the effect of these MoF interventions is short-lived because of BoJ policy.

Japanese Yen

Rising long-term yields in sovereign bond markets reflect growing concern over sovereign debt levels and the risk of fiscal dominance. When central bank policy is dominated by government bond markets’ need for support, with lower interest rates prioritized above containing inflation, the currency’s purchasing power is eroded, as in Japan.

The US 30-year Treasury yield has climbed to 5.275%, reflecting concerns over currency debasement.

30-Year Treasury Yield

The Japanese JGB yield is lower at 3.98%, but this reflects sizable ongoing QE by the Bank of Japan aimed at suppressing long-term rates.

30-Year JGB Yield

The Bank of Japan has higher debt levels relative to GDP than the UK and should theoretically trade at a higher yield. The difference in the 30-year Gilt yield lies in central bank monetary policy: the Bank of England is steadily shrinking its balance sheet, while the BoJ is actively buying JGBs in the secondary market to suppress yields.

30-Year UK Gilts Yield

Dollar & Gold

Rising short-term yields are strengthening the Dollar, with the 1-Year Treasury yield gaining more than 50 basis points in the last 6 months.

1-Year Treasury Yield (CNBC)

Gold has softened considerably from its peak of $5,500 per ounce and has been testing primary support at $4,000 over the past 8 weeks.

Spot Gold

Gold ETF inflows slowed in the first half of 2026 but remained positive, driven by continued inflows into Asian funds. North America experienced an outflow of $7.7 billion, European inflows slowed to $3.2 billion, while Asia recorded a strong inflow of $12 billion.

Gold ETF Flows

Average daily trading volumes surged to a record $488 billion in the first half of 2026.

Gold Average Daily Trading Volumes

OTC trading, led by the LBMA, averaged US$249bn/day, substantially above 2025 levels and underscoring the depth of institutional participation. Exchange-traded volumes also jumped, reaching US$227bn/day – 22% higher than the 2025 average – supported by elevated investor activity. Meanwhile, global Gold ETF trading averaged US$12bn/day – up 73% from 2025 – fueled primarily by robust trading in US funds as investors increasingly turned to Gold amid heightened macroeconomic and geopolitical uncertainty.

Comex futures net longs increased to 538 tonnes, up 16% since May, and the highest month-end level since January despite a weakening gold price. A closer look shows retail participation (non-reportable net longs declined in June, while other reportables, which capture large trades outside the managed money category, were up 16% from May. Managed money net longs remained broadly stable, declining by just 43 tonnes year-to-date. Again, H1 investor behavior differed: retail positioning largely tracked short-term price movements while larger traders’ positions have, in general, stayed stable since mid-March. (WGC)

Comex contracts standing for delivery jumped to 13,123 in July from 8,838 in May, and a 9.0% increase over July last year.

Spot Gold

China

The Chinese NBS Manufacturing PMI fell to 49.2 in July, down sharply from 50.3 in June. Values below 50 indicate a contraction in the manufacturing sector.

China: NBS Manufacturing PMI

The OECD Composite Leading Indicator for China fell to 98.6 in June, below its long-term average of 100, signaling a contraction.

OECD: China Composite Leading Indicator

The RBA’s activity indicators for China show industrial production is holding up, boosted by record exports. However, real retail sales growth has stalled, while fixed asset investment has contracted sharply following Trump’s tariff blitz last year.

OECD: China Activity Indicators

Household credit growth (purple below) has also stalled. Business credit has taken up the slack, but government credit growth is also contracting.

OECD: China Total Social Financing

Conclusion

10-year US Treasury yields jumped to 4.745% after the Fed kept its funds target range at 3.5%-3.75%, reflecting bond market concerns over inflation.

The new Fed Chair’s strategy is to keep short-term rates low and allow long-term rates to rise, to slow the rate of demand growth in the economy and curb inflation. However, nominal GDP is growing at an annual rate of 6.5%, which means that 10-year Treasury yields would need to rise by 175 basis points to keep inflation in check. An increase to 6.5% would likely cause a sharp contraction in stocks.

Japan’s Ministry of Finance has intervened to support the Yen. However, the effects will likely be short-lived, as the Bank of Japan continues to maintain stimulative monetary policy, which fuels inflation and undermines the currency.

Rising long-term sovereign debt yields reflect bond market concerns over rising sovereign debt and the risk of fiscal dominance, as in Japan, where the central bank has prioritized maintaining an orderly bond market above price stability. Erosion of the currency purchasing power is the inevitable outcome.

Gold has found strong support at $4,000 per ounce, with long-term investors prepared to wait out the turmoil in the Middle East. Demand from Asian investors has been particularly strong, but could be undermined if China goes into recession.

China’s economy shows increasing signs of contraction, precipitated by a decline in business investment following President Trump’s 2025 tariff attack. Household credit and real retail sales have stalled, and the NBS Manufacturing PMI fell to 49.2, signaling a contraction. Higher fuel prices would be an added headwind that could tip the economy into recession.

Acknowledgments

Posted on

Global Oil Shortage – This Time It’s Different

Key Points

  • We are on the 10th day of a hot war in the Persian Gulf.
  • The Memorandum of Understanding is a distant memory.
  • Tanker traffic in the Strait of Hormuz has died.
  • Brent Crude futures rebounded to above $90.00 per barrel.
  • What is different is that China is not cutting oil imports like last time.

Tehran and Washington are doubling down on their standoff over the Strait of Hormuz, as a Red Sea blockade risks shutting another key shipping route amid an expanding war. Days of U.S. strikes have not loosened Tehran’s chokehold over the Strait of Hormuz, a vital corridor for the world’s oil supply, while tit-for-tat strikes have taken the place of a collapsed ceasefire. A tanker came under attack in the strait early Tuesday, near Oman, forcing the crew to abandon the ship on a lifeboat, the British navy’s maritime trade operations center said. Iran said fires broke out on two tankers that passed through an unauthorized route. (Washington Post)

Brent Crude futures have rebounded to above $90 per barrel.

Brent Crude Futures (ICE September'26)

Crude oil tanker traffic through the Strait of Hormuz has come to a halt.

Strait of Hormuz Tanker Traffic

Strategic Petroleum Reserves have fallen by 100 million barrels since the start of the war.

EIA Strategic Petroleum reserve (SPR)

The drawdown of reserves helped to keep a lid on oil prices, but the biggest contributor to low prices was the sharp fall in Chinese oil imports from 12 million barrels/day in March to 5 million barrels/day in early July. This enabled a recovery of imports by the rest of Asia.

Asian Crude Oil Imports

What is different this time is a sharp rebound in Chinese imports. If China resumes imports of 10 to 12 million barrels/day, then global demand has to shrink by 5 to 7 million barrels/day, which would likely trigger a global recession.

China Crude Oil Imports

Gasoline prices in the US are back above $4.00 per gallon.

EIA US Gasoline Prices

Refiners’ margins have widened, likely a result of falling inventories of finished product. The 3-2-1 crack spread increased to $68.17 per barrel, above its 2022 peak at $60 per barrel.

Energy Channel: 3-2-1 Crack Spread

10-year Treasury yields climbed to 4.63%, with rising inflation expectations driving yields higher.

10-Year Treasury Yield

The University of Michigan survey of 1-year inflation expectations averaged 4.2% in July, with the 3-month moving average at 4.5%.

University of Michigan: 1-Year Inflation Expectations

2-year Treasury yields anticipate rate hikes ahead, testing resistance at 4.25%, 50 basis points above the Fed funds target range of 3.5% to 3.75%.

2-Year Treasury Yield (CNBC)

Bitcoin1, the canary in the coal mine, continues to test primary support at 60,000. A breach of support would warn of a sharp contraction in financial market liquidity.

Bitcoin (BTC)

However, the S&P 500 is consolidating in a bullish narrow triangle below 7600. Declining Trend Index peaks above zero indicate secondary selling pressure, and a breakout above 7600 would offer a target of 8000.

S&P 500

Gold is consolidating in a narrow rectangle above primary support at $4,000 per ounce. A breakout above $4,200 would signal respect of support, with an initial rally to $4,500.

Spot Gold

Conclusion

Ongoing conflict and restricted tanker traffic through the Strait of Hormuz will likely drive Brent Crude above $100/barrel. A resumption of Chinese crude imports at above 10 million barrels/day would drive Brent towards $150/barrel.

Interest rates are rising in anticipation of higher inflation, but the S&P 500 is testing resistance at 7600, and Gold is consolidating above $4,000 per ounce. A sharp rise in oil prices and inflation would be bearish for both in the short-term, but a divergence between interest rates and inflation would be a strong bull signal. Suppression of long-term Treasury yields, through Fed QE or other means, would drive real interest rates below zero, fueling a massive speculative boom in real assets.

Acknowledgments

Posted on

Brent Flat, Bitcoin & Gold Sink Again

Key Points

  • Brent Crude tests support at $70 per barrel.
  • Gold tests support at $4,000 per ounce.
  • The Dow closes at a new high.
  • Bitcoin breaches support at 60,000, signaling risk-off across financial markets.

Brent Crude prices remain flat at close to $70 per barrel despite on-again/off-again peace talks.

Brent Crude

We are entering the summer driving season in the US, when demand for gasoline peaks. Gasoline prices will likely remain high as refiners enjoy wide profit margins, with the 3-2-1 crack spread2 above $60 per barrel for the first time since Russia’s invasion of Ukraine in 2022.

Energy Channel: 3-2-1 Crack Spread

Bitcoin1 broke primary support at 60,000. Expect retracement to test the new resistance level, but respect will likely confirm another decline. Falling Bitcoin prices signal a market-wide shift to risk-off.

Bitcoin (BTC)

However, the Dow Jones Industrial Average closed at a new high. The replacement of Verizon (VZ) in the Average with Alphabet (GOOGL) on June 29 may have something to do with this.

Dow Jones Industrial Average

The S&P 500 also rallied, testing resistance at 7500. A follow-through above the recent high would offer a target of 8000.

S&P 500

Dollar & Gold

The Dollar retreated slightly, but all eyes are on the Japanese Yen, which weakened to its lowest point against the Dollar in more than 40 years. Expected intervention by Japan’s Ministry of Finance would temporarily strengthen the Yen but would be self-defeating, as it would increase selling pressure in Japan’s bond market. Rising bond yields force the Bank of Japan to intervene by buying bonds. That weakens the Yen and negates the MOF’s earlier move.

Japanese Yen

This is a difficult trap to escape from. If the BOJ raised its policy rate from the current low of 1.0%, it would strengthen the Yen but increase upward pressure on bond yields, forcing the Bank to buy more bonds, thereby weakening the Yen.

Gold is testing primary support at $4,000 per ounce again, with declining Trend Index peaks warning of secondary selling pressure.

Spot Gold

Plunging open interest on Comex Gold futures indicates that speculators are losing interest in the precious metal.

Gold Futures Open Interest

However, one major player is buying the dip. Bloomberg reports:

Imports were around 163 tons last month, the highest since March 2024, according to customs data released on Saturday. Volumes for the first five months of 2026 were about 692 tons, up by about 76% from a year earlier.

China: Nonmonetary Gold Imports

Conclusion

We expect Brent Crude to remain around $70 per barrel, provided there is no interruption to shipping in the Strait of Hormuz. This eases inflation expectations, but existing pressures persist and prevent the Fed from cutting rates.

Stocks remain bullish, but Bitcoin warns of rising risk aversion.

Gold will likely remain under pressure while negotiations with Iran continue, but China has increased its imports of nonmonetary Gold, buying the dip. We expect the uptrend in Gold to continue for decades, interspersed with regular sell-offs like the present, curbing speculators’ enthusiasm and enabling long-term players to build their positions.

Acknowledgments

Notes

    1. Cryptocurrencies are the highest-risk asset class, and we analyze Bitcoin (BTC) solely to identify risk sentiment in financial markets. Our analysis is not a recommendation to buy or sell BTC, nor is it a commentary on the merits of cryptocurrency.
    2. The 3-2-1 crack spread is calculated on the theoretical refining margin if a barrel of oil is split 2:1 between gasoline and diesel. A spread of $60 indicates that refiners’ margins would have tripled from $20 in January 2026.
Posted on

China’s NBS Manufacturing PMI for November

China’s NBS Manufacturing PMI increased to 49.2 for the month of November, up from 49.0 in October. The index indicates that the manufacturing sector has been contracting for the past 8 months, but only values below 49.0 are considered a risk-off signal.

China: NBS Manufacturing PMI

Conclusion

The NBS Manufacturing PMI for China continues to signal risk-on, and the Australian bull-bear indicator is unchanged.

Acknowledgements

Posted on

Trump-Xi more of the same

United States President Donald Trump and his Chinese counterpart Xi Jinping have agreed to a trade truce under which the US will ease tariffs and Beijing will restart imports of US soya beans, delay the introduction of export restrictions on some of its rare earth metals, and intensify efforts to curb illegal fentanyl trafficking. (Al Jazeera)

Trump threatened a 100% import tax in retaliation for China’s rare earth restrictions, but he told reporters after the meeting that total tariffs on China would be reduced to 47%.

There is mutual recognition that neither country wants to risk damaging the world economy, as this would harm itself.

When the two were seated at the start of the meeting, Xi read prepared remarks that stressed a willingness to work together despite differences. (APNews)

The meeting was shorter than expected, which indicates that neither side deviated from an agreed-upon script. Trump described the meeting, which lasted an hour and forty minutes, as “amazing” and “12 out of 10,” but analysts remain skeptical.

“The proposed deal on the table fits the pattern we’ve seen all year: short-term stabilization dressed up as strategic progress,” said Craig Singleton, senior director of the China program at the Foundation for Defense of Democracies. “Both sides are managing volatility, calibrating just enough cooperation to avert crisis while the deeper rivalry endures.” (APNews)

The US will likely also reduce restrictions on exports of advanced computer chips to China. According to the president, the issue was discussed, and Nvidia will hold talks with Chinese officials.

Posted on

The Mistaken Myth of an Invincible China | Robin J Brooks

An alternative view on why China is increasing export controls on critical materials:

China this week put new export controls on rare earths and other critical minerals needed for US defense and technology production. This step drastically escalates the tariff stand-off with the US and fits neatly into the widespread narrative that China has the upper hand over the US. That narrative is nonsense….

You can read more at Robin Brooks.

Conclusion

I’m unsure how China stepping up export controls and provoking President Trump will bring tariffs down. Whether China’s actions are a sign that it has the upper hand in negotiations or not, this will likely escalate the trade war, increasing volatility in global financial markets.

Posted on

Rising recession risk threatens bond market

Summary

  • Trade talks with China have stalled
  • President Trump announces steel and aluminum tariffs will increase from 25% to 50%
  • Input costs for US manufacturers are expected to soar
  • Spending is expected to slow after the introduction of tariffs in April
  • The economic outlook is clouded with uncertainty, and the risk of a recession is rising

President Trump accused China of “totally violating its agreement” with the United States last week. (Reuters)

The Geneva agreement concluded between Treasury Secretary Bessent and his Chinese counterpart called for a 90-day pause in increased tariffs and for China to lift restrictions on exports of critical materials such as rare earths needed for semiconductor, electronics, and defense applications.

According to a US trade representative, the Chinese are moving slowly on granting export licenses for critical materials. The automobile industry is already warning that shortages of rare earth magnets could halt production in a matter of weeks.

The Chinese slow-walking of export licenses appears to be retaliation for the US last week imposing license requirements, and revoking some licenses, for exports of design software and chemicals for semiconductors, butane and ethane, machine tools, and aviation equipment.

In another blow to the auto industry, President Trump announced that he will increase tariffs on steel and aluminum imports from 25% to 50%. Steelmakers are expected to benefit from higher domestic prices, boosting output, but automobile manufacturing, heavy engineering, and construction industries will likely bear the costs.

Steel exports from Canada and Mexico will be most affected, but South Korea, Germany, and Brazil are also expected to suffer. The EU has threatened retaliatory measures if the issue cannot be resolved.

Aluminum imports are likely to continue despite the increased tariffs. Bauxite and electricity are the two primary input costs of smelters, and domestic US smelters will struggle to match the low-cost hydroelectric power of global competitors.

Financial Markets

The S&P 500 is testing the band of resistance at 6000, but short weekly candles indicate hesitancy.

S&P 500

Strong liquidity supports financial markets, with the Chicago Fed National Financial Conditions Index falling to -0.606, signaling easy monetary conditions.

Chicago Fed National Financial Conditions Index

10-year Treasury yields are testing support between 4.4% and 4.5%, but the weak dollar warns of capital outflows that are expected to send long-term yields higher.

10-Year Treasury Yield

JPMorgan CEO Jamie Dimon says, “You are going to see a crack in the bond market. It is going to happen…. I’m telling you it’s going to happen….”

Economy

Former Fed economist Dr Lacy Hunt warns that the US economy is slowing, with a higher than 50% probability of recession. He warns that the economy is far weaker than generally understood, and what markets are not considering is that spending brought forward to front-run tariffs is likely to cause a sharp drop in spending in the next few months.

A recession would also cause the fiscal deficit to increase sharply, by at least another 2.0% of GDP, adding further stress on the bond market.

The ISM manufacturing PMI declined to 48.5% in May, indicating a long-term contraction.

ISM Manufacturing PMI

Manufacturing inventories surged in March as manufacturers brought forward purchases to get ahead of April’s tariff increases.

ISM Manufacturing Inventories

Imports also surged in the first quarter, followed by a steep plunge in May.

ISM Manufacturing Imports

Exports are contracting at a similar rate.

ISM Manufacturing Exports

Prices is the only sub-index that has surged, warning of steeply rising input costs.

ISM Manufacturing Prices

Crude Oil

OPEC+ decided to increase production targets by 411.000 barrels per day in July, which is equal to the increases in May and June.

However, in a sign of shrinking global trade, China’s seaborne imports declined by more than a million barrels per day in May. Kpler estimates imports at 9.43 mbpd compared to 10.46 mbpd in April and 10.45 mbpd in March. (Reuters)

Brent crude is likely to re-test support at $60 per barrel, and breach would offer a target of $50.

Brent Crude

Dollar & Gold

Capital outflows are weakening the dollar. The US Dollar Index has broken support at 100, and follow-through below 98 would confirm another decline with a target of 90.

Dollar Index

Gold rallied to test the band of resistance at $3,400 per ounce. A breakout above $3,500 would strengthen our target of $4,000 by the end of 2025.

Spot Gold

Conclusion

Due to high levels of uncertainty, consumers and corporations are expected to defer capital expenditures in the months ahead. The drop in spending is likely to be accelerated by the build-up in inventories and the bringing forward of expenditures to get ahead of tariff increases in April.

Contracting imports and exports in the manufacturing sector warn that the economy will slow. Falling crude oil imports in China paint a similar outlook, suggesting a global recession.

A recession would increase the deficit and further stress the bond market, which is already concerned about spiraling debt levels.

A falling dollar and rising gold price warn of capital outflows from US financial markets. JPMorgan CEO Jamie Dimon tells us to prepare for a coming crack in the bond market. That would mean higher long-term yields and sharply lower stock prices, likely boosting demand for gold even higher.

Acknowledgments

Posted on

Gold bear trap

Gold briefly broke support at $3,000 per ounce, threatening a correction to test the support band between $2,800 and $2,850. However, strong buying drove the precious metal above the support level, displaying a long tail on today’s candlestick. A breakout above $3,050 would complete a bear trap reversal, signaling a rally to $3,150.

Spot Gold

According to the IMF, gold increased to 21% of official currency reserves. However, gold reserves are far below the 60% to 70% required for a viable gold-backed financial system, as in the 1960s.

Official Gold Reserves

China’s and Saudi Arabia’s gold reserves are climbing steeply, while Western central bank holdings remain below 22,000 tonnes.

Increase in Rest-of-World (China) Gold Reserves

China’s actual reserves are likely higher than the official IMF figures. Jan Nieuwenhuijs at The Gold Observer estimates that China purchased 570 tonnes of gold through unofficial channels last year, with their total holdings close to 5,000 tonnes compared to the 2,280 tonnes in official figures.

Conclusion

We are long-term bullish on gold while the dollar-based global financial system weakens due to excessive government debt and steep fiscal deficits.

The false break below $3,000 warns of a bear trap. Recovery above $3,050 per ounce would confirm a short-term target of $3,150.

Acknowledgments

Posted on

Gold rises to a new high while Dow and ASX 200 retreat

The rising uncertainty in financial markets undermined stocks despite solid consumer spending. However, gold rose to a new high, while Germany’s DAX and Hong Kong’s Hang Seng Index also enjoyed strong advances.

The two-day rally on the S&P 500 faded, with a lower close warning of another test of support at 5500. A breach of support would confirm the bear market.

S&P 500

The Dow Industrial Average is in a similar position, hesitating below resistance at 42,000. A reversal below the recent low would again confirm the bear market.

Dow Jones Industrial Average

The Fed is expected to keep interest rates unchanged at this week’s FOMC meeting. The spread between the 2-year (purple) and fed funds rate (gray) shows the market pricing in an average 40 basis points of rate cuts over the next two years.

2-Year Treasury Yield minus Fed Funds Rate below zero warns of Fed rate cuts

Treasury yields remain low, with the 10-year continuing to test support at 4.1%.

10-Year Treasury Yield

However, credit markets are tightening due to rising uncertainty, with high-yield spreads leaping by 160 basis points since the end of January.

Junk Bond Spreads

Consumers

Consumer spending remained reasonably strong in February. New housing starts (purple) recovered due to lower mortgage rates, while February new housing permits (green) held at similar levels.

Housing New Starts & Permits

Thirty-year mortgage rates have eased to 6.65%, in line with softer 10-year Treasury yields.

30-Year Mortgage Rate

Light vehicle sales similarly recovered to nearly 16 million annual units in February.

Light Vehicle Sales

Dollar & Gold

The Dollar Index continues to test support at 103. Breach would offer a target of 100.

Dollar Index

Gold is among the few beneficiaries of the weak dollar and rising uncertainty, advancing to a new high of $3,033 per ounce.

Spot Gold

Australia

The Australian ASX 200 index found short-term support at 7700, but the rally soon faded. A breach of 7700 would confirm the bear market.

ASX 200 Index

The Financials Index displays a dead cat bounce at 8000. Breach of support would further strengthen the bear signal.

ASX 200 Financials Index

Germany

Germany’s DAX is another beneficiary of the uncertainty, threatening a breakout above 23,500 after Germany’s parliament voted in favor of a 500 billion euro fund for infrastructure and easing strict borrowing rules to allow for increased defense spending.

DAX Index

Hong Kong

Hong Kong’s Hang Seng Index also displays a strong advance.

Hang Seng Index

Conclusion

Consumer spending remains robust, but financial markets face rising uncertainty. Widening credit spreads warn of a likely contraction in new investment.

The Dow and S&P 500 rally is fading, and reversal below recent support levels would confirm a bear market.

Australia’s ASX 200 index displays a similar pattern and breach of support at 8000 on the ASX 200 Financials Index would confirm the bear market.

Gold rose to a new high of $3,033 per ounce, while the current turmoil also boosted Germany’s DAX and Hong Kong’s Hang Seng Index.

Acknowledgments

Posted on

How tariffs could break America

“To me, the most beautiful word in the dictionary is tariff….it’s my favorite word.” ~ Donald Trump, October 2024

Americans’ experience with tariffs is mixed. The Smoot-Hawley tariffs of the 1930s prompted retaliatory tariffs and trade barriers from trading partners, causing a collapse in international trade that badly hurt US manufacturers. The tariffs were misguided because, at the time, the US ran large trade surpluses, which made it vulnerable to retaliation.

Now the US runs large trade deficits, of between $60 and $100 billion per month, which makes it far more difficult for trading partners to retaliate effectively.

US Monthly Trade Deficit (billions)

Stephen Miran, Trump’s nominee for chairman of the Council of Economic Advisers, wrote a 40-page “job application” in October. In it, he praises Trump’s past performance with tariffs in 2018 and proposes restructuring the global trade system. However, misguided use of tariffs could damage the US.

Miran proposes implementing import tariffs, mainly targeting those trade partners that run large trade surpluses with the US, notably China. China’s global trade surplus has expanded to more than $100 billion per month, and a large percentage of this trade is with the US.

China: Monthly Trade Surplus

Import Tariffs

A tariff on imports will likely provoke two main responses: retaliatory trade barriers and a stronger Dollar.

Retaliation

We can expect trading partners to erect trade barriers to target politically sensitive industries in the US. In the 1930s, Europe responded with import restrictions on US automobiles, hurting the Ford Motor Company. Nowadays, China will likely restrict exports of critical materials in markets it dominates—like germanium, gallium, and rare earth elements—targeting semiconductors, electric batteries, and defense technologies. Another Chinese favorite is tariffs on agricultural imports like soybeans, targeting mid-west farmers. Electric vehicle imports are another obvious target, particularly Tesla because of Elon Musk’s proximity to the president.

Tesla (TSLA) has fallen 39% from its high in December.

Tesla (TSLA)

The Dollar

The Dollar will likely strengthen if trading partners do not retaliate against increased tariffs. A stronger Dollar will tend to offset the cost of the tariff to consumers, as in 2018-2019, when the Yuan weakened markedly against the Dollar.

Yuan per US Dollar

The result was that the US current account showed little benefit from the 2018-2019 tariffs.

US Current Account Deficit

To the extent that the exchange rate adjusts to absorb the effect of the tariff–so that the Dollar price of the imported goods does not change–the tariff is effectively a tax on the foreign exporter. However, the cost incidence is not that straightforward.

Cost Incidence

A central argument for tariffs is that the exporter, not the US consumer, bears the cost. However, it’s not that simple.

Miran cites a 2019 NBER paper by Cavallo, Gopinath, Neiman and Tang which found that the dollar import price increased by the amount of 2018-2019 tariffs, and that appreciation of the Dollar did little to offset this. “The move in the currency didn’t pass through into import prices.”

Pass Through of Tariffs to Import Prices

While Miran is correct that there may be longer-term adjustments, the study makes an important distinction. US producers responding to retaliatory tariffs on their exports were forced to bear a large percentage of the cost. Export prices for affected goods (red below) fell sharply relative to exports without tariffs (blue).

Affect of Retaliatory Tariffs on Export Prices

The difference is that US agricultural exports were a non-differentiated product with ready substitutes. China imposed a tariff on US soybean imports, comfortable in the knowledge that importers would increase orders from alternative suppliers like Brazil. So US farmers were forced to cut prices to compete.

The tariff cost for differentiated products, with no ready substitutes, such as high-level semiconductors and equipment, is far more likely to be borne by the customer.

Weakening the Dollar

Miran recognizes that the strong Dollar will harm exports and speculates that strategies could be employed to weaken the Dollar. However, that would increase the cost incidence on the consumer.

Efforts to weaken the Dollar would likely undermine its role as the global reserve currency and accelerate the migration of foreign central bank reserves to gold bullion as a reserve asset.

There are three likely negative consequences. First, a falling dollar would reduce foreign support for US Treasury markets, driving up long-term interest rates that would hurt financial markets and the economy.

Second, discouraging direct foreign investment in US financial markets—by tearing up tax treaties, for example —would cause an outflow from mega-cap technology stocks, Treasuries, and other key foreign investment targets. The result could crash financial markets and the economy.

Third, printing Dollars to buy assets in a sovereign wealth fund or other strategies that involve increased fiscal spending are likely to fuel an increase in inflation.

Weakening the Dollar may also involve lowering US interest rates vis-a-vis trading partners. However, this assumes that foreign central banks will not respond in kind and that the Fed will cooperate, ignoring the inflation risk.

Re-industrialization

The aim of tariffs is to create a favorable environment for establishing new industry. However, there are many barriers other than the price of competitive imports.

First, you need a skilled workforce with the education and training required to run new factories. Companies establishing semiconductor foundries in the US, for example, under President Joe Biden’s CHIPS and Science Act, have encountered skills shortages. (The Economist)

Then you need infrastructure. ALCOA, the largest aluminum producer in the US, relocated smelters to Canada because of advantageous electricity costs. CEO Bill Oplinger says the increased tariffs would not entice it to return. (Reuters)

You also need to secure the key materials required to support new industries, whether bauxite to supply aluminum smelters, copper for EVs and turbines, or critical materials–like gallium, germanium, and rare earth elements– for high-tech industry. China has spent the last two decades tying up supply contracts, and the US is a late arrival to the party.

Conclusion

Tariffs on imports will likely provoke retaliatory tariffs from trading partners, which could harm international trade and exact a cost on both economies. The US is in a strong position because of its large trade deficit; so it can inflict greater damage on its competitor. However, we should not ignore other forms of retaliation like restricting access to critical materials, where there are no ready substitutes, and erecting other trade barriers that impose a cost on US exporters.

Under no circumstances should tariffs be placed on imports of goods where there is no readily-available substitute. The US consumer will bear the cost.

The Dollar will also likely strengthen in response to US tariffs on imports, which could partially offset the cost of the tariff to consumers. However, a strong Dollar will reduce the competitiveness of US manufacturers in export markets. Miran speculates that the US may be able to offset this by policies to weaken the Dollar. But you can’t have your cake and eat it too.

Efforts to weaken the Dollar could also undermine its role as the global reserve currency, crash financial markets and the economy, or cause a resurgence of inflation. If not all three.

A strategy to re-industrialize the US economy requires a holistic approach. First, ensure that you build up the necessary skills and resources through a comprehensive education and infrastructure program and secure supplies of key materials. Then, progress to the next stage of establishing the groundwork for a new global trade and currency accord. Ignoring the first stage is like putting the cart before the horse.

An impatient president has surrounded himself with a team unlikely to oppose him. Developing a program to re-industrialize the economy will require skill, patience, and meticulous planning. It could take the better part of a decade, but that seems unlikely to happen.

Acknowledgments

Powered by WordPress / WordPress Maintenance Service By Website Helper