S&P 500 and the trade war

We are now headed for a full-blown trade war. Donald Trump may have highlighted the issue but this is not a conflict between him and Xi — it should have been addressed years ago — nor even between China and the West. Accusations of racism are misguided. This is a conflict between totalitarianism and the rule of law. Between the CCP (with Putin, Erdogan, and the Ayatollahs in their corner) and Western democracy.

Australia will be forced to take sides. China may be Australia’s largest trading partner but the US & UK are it’s ideological partners. I cannot see the remotest possibility of Australia selling out its principles for profits, no matter how tempting the short-term rewards (or threatened hardships). We have a proud history of standing up against oppression and exploitation.

Disruptions to supply chains and supply contracts in the US (and China) are going to be significant and are likely to impact on earnings. The S&P 500 reaction is so far muted, with retracement testing medium-term support at 2800. There is also no indication of selling pressure on the Trend Index. Nevertheless, a breach of 2800 is likely and would warn of a test of primary support at 2400.

S&P 500

Falling Treasury yields highlight the outflow from equities and into bonds. Stock buybacks are becoming the primary inflow into stocks.

10-Year Treasury Yields

However, corporate bond spreads — lowest investment grade (Baa) yields minus the equivalent Treasury yield — are still well below the 3.0% level associated with elevated risk.

S&P 500

Profits may fall due to supply disruption (similar to 2015 on the chart below) but the Fed is unlikely to cut interest rates unless employment follows (as in 2007). Inflation is likely to rise as supply chains are disrupted but chances of a rate rise are negligible. Fed Chairman Jay Powell’s eyes are going to be firmly fixed on Total Non-farm Payrolls. If annual growth falls below 1.0% (RHS), expect a rate cut.

S&P 500

This excerpt from a newsletter I wrote in April 2018 (Playing hardball with China) is illuminating: “In 2010, Paul Krugman wrote:

Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years, as its surplus ballooned, and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. (The Peterson Institute for International Economics estimates that the renminbi is undervalued by between 20 and 40 percent.) And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”

But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.

Krugman (no surprise) now seems more opposed to trade tariffs but observes:

….I think it’s worth noting that even if we are headed for a full-scale trade war, conventional estimates of the costs of such a war don’t come anywhere near to 10 percent of GDP, or even 6 percent. In fact, it’s one of the dirty little secrets of international economics that standard estimates of the cost of protectionism, while not trivial, aren’t usually earthshaking either.”

Trump has to show that he is prepared to endure the hardships of a trade war and not kowtow to Beijing. But the chances of a reasonable response are unlikely.

Men naturally despise those who court them, but respect those who do not give way to them.

~ Thucydides (circa 400 BC)

Paul Krugman: Hawks Crying Wolf | NYTimes.com

According to a recent report in The Times, there is dissent at the Fed: “An increasingly vocal minority of Federal Reserve officials want the central bank to retreat more quickly” from its easy-money policies, which they warn run the risk of causing inflation…

…The Times article singles out for special mention Charles Plosser of the Philadelphia Fed, who is, indeed, warning about inflation risks. But you should know that he warned about the danger of rising inflation in 2008. He warned about it in 2009. He did the same in 2010, 2011, 2012 and 2013. He was wrong each time, but, undaunted, he’s now doing it again…

Read more at Hawks Crying Wolf – NYTimes.com.

Paul Krugman: Why We Fight Wars | NYTimes.com

…Once upon a time wars were fought for fun and profit; when Rome overran Asia Minor or Spain conquered Peru, it was all about the gold and silver. And that kind of thing still happens. In influential research sponsored by the World Bank, the Oxford economist Paul Collier has shown that the best predictor of civil war, which is all too common in poor countries, is the availability of lootable resources like diamonds. Whatever other reasons rebels cite for their actions seem to be mainly after-the-fact rationalizations. War in the preindustrial world was and still is more like a contest among crime families over who gets to control the rackets than a fight over principles.

If you’re a modern, wealthy nation, however, war — even easy, victorious war — doesn’t pay….We might add that modern war is very, very expensive….So the thesis of “The Great Illusion” was right: Modern nations can’t enrich themselves by waging war. Yet wars keep happening. Why?

One answer is that leaders may not understand the arithmetic…..The larger problem, however, is that governments all too often gain politically from war, even if the war in question makes no sense in terms of national interests.

Read more at Why We Fight Wars – NYTimes.com.

Poles Apart – NYTimes.com

I enjoyed this comment on the NYtimes website by A Man from Poland in response to Paul Krugman’s criticism of Mitt Romney lavishing praise on the Polish economy. Especially because Krugman concludes: “Doesn’t anyone tell Romney to do his homework?”

Mr Krugman,

I see that you don’t know too much about situation in Poland.

Of course I agree that currency depreciation was one of main reasons of Poland’s relative resilience in the crisis.

But there were second very important reason – income tax cuts in 2008.

In 2008, the first time from 10 years we had income tax cut in Poland.

Till 2007 we had 19%, 30% and 40% progressive income tax rates. In 2008 19% tax rate was decreased to 18%, 30% was decreased to 18% and 40% tax rate (for the richest taxpayers) was reduced to 32%. So, we changed 19%-30%-40% progressive system into less progressive, lower income tax system 18%-32%.

In 2008 there was also social security tax reduction which additionally decreased labour cost in Poland.

So, thanks to income tax cuts and social security tax cuts we have maintained (roughly) employment rate and consumption level in Poland and it was second important reason of quite good situation in Poland.

via Poles Apart – NYTimes.com.

Ron Paul v. Paul Krugman: Austrian v. Keynesian

Aired on Bloomberg TV 4-30-2012 Ron Paul vs Paul Krugman Debate

Paul Krugman is simply wrong about needing the government to set interest rates. The market would do a better job of managing demand and supply. Where government is needed is to regulate the banks and prevent excessive debt growth by the banks.

Conversations with Great Minds – Paul Krugman – End This Depression Now

Thom Hartmann is joined by Nobel Prize winning economist Dr. Paul Krugman, professor of economics and current affairs at Princeton University and columnist on the New York Times. His new book is titled: End This Depression Now. Europe is in crisis mode. The United States could be headed off a fiscal cliff at the end of the year.

Part 2:

Comment:~ Paul Krugman believes in big government and big unions and dismisses the alternative as “voodoo economics”. The issues are more complicated than this. John Maynard Keynes was right in some areas — austerity does not restore confidence in a shrinking economy — but over-simplistic in others. If governments do run deficits — I believe this is a necessary evil during a financial crisis — increasing government spending on welfare payments and non-productive assets simply carries the country to the next crisis — ballooning public debt. The only way to avoid this is to channel fiscal deficits into productive investment which will enhance GDP growth and help to repay the debt incurred.