The trade war between US and China, the biggest in modern American history,seems to have some aspects not picked up by the media.
As the pressure on China increased, a strange accident occurred last Sunday morning - Saudi Arabia said two of its oil tankers were attacked while sailing toward the Persian Gulfand as many as four ships were damaged. The details are murky, but the reaction laud:Saudi Energy Minister Khalid Al-Falih said the incident aims “to undermine (…) the security of oil supplies to consumers all over the world”. He urged “to mitigate against the adverse consequences (…) on energy markets, and the danger they pose to the global economy.”The US Navy’s 5thfleet which patrols the Persian Gulf from its base in Bahrain declined to comment on the incident.
It should be noted, that the Chinese economic model depends on the security of long maritime supply lines (both into and out of the country) which China is not able to guarantee on their own, they need the US navy to do that.
It could be that president Trump wants US to be paid for this protection, and the incident in the Gulf served as reminder of who’s got the upper hand.
He is a businessman after all.
As a side note, given the level of tension it is amazing that the stock markets are still priced for perfection.
Trade with the US has one aspect many don’t realize – it lubricates the international financial system by doubling the money that is called US “trade deficit”.
In essence, limiting the trade will have a double negative effect on the suppliers.
The trade works like this: let’s say a firm from Japan sells $1M worth of products to a customer in the US. Their invoice gets paid in US$ for which the Japanese have little use – most of their costs are in Yen, they pay taxes and dividends in Yen.
So, they deposit the $1M in a bank and the money eventually lands at the BOJ, the central bank of Japan.
BOJ creates out of thin air the equivalent of $1M in Yen which then goes to the firm’s account. Now, BOJ also has little use for the dollars, but they have options: they can deposit them at the Federal Reserve or buy American government bonds, in both cases earning an interest.
At the end of this transaction the dollars end up back in the US and there is a fresh equivalent in new Yen on deposit in Japan.
The amount of money involved doubled, and consider that US trade deficit in 2018 was $621 billion, where typically the purchase of goods was offset by the sale of government bonds.
The bottom line is, the size of US trade deficit totally depends on the accounting scheme applied.
To be sure, the bonds are never re-paid, just “rolled over” at maturity.
The real issue is this: by trading financial instruments for real goods the domestic manufacturing base is being destroyed. Trump wants to stop that, as this impacts the lives of people who got him elected and he made promises.
If you have the feeling that there is no free lunch in real life, you’re right. While the bonds sold represent just an accounting entry, the interest payments are real – the compounded interests the US pays out is almost the size of Pentagon budget.
A kid with a calculator will realize quickly that this can’t go on forever.
Hence the governments all over the world have a history of defaulting on their sovereign debt. Some are serial defaulters, like Argentina, some have a history of extending maturities at will, suspending coupon payments and the like.
The Italians practically wrote a book on that.
I have little doubt that the US will be the last to default and it will be the least painful process, perhaps converting debt to equity.
The demand for US bonds and equities remains strong – the money needs to be parked somewhere, and US has the deepest and most liquid markets.
It’s a waiting game – and nobody wants to blink first.