US President Donald Trump’s reckoning is dominating headlines. The deadly Capitol Hill riots the US president fomented have left him fighting for his political life eight days before Joe Biden’s arrival.
Yet another casualty of the Trump era might soon be leading the global news cycle: a US bond market whose credibility Trump may be leaving for dead.
Look no further than 10-year Treasury yields rising on Friday after a surprisingly weak US unemployment report. The 140,000 drop in December payrolls was the clearest sign yet that the world’s largest economy is hitting a fresh Covid-19 wall.
What does this mean? No “V-shaped” recovery, no inflation and even less risk of Federal Reserve tapering. So sell orders are flying.
To understand what’s afoot, look no further than financier Ray Dalio’s recent musings on China and, by extension, the financial dumpster fire Trump leaves behind.
In a series of recent blog postings and interviews, the Bridgewater Associates founder is highlighting how China used the last four years of Trumpian chaos to great effect to become the world’s financial center.
He makes some rock-solid points.
“China already has the world’s second-largest capital markets, and I think they will eventually vie for having the world’s financial center,” Dalio, one of the world’s biggest money managers, warned. “Throughout history, the largest trading countries evolved into having the global financial center and the global reserve currency.”
In 2020, the yuan made great strides in becoming just that – and with a sizable assist from Trump’s multi-pronged trade war. Over the last 12 months, its increase not only against the dollar, but on a trade-weighted basis too, is nearing 10%. The recent rise in US Treasury yields is partly the result of waning trust in the dollar.
The surge in US public debt toward the US$30 trillion mark on Trump’s watch is one depressant. So are the Fed’s titanically large easing moves since February 2017, when Trump named Jerome Powell as Fed chairman.
And so too is lost trust in America as the proverbial adult in the room in global economic circles.
Trump’s misguided trade war
That has Yale University economist Stephen Roach worried a dollar collapse could come “much sooner than expected” and unfold “at the speed of light” as alarm grows over the underlying state of the US financial system.
Trump began to abdicate reserve-currency status by scrapping the 23-year-old “strong dollar” imperative. It signaled the US had adopted a mercantilist, developing nation-like exchange-rate policy.
The bigger affront, though, may be a giant trade war that Trump’s government ended up losing, and spectacularly so. Decades before his shock election in November 2016, businessman Trump railed against trade deficits with Asia.
In the 1980s, it was Japan that Trump complained had “systematically sucked the blood out of America” and “gotten away with murder.” Beijing has since replaced Tokyo as Trump’s boogeyman. As president in 2018, he began slapping taxes on nearly $400 billion of goods from China.
Turns out, it was Trump’s chaotic trade war that sucked the blood out of the stable economy predecessor Barack Obama bequeathed him.
No student of Economics 101, Trump ignored warnings from analysts across the political and ideological spectrum that deficits with Beijing weren’t the problem. The gap is, and always has been, a symptom of the structural commercial relationship between the two biggest economies.
One byproduct of misdiagnosing the problem was that Trump literally made the trade deficit with China great again. In the 11 months to November 2020, the gap widened to $287 billion – $33 billion bigger since 2016.
Even when the US-China deficit did show signs of narrowing, it reflected multinational companies moving jobs not back to America, but rather to Vietnam.
Trump loses, Xi wins
Trump was rolled in “phase one” trade deal negotiations by Chinese President Xi Jinping.
Twelve months ago, Xi’s government did indeed agree to start buying more than $170 billion of US goods. Xi, though, got away without having to agree to lower non-tariff barriers or stop subsidizing state-owned enterprises.
Trump’s increasingly erratic behavior in 2020, meantime, gave Xi’s government scope to throttle back imports.
As of the end of November, China had bought just over 50% of the pledged amount, and without the condemnation that normally emanates from Group of Seven circles. Trump squandered much of the goodwill that a more assertive trade policy might’ve garnered with a scattershot assault on Chinese tech.
All things considered, a regulatory appraisal of potential risks posed by Huawei Technologies, Tencent’s WeChat, Alibaba’s Alipay or ByteDance’s TikTok is prudent and understandable. Instead, the bans emerged chaotically and arbitrarily via mean tweets from the now-defunct @realDonaldTrump Twitter feed.
These antics play right into China’s hands as 2021 begins. This is the crux of hedge fund guru Dalio’s view. As Trump trashes trust in US institutions – and literally seemed to plot a coup – Xi’s men are working steadily behind the scenes to ensure Shanghai, Shenzhen and Hong Kong rival New York and London as financial hubs.
The year 2020, he correctly told the FT, was a “defining year” for Chinese capital markets. One reason was China was putting the pandemic in the rearview mirror and its outlier economic recovery.
The US, by sharp contrast, is careening toward 22 million Covid-19 cases and 4,000 deaths per day.
As the US limps along, the International Monetary Fund sees China growing 7.9% in 2021, following 1.9% last year. In fact, China, says IMF Chief Economist Gita Gopinath, is skewing the global average upward.
More aid coming
Without China, she notes, “cumulative growth for 2020 and 2021 is negative.”
That is creating an investment frenzy as foreign investors rush into Chinese debt. In 2020, overseas punters gorged on more than 1 trillion yuan ($155 billion) of mainland bonds and stocks. Higher Chinese yields are one clear attraction. Rates on 10-year Chinese government bonds are 3.1% versus 1.2% in the US.
Along with Trumpian chaos, the recent rise in US yields is partly a Covid phenomenon. As infections surge and US growth wanes, there’s a realization that Congress needs to dole out more aid to households, adding to America’s debt burden.
On top of the pandemic, many households are feeling the pain from Trump’s tariffs, notes trade expert William Reinsch at the Center for Strategic and International Studies. Overall, he says, Trump’s taxes “caused a lot of collateral damage in the US” and left the US-China dynamics intact.
One National Bureau of Economic Research study found Trump’s tariffs cost US households $16.8 trillion in 2018 alone. Mary Amiti, Stephen Redding and David Weinstein argued that “continuation of the tariff policy could be especially costly for multinational companies that have made substantial sunk-cost investments in supply chains in other countries, for example by relying on facilities in China or other impacted countries.”
The NBER study estimated that about $165 billion worth of trade has already been rerouted to avoid them. As 2021 unfolds, the data show that far more of those jobs are making it to Vietnam, Bangladesh and other links in Asian supply chains than the US.
The ways in which Trump trashed Washington’s credibility in global circles could be Biden’s biggest headache. On January 20, Biden will learn first-hand what economist Zhu Min has been warning about in currency circles since July 2020.
Zhu, a former International Monetary Fund deputy managing director, worries a sudden “blow-up event” might tank the dollar.
Dollar up, dollar down?
Some argue fears of a dollar plunge are overdone. Among them is Mark Sobel, the US chairman at the Official Monetary and Financial Institutions Forum, or OMFIF, who said “the dollar may indeed fall this year, but an overly negative narrative is unwarranted.”
The dollar, Sobel says, “is already falling sharply,” having lost about 13% from its March highs. As such, Sobel takes exception with a number of arguments for a sharp dollar decline. More likely, he says, any dollar decline will be slower and more orderly.
Harvard economist Jason Furman says he’s also “puzzled by the confidence of predictions of dollar decline/crash.” Extreme uncertainty in 2021, he notes, could help stabilize the dollar.
So could Biden’s arrival on the scene. An old political hand, Biden is surrounding himself with credible cabinet members. Former Fed Chair Janet Yellen, Biden’s pick for Treasury secretary, is as un-Trumpian an economist as you’ll find in Washington.
The odds are that Antony Blinken will quickly rebuild a Department of State that Mike Pompeo leaves in tatters.
It could be too late, though, says economist Nouriel Roubini at New York University. The year 2021, he said, will be a year of conflict and dollar/yuan the main proxies.
China seems better prepared for what’s to come, economically-speaking. Xi’s government, for example, spent the Trump years building economic muscle, while Trump’s White House indulged in economic Red Bulls and steroids.
No, Beijing has not enjoyed Trump’s tariffs, bans on Chinese national champions, Twitter tirades or being blamed for the White House’s incompetent Covid-19 response. But as Trump flailed about in Washington, Xi was busy revising China’s economic model in two ways.
One was accelerating the process of yuan internationalization. In 2020, China scored long-sought inclusion in yet another key global bond index – the FTSE Russell benchmark. The People’s Bank of China resisted the aggressive easing seen at the Fed.
As 2020 inched to a close, state-controlled oil company Saudi Aramco signaled it was working on floating yuan-denominated bonds. That means an about-face for a pivotal industry that long favored the dollar.
And given the yuan’s advance last year, it’s easy to see why investors of Dalio’s importance see the yuan as the global currency to watch.
Two was China recalibrated growth engines in ways the US didn’t. Investing in China sure has its challenges and risks. Look no further than confusion over the planned initial public offering by Jack Ma’s Ant Group.
Yet, Dalio points out that China over time could become a “very meaningful” portion of Bridgewater’s business. With $151 billion of assets under management, “big money” doesn’t get much bigger.
Some of Dalio’s optimism stems from Xi’s grand scheme to create a world-beating special enterprise zone in southern China known as the Greater Bay Area. It groups Hong Kong, Macau and nine other municipalities: Guangzhou, Shenzhen, Zhuhai, Foshan, Huizhou, Dongguan, Zhongshan, Jiangmen and Zhaoqing.
This cluster of high-tech megalopolises aims to boast at least two – and likely more – finance hubs to rival New York, London and Tokyo. As Bay Area innovators churn out more tech “unicorns,” they’ll have their pick of several mainland bourses to IPO on.
Economic war losses
Trump’s trade war, by contrast, did zero to build economic muscle in the US.
Nothing about Trump taxing Chinese goods or banning companies made corporate America more competitive. Hand-to-hand combat with Xi did nothing to increase American innovation or productivity, improve education or crumbling infrastructure, or curb an unsustainable national debt.
Nothing Trump did reorients California’s Silicon Valley toward disruption rather than finding better ways to sell internet ads. Instead of giving the US an edge in the renewable energy boom, Trump forfeited the future to Xi’s economy.
While China invested trillions on the future of batteries, electric vehicles, semiconductors and solar panels, Trump brought back coal and pressured Detroit to make less fuel-efficient cars.
This is the competitive landscape Biden inherits as Trump leaves the scene: a Covid-wracked economy; a depleted Treasury; a world angry about the last four years; a bond market on edge; and a China, for all its troubles, preparing to take center stage – and more of Dalio’s money.
Good luck to you, President-elect Biden.