Trade End Game Scenarios: Boycott Treasuries vs Yuan Devaluation

Since there is no longer any reasonable debate about a trade war having started, let's investigate how it ends.

End Game Analysis

Treasury Boycott Thesis

I am surprised that Rosenberg brings this up because in my mind, this hash has been settled long ago.

What exactly would China, Japan, and Germany do with their reserves and ongoing trade surplus? Mathematically they have to do something.

Historically, that something has been to buy treasuries. But I suppose China could buy could be gold or US equities. The latter would be smack in the middle of an obvious bubble.

And if China were to dump US treasuries, the alleged nuclear option, it would serve to strengthen the Yuan. Recall that China sold US treasuries to support the Yuan and stop capital flight. In a trade war, China would not want an appreciating currency!

I think Rosenberg proposes nonsense, but given the nonsensical actions of Trump, I cannot rule out nonsensical or illogical responses.

This leads us to the most logical real threat.

Yuan Devaluation Thesis

China cannot retaliate with enough tariffs on its own to combat tariffs imposed by the US. However, the yuan does not float. China could devalue the yuan enough to counteract the value of US tariffs.

Of course, Trump could ban Chinese imports in response, but prices at Walmart, Costco, Target, everywhere, would skyrocket.

This scenario is nearly the opposite of what Rosenberg suggests. It is also far more credible.

But hold on. It is not without risk. Recall that China sold US treasuries to stop capital flight. If China devalues, there is a strong likelihood that capital flight would intensify.

Sester Chimes In

Excuse me Brad, but it's now $450 billion proposed.

Lance Roberts Chimes In

Back to Rosenberg

This Tweet makes far more sense.

Relax, Nothing Worse Will Happen

This whole thing could blow over. Trump and China may come to an agreement that brings us back from the brink.

Options

  • Door 1: Treasury boycott with untested results likely to be hugely negative for everyone
  • Door 2: Devaluation with known immediate consequences that are certain to be bad for everybody. The long-term prognosis depends on further retaliations.
  • Door 3. Cooler heads back off the crisis a bit.
  • Door 4. Every country abolishes all tariff

Realistically, door 4 is closed. Curiously, it's the best option no matter what any other country does.

Winning by Losing

  1. Trump Ups the Ante: Trump Now Threatens Tariffs on All Goods from China: $450 Billion
  2. A Fed study shows "Tariffs Kill High-Paying American Manufacturing Jobs and Businesses".
  3. Auto job losses alone are likely to hit 45,000 as noted in Pandora's Box: Another Look at Steel Tariffs.
  4. On June 8, I noted Three US Tire-Chord Makers Threaten to Close Doors Due to Trump Tariffs.

Trump believes China will lose more. This we call "winning".

Mike "Mish" Shedlock

Comments (26)
No. 1-26
Roger_Ramjet
Roger_Ramjet

I didn't see Rosenberg's tweet (I'm not on twitter). He's a pretty thoughtful fellow, could you add it to the post?

Kinuachdrach
Kinuachdrach

Mish - you keep pushing unilateral free trade. You have never addressed the real world observation that China has done better over the last 20 years with mercantilist high tariffs and higher non-tariff barriers than the US has done with low tariffs and mostly non-existent non-tariff barriers. When theory does not match reality, theory has to be revised.

Roger_Ramjet
Roger_Ramjet

While I believe that Trump is deeply dissatisfied with the trade deficit with China (although he may not have fully thought through the former symbiotic trade relationship between the US and China, whereby China would sell the US cheaper goods (China benefit) while China would finance US deficits by investing the surplus in US treasuries and pollute its own homeland (US benefit). That mutual relationship worked great for both sides for many years.

But given the growing tensions with China over its emerging dominance in the Asian region, the build-up of its military and support for various US nemesis countries (i.e. Russia, North Korea), it could be that reducing the trade deficit may not be the ultimate goal. The US deep state may have more malevolent intent.

Destabilizing China’s economy and impeding its ability to challenge the US in the region would certainly remove a thorn in the side of the US and potentially enable to the US to re-emerge as a dominate player in Asia. As such, any growing military tension with China would certainly put China’s US Treasury holdings at risk as no one would be surprised or dismayed if the US were to default on US Treasury holdings held only by China. I certainly could see a scenario where China would stop adding to its US Treasury holdings, if not reduce them substantially, especially if China thought that this trade war was a cover for something much more sinister being conducted by the US deep state. But hey, the US would never do that, right?

AWC
AWC

BTFD. The Fed had no problem putting 4.5 Trillion on it’s balance sheet before. No reason it won’t double down if all this trade banter dislocates it’s “growth” agenda.

Premitive1
Premitive1

You make the assumption that "China has done better" because of their mercantilism. I presume Mish would argue that "China has done better" despite these policies. You have not demonstrated any correlation between hypothesis and conclusion.

Kinuachdrach
Kinuachdrach

Premitive1 - That is a fair point (although you should note I was reporting an undeniable factual observation about the relative economic performance of China and the US over the last 2 decades, not making any assumptions about cause & effect). There are indeed many factors at work in economies beyond tariffs. Acknowledging that raises two further questions:

  1. If China has done well (improved living standards, vastly increased real economy industrial base, etc) in spite of having high tariffs, then what are the truly important policies which China has adopted (and the US has not) to produce this desirable result?
  2. If high tariffs turn out to have a minor second order impact on the economy, then why should any sensible person get hot under the collar about "trade wars" and tariffs?

Any thoughts on those questions would be much appreciated.

Realist
Realist

People keep complaining about the US being screwed out of millions of jobs because of unfair trade. Yet US manufacturing is at record highs, US unemployment is at record lows, and there are more jobs sitting empty than there are unemployed workers. The economy has been growing for 9 straight years and could easily keep growing for many more years, assuming that this trade war doesn’t escalate. The only people not working are those without any skills. Most businesses would like to expand, but can’t find workers to expand with. People also keep complaining that other countries have high tariffs that hurt the US, yet the US has higher tariffs than Europe, Japan, Canada, Australia and most other developed countries. The US has all kinds of subsidies and supports for its businesses, particularly agriculture, yet it complains if any other country does the same. To observers in other countries, the US looks like a spoiled fat bully who wants to take the one piece of candy that the poor kid has.

Cbb
Cbb

Hi Mish, what is your thoughts on the following options :

1- If China buys Gold instead of US Treasuries with their trade surplus ?

2- China use export prices in US dollar for US market, what happens if suddenly China does not accept US dollars but ask for payment in other currencies, gold or even Yuan ( Yuan is not fully convertible this may require Chinese Government to take steps to accommodate this and at the same time they have to print more Yuans in circulation) ?

VPKK
VPKK

Selling treasuries and devaluing the yuan are both stupid suggestions — which equal to committing suicide.

wootendw
wootendw

China should print Yuan and buy gold with it until the price of gold skyrockets (and the value of the Yuan drops). There won't be capital flight then.

FloydVanPeter
FloydVanPeter

I suspect that this whole tariff thingy is putting pressure on Chaina to pressure NK...

Sergei
Sergei

China will buy more US Treasuries in order to devaluate yuan. Period.

themonosynaptic
themonosynaptic

There is a danger here that the trade war will artificially trigger a recession, leaving the underlying real causes of the next recession in place. This will result in a lot of effort to stop a one time, artificial problem (Trump's trade war) and cause the following recession to be larger because the real systemic problem has gone on twice as long as usual.

themonosynaptic
themonosynaptic

Trump is going to war with the true ruler of the planet - the bond market. Good luck with that.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

I am unsure of what would happen if China bought gold. But consider the idea that it may strengthen the Yuan. Is that what China wants in a trade war?

Democritus
Democritus

It's easier to create money than to create goods. I mean creating trillions of dollars can be done by pressing a button and it's there. So being a permanent net exporter, gathering huge amounts of foreign cash that inflates away is a loosing policy. Can it be that Chineese people will get more prosperous if their appreciating Yuan is going to buy them more and more lovely foreign goods?

Stuki
Stuki

The "theory," at least the economic one, is that of diminishing returns. Early growth is easy, as you're just picking low hanging fruit. And have learned from those who have come before how to do so efficiently. When China starts at nothing, and the US at everything, it's kind of hard for the US to "do better."

As I've pointed out before, a much more apples to apples comparison is China vs Taiwan or Hong Kong. All started out the same. Some traded freely, others didn't. Who have "done best" since they separated? Hint: As always, it ain't the commies.....

KidHorn
KidHorn

An end result is China will have higher unemployment and more steel. Seems like a logical thing to do would be for China to spend more on military production. Not less. They used to build cities. Now they'll build aircraft carriers.

Eighthman
Eighthman
  1. so what if the US monetizes its deficits? Japan has gotten away with this nonsense (de facto) for decades. Why sell Treasuries at all? Just "print" away.

  2. The trade war looks nuts. What is China supposed to do? Stop exporting to the US? Stop buying up US businesses? Buy more US goods that the US can't supply anyway ( like ag products might be maxed out? Irrational, indeed.

Kinuachdrach
Kinuachdrach

Not really. The theory that underpins the unilateral free traders is Ricardo's 19th Century theory of Comparative Advantage. In its simplest terms, if the guy who is an excellent maker of bows & arrows supplies those to the guy who is an excellent hunter in exchange for meat, they both eat better.

Of course, the real world is much more complicated than that over-simplified theory. Remember the other way of hunting -- throw out free food to the animals (marks!), and they eventually come to the hunter to be slaughtered. Once the Chinese have established functional monopolies, what price do you think the US consumer will be paying?

Another interesting real-world observation is the opposite of Diminishing Returns -- economic growth (and living standards) have grown increasingly fast over the centuries -- at least until the 1970s, when Mish would say we went off the Gold Standard, and I would say we unleashed a torrent of excessive regulation with the EPA. Who knows? Maybe both factors were involved?

FelixMish
FelixMish

That China has done better than the US in the last 20 years is to be expected and desired. They started from the bottom like many before them. 20 years from now, the same thing will be able to be said of Viet Nam, several countries in Africa and, well, pick any country now at the bottom of the barrel.

In practice, any country currently on the low end of the industrial revolution curve has no excuse but ineptitude not to change-for-the-better more than the US (using the usual 19th century metrics). As it turns out, the trend is exactly what the learning curve says it would be: Each country changes for the better quicker than those before it. Ho, hum.

Overall this is very good for those on the top end of the curve. Sure, it's not universally good for every person in the top end. Especially if they rate themselves by comparing how much they changed against those who changed a lot. Or if the industrial revolution process eliminated their job. But, what else is new?

Consider this, if you are an American: Do you want Mexico to stay poor, or do you want them to be at Canada's level?

FelixMish
FelixMish

K, I like your quick summary of Ricardo.

Couple nits:

That the real world is more complex than the theory makes the theory work better. More opportunity for efficiencies.

You're bringing up something often brought up: The idea someone is going to capture a market and then crank up the prices. Same argument as in the '30's against the new grocery store chains. It's hard to find examples of that really happening but easy to find examples of the prices staying low and going lower. Market dominance seems to lead not to high, captive prices, but to the "monopoly disease". That's when the monopoly starts doing things more for themselves and less for their customers. Very hard to find a long term monopoly that escapes the disease. "We don't care. We're the phone company" used to be a joke inside the Bell system, for instance. Or pick pretty much any US Gov operation's behavior despite valiant efforts made by good individual people inside the operation.

I agree about changes since 1970. Lots of candidates for culprit. But one not often mentioned is we're counting the wrong things. Again, quality of stuff has changed remarkably but that change isn't measured well or publicly.

Stuki
Stuki

Comparative advantage is neither all the "theory" there is, nor ever presented as the one true explanation for everything. It isn't 42. Hence, merely observing that A has reported faster economic growth than B over a period, despite B imposing somewhat fewer restrictions on trade than A, doesn't somehow invalidate Ricardo, any more than birds invalidate gravity.

When you start with nothing, and have a blueprint readily available to you for how plenty of other countries went from nothing to quite a lot more, undertaking that development yourself doesn't take the world of resources. But once you are already at the cutting edge of anything, growth from there is harder.

And, this is important: Not because some hack with rudimentary skills at feeding numbers into a statistics program and a desire to get his name on a published article, managed to fit some data to a curve and "prove" so. But simply because when a rational being wanting to improve his condition is presented with a world of varying opportunities for how to spend his limited time and resources, he will first pick the opportunity that yields the greatest payback (read growth) for his efforts. Then, once this is done, he is stuck picking the second best. Then the third best, and so forth... Which, inevitably, not subject too any empirical pretense of verification nor refutation, leads to initial growth being faster,. Then getting slower as the easy pickings have already been done.

When some starving Chinese guy starts out low enough, simply crawling over and picking up food scraps the Average Silicon Valley engineer throws away as trash, results in faster measured growth for the Chinese than for even the most productive Silicon Valley startup in history. "Comparative advantages" at trash pickup vs software writing be damned.

Hence, if you want to do an apples to apples comparison of which countries' trading regimes look to have the fastest growth, you have to start with countries that start at the same place development wise. A five year old kid of two dwarfs growing faster than the fully grown son of two basket ball players, doesn't really tell you much about how parental height affect chilenerens' growth, after all.....

And, it so happens, WRT China, an apples to apples comparison is available: Taiwan. And, albeit slightly less direct, Hong Kong. All started at the same spot. All grew at different rates since that time. Two have had comparatively free trading regimes, while the third has been more closed. In which ones have citizens enjoyed the greatest growth of living standards since back when they were separated? North and South Korea is another example. As is Singapore vs Malaysia post split. And East and West Germany. As were, earlier, the cities of Italy that traded, vs those who did not. As well as Holland and England vs European peers with less of a trading fleet.

Kinuachdrach
Kinuachdrach

FelixMish, Stuki -- you both make good points. It is a complicated world, and many factors come into play. Despite economists with their equations, it is pretty clear that we don't understand much of what drives the real (as opposed to financial) economy. Think about the situation at the end of WWII, when all the US war production facilities were being shut down and millions of soldiers were being demobilized (aka laid off). Every economist knew there would be a recession (historically typical of the end of wars); instead, there was a boom. Talk about getting it wrong!

Trying to understand how reasonable people can come to different conclusions -- my guess is that a lot of the difference depends on whether people take a short-term or long-term perspective. Another element is that some people start from the bastardized Keynesian view that Consumption is all-important (which I think does a disservice to Keynes); others start from the Say's Law view that there has to be Production before anyone can consume anything, or trade with others for part of their production.

J P
J P

Mish. Swapping treasuries for gold wouldn't necessarily strengthen the yuan. It could just strengthen gold.