Donald Trump really wants to punish China and the world. We can focus on China and see what will happen to our relationship with the world. Tariffs keep escalating. Chinese stocks are leveraged as collateral to other deals and are subject to margin calls. There may be some weakness in China.

The one thing we need to know about Donald Trump is that he has certain principles. They can be dangerous, and against all sound economic reasoning. But that doesn't matter to him. His tariffs are one manifestation. His desire to buy back treasuries on the cheap is another manifestation.

As the stock markets in China continue to decline, China will likely sell a lot of US Treasuries at some point, because of needed cash and to inflict some pain on the adversary. It will likely be measured. But Donald Trump has said he wants to buy back treasuries at a discount. He originally said he wanted to default but it was changed to buy back at a discount. He has never refuted this position.

There are problems associated with discounting American debt.

1. Central banks could care less about stock markets. This is why stocks are really speculative investments. The PBOC and the Fed simply do not care if markets crash. They do, however, care about their government bonds. As for the Fed, well it would not look kindly on discounting precious treasury bonds.

2. The US government would then issue new bonds to China, at a lesser value on paper but with higher interest rates. This, of course, would put all US programs in jeopardy. All safety net programs, Social Security, etc, could be affected. It would put at least some collateral in jeopardy. It would unsettle all financial markets. It would bludgeon the new normal as I wrote could happen based on the administration's planning papers.

I think undoing world collateral is a goal of this administration. In the above article Peter Navarro and Wilbur Ross are quoted:

Most recently, the 2012 South Korea trade deal was negotiated by Secretary of State Hillary Clinton – she called it “cutting edge.” It was sold to the American public by President Obama with the promise it would create 70,000 jobs. Instead, it has led to the loss of 95,000 jobs and roughly doubled America’s trade deficit with South Korea. Corporate America does not oppose these deals. They both allow and encourage corporations to put their factories anywhere. However, Mr. and Ms. America are left back home without high-paying jobs. There is nothing inevitable about poorly negotiated trade deals, over-regulation, and an excessive tax burden – this is a politician-made malaise. Therefore, nothing about the “new normal” is permanent. [Emphasis mine]

That is the only mention of the New Normal. The only way to break it is for interest rates to rise and collateral in markets far and wide to go bad. I believe that this will result in a massive credit crisis in our nation and maybe throughout the world, leading to possible war and/or overthrow of the Republic.

3. The US could see markets that should be opened suddenly close to American businesses. This will be likely a permanent shift, and it could happen if the US is no longer welcome to the Chinese belt and road investment plan for Central Asia. Putting a dollar value on that lost business is simply impossible because no one knows how successful the Chinese will be.

4. As Michael Roberts, an economist at the City of London, has said, free trade weakens the weak and strengthens the strong, but a trade war weakens everybody. He acknowledges that free trade is not perfect, but that trade wars are a disaster. In order to punish the world in a trade war, it is necessary for POTUS to punish the United States as well. The only time trade wars possibly will not punish the aggressor nation is if the unemployment is huge, as in Nazi Germany in the 1930's. That economic plan grew the nation but didn't end so well.

5. The US must run trade deficits because we are the world currency. There are major advantages to having the reserve currency. Trump wants to give that power away. That power insures investment in the USA. It insures people with money coming to bring us jobs. Yes, some of the investment can be tweaked by law, to give more benefits to US citizens looking for work. It is not a perfect system. But it is an advantageous system in the long run.

But Donald Trump wants to eliminate trade deficits. Michael Pettis at Financial Sense has given us information about this very issue with a refreshing argument regarding wealth distribution and trade imbalances. This group is an outlier regarding whether trade wars hurt all nations (most economists think they normally do with the occasional exception as we saw in Nazi Germany), but Financial Sense points out that there is another reason why this trade war could set back the United States.

Trump created tax cuts for the rich in order to transfer wealth from the working people to the big corporations. When Germany did this, as the article notes, Germany began running surpluses. From Financial Sense:

It is not at all a coincidence that Germany began to run surpluses just when households began to retain a smaller share of what they produced. Contrary to Oettinger’s claims, Europe is not running a surplus with the United States because Americans for the first time discovered German cars. It is running a surplus with the United States because between 2003 and 2005, to reduce domestic unemployment, Germany implemented policies that reduced the share of income German workers received and caused business profits to soar.

Trump is not adverse to other efforts to transfer wealth from main street to Wall Street. Tariffs themselves shift income. Financial Sense is saying that surpluses are a function of how income is distributed and about how nations treat their citizens. There is some truth to this view, as we already know that Germany's citizens have a low rate of homeownership and the nations formerly called PIIGS, like Italy, have more wealth (and the downside, more debt) distributed towards the people than does Germany.

As for how tariffs would work regarding the United States and imbalances, Pettis makes a very interesting comment:

In the United States, it turns out, tariffs are unlikely to have an effect on the trade deficit because the relationship between domestic savings and domestic investment is determined not by domestic savings preferences but rather by foreign capital inflows. These foreign capital inflows are themselves determined by the need for foreigners to park their excess savings in a safe haven. 

In the United States, it turns out, tariffs are unlikely to have an effect on the trade deficit because the relationship between domestic savings and domestic investment is determined not by domestic savings preferences but rather by foreign capital inflows. These foreign capital inflows are themselves determined by the need for foreigners to park their excess savings in a safe haven. 

Our safe haven/reserve currency status, then, dooms any effect tariffs may have on the trade deficit! 

Perhaps this is the fear companies presently have, that consumption will be lowered during this administration, first by tax cuts for the rich, second by cutting social programs, third by the imposition of tariffs, fourth by globalization and fifth by robotics. So, when consumption does decline, and investment is not present to offset, real problems happen with the economy, again according to Financial Sense.

The final point of the article is a simple truth, the US runs a capital surplus as a safe haven and that is offset by a trade deficit which cannot be changed without stopping the flow of investment into the USA. 

The Goal of Trump

Ultimately, getting bond yields to rise the way POTUS desires, would undo world collateral. I think that is a probable goal of this administration. Real reflation requires higher yields. 

So, how does punishing China fit in with this administration goal? Well, punishing a nation that buys your debt because you are stable does not reconcile with a madman in the White House doing all he can to appear unstable. And taking the trade war to the very end, the discounting of treasury bonds, would not bode well for the Chinese view of safety.

And if the US government buys back bonds at a discount, it is a red flag to ratings agencies that the government simply does not have enough stability to redeem bonds at full price! Offering new bonds with higher yields instead of paying full price would have to tarnish the credit rating of the United States.

Fitch is crystal clear in this assessment, that Donald Trump, in wanting to punish nations through tariffs, is a risk to the world economy even without buying back bonds at a discount. We can imagine how those agencies would assess his behavior if he carries out all of his threats. But so far, Fitch has seen enough.

In a nightmare scenario, maybe Donald Trump has already contemplated stopping the flow of foreign funds to the United States as a safe haven. That is, whether he has thought that far or not, a probable end result of his thinking, what with the destabilizing of our treasuries and massive permanent tariffs, and a weakening of global alliances. America First must mean we are totally isolationist, closed to foreign investment as a means of destroying the safe haven, and closed for business, except for what we choose to export. 

For Further Reading:

Henry Kissinger Schools Mercantilist Trump About Reserve Currency

Things That Smart People Don't Know