Sources Of Imbalance And The Pushback Against New Divergence

The US dollar's surge alongside gold has eclipsed the equity market rally as the key development in the capital markets. Even the traditional, seemingly safe-haven yen was no match for the greenback. The dollar appeared to have been rolling over in Q4 19, as the sentiment surveys in Europe improved, Japanese officials seemingly thought the economy could withstand a sales tax increase, and data suggested the Chinese economy was gaining some traction.  

However, 2020 has begun with new divergence. The Covid-19 virus has not only crippled the Chinese economy, but its sheer size and magnitude of its integration in the global supply chains have far-reaching knock-on effects. Asia-Pacific economies that were increasingly reliant on Chinese input and demand are the most vulnerable. Estimates suggest that the world's second-largest economy is operating at well less than 50% of capacity. Indeed, the extension of the stoppages and disruptions increase the likelihood that the Chinese economy contracts in Q1. The supply chain disruptions are adversely impacting Japanese and Korean automakers. German automakers derived a substantial share of their profits from China, and car sales continue to weaken. Volkswagen, for example, has ceased production at a third of its 33 plants in China, which accounts for around half of its total production. Chinese autos sales in the first half of February were off 92% from a year ago.  

Japan's sales tax increase in October and the typhoons dealt the world's third-largest economy a significant blow and a deep quarterly contraction of 1.5%. Despite government efforts to soften the blow through incentives to consume, the impact was nearly as much as the previous sales tax hike. This self-inflicted shock, coupled with the slowing of China and the typhoons, leaves the Japanese economy vulnerable. Japan's exposure to China, through trade and tourism, may be a sufficient knock for the fragile economy to lead to a contraction here in Q1. It would be the second consecutive quarterly contraction, a rule of thumb often used to mark a recession, and underscores the fact that negative interest rates do not prevent economic downturns. 

Arguably, the tightening of Japan's fiscal policy through the tax increase was partly offset by the other fiscal incentives to blunt the contractionary impulse. Yet the measures appeared to have minimal impact at best. The tax, which has been increased in a few steps, was initially foisted on Japan by multilateral institutions, but took on a political life of its own in Japan beyond the economic arguments. Pundits and journalists shake their heads at what appears to be a self-defeating policy. However, Germany's reluctance to use its fiscal space is seen as not just folly but dangerous, as well. 

The European Central Bank, the IMF, and many American and British economists do not understand why Germany is not borrowing money at negative interest rates to fund public investment. Even the German Bundesbank has accepted that the fetish for the "black zero," which both parties of the coalition government have supported in word and deed, is doing harm. Often, the conversations have an air of "America is from Mars, and Europe is from Venus." Little illustrates this insight, like the appreciation that "guilt" and "debt" are derived from the same word in German and Dutch. In America, in contrast, debt and bankruptcy have been liberated from moral stigma. It is about using OPM or other people's money. The ability to service one's debt has become the issue, not the debt itself. Between student loans, mortgages, auto loans, and credit cards, Americans spend most of their lives in debt. 

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Read more by Marc on his site Marc to Market.

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Gary Anderson 1 month ago Contributor's comment

Trump has panicked in the face of the Coronavirus by pleading with the world that we are open for business. His trade wars coupled with the pandemic possibly coming to America could devastate debt fueled America.