Not Your Grandfather’s Trade War: The Revenge Of Bad Money, Part 1

With his China Trade Wars tweet this AM, the Donald has proved once again that he has an uncanny ability to get to the heart of matters….even if by sheer accident!

Yet he’s right.The trade war was “lost many years ago” and it’s the reason Flyover America has rallied to his bluster and bombast on imports and the nefarious practices of furin guberments:

We are not in a trade war with China, that war was lost many years ago by the foolish, or incompetent, people who represented the U.S. Now we have a Trade Deficit of $500 Billion a year, with Intellectual Property Theft of another $300 Billion. We cannot let this continue!

But, alas, the “foolish or incompetent people” skewered in the Donald’s 7:22 AM tweet are not some defunct Commerce Department or USTR officials from bygone times.

Nope, it’s not pointy-head trade bureaucrats at all. The actual culprits are the “low interest” men and women resident in the Eccles Building, who over the past three decades have transformed the Fed into a Bubble Finance machine and the main street economy into a hollowed out tower of debt.

In a manner of speaking, free money has trumped free trade. And that means what is aborning is not your grandfather’s garden-variety trade war; it’s the abiding revenge of bad money—–a debilitating affliction that cannot be bargained away by cooler heads among professional trade negotiators as the dip buyers are so foolishly betting again today.

The truth is, the Red Ponzi is an absolute freak of economic nature that has laid waste to much of the US industrial economy. But the dark secret unbeknownst to the Donald, and the Wall Street/Washington establishment alike is that the China monster was enabled, fostered and feed by the US central bank’s pursuit of an upside-down monetary policy after 1987.

The turning point came when Mr. Deng concluded that Mao had been wrong about the source of state power: Rather than emanating from the barrel of a gun, as the Great Helmsman had insisted, Deng Xiaoping ordered a 60% depreciation of the yuan, thereby recognizing the far greater efficacy of the credit power that issued from the end of the central bank’s printing press.

Then and there the die was cast. Faced with world history’s greatest mercantilist export campaign and the draining of China’s vast rice paddies of tens of millions of cheap workers to fill Mr. Deng shiny new export factories, the US economy required one thing above all: Namely, a systematic deflation of its bloated price, wage and cost structure; high interest rates to dampen consumption and encourage savings; and sustained supra-historical levels of investment in plant, equipment and technology to equip American workers with an insuperable edge in tools and labor productivity.

Needless to say, Greenspanian money-pumping, soaring debt and wealth effects driven financialization were not merely the opposite of what a regime of sound money would have generated; they were the kiss of death for jobs, prosperity, and hope in Flyover America, as the chart below so dramatically illustrates.

Folks, this chart is not the fruit of Adam Smith’s unseen hand of free trade going about the work of the economic gods. China’s monthly exports to the US of just $490 million in November 1987 did not explode by 98X over the next 30 years to $48.2 billion in November 2017 owing to comparative advantage!

Indeed, the chart below would not have happened in 10,000 years under a regime of sound money and honest price discovery in the capital markets. To the contrary, China’s initial advantage in cheap labor would have led to a large inflow of reserve assets (e.g. gold) to China and a large outflow from the US, causing wage and cost inflation in China and deflation in the US.

Stated differently, when coupled with sound money, the free market is not suicidal. Instead, current account imbalances get settled via the movement of true reserve assets. That settlement process, in turn, causes domestic interest rates to fall and credit to expand in the case of inflows, and the opposite to occur in the case of persistent trade deficits and reserve asset outflows.

At length, domestic prices, costs and wages clear at sustainable levels and current accounts remain in reasonable equilibrium among trading partners over the longer run. By contrast, the purple peak in the upper right hand of the chart below represents a 17% compound annual rate of growth for thirty years running; it’s the work of free money, not the free market.

Nevertheless, the so-called “free traders” of the mainstream media are out in force today lamenting the Donald’s purported economic ignorance. When it comes to cardinal intellectual error, however, we are not sure which is worse as between the Donald’s 17th-century mercantilism or a bit of undiluted tommyrot we heard this morning from CNBC’s in-house Wall Street shill, Steve Liesman.

Not to worry about giant trade deficits or a 98X growth in imports from China, he opined, because it’s actually a sign of success.

“When we get wealthier we buy everything made here and then add some more from abroad”.

Not so fast, we’d say. Liesman was talking about the kind of transient paper wealth that is measured by multiplying billions of equity shares by their fantastically inflated prices. As we have learned twice already this century, however, that kind of wealth can plunge by 50% or more in a relative heartbeat when the Fed’s serial financial bubbles finally collapse under their own weight.

The truth of the matter, of course, is that the above chart for China is not an aberration; it’s only the poster child for the underlying economic rot that has been induced by bad money. As we will demonstrate in the balance of this series, the chart below for total US trade (including both goods and services) has been enabled by a central bank driven monetary inflation that has nothing to do with sustainable wealth at all.

In a word, the Fed printed—so they printed. We are referring to virtually every other major central bank in the world, and the mercantilist disease that has spread to all four corners of the planet.