Another boring few days of saber-rattling in the great Trade face off. – now supplemented by currency wars. Not unsurprisingly equity markets have reacted badly.
What has caught my eye though are a few standouts numbers from market commentators – underlined and in bold below.
The first is from the commodity team at SocGen. If China is having a tougher time because of trade spats, we’d expect to see some blowback in the commodity markets. To a degree that’s already happened with oil – my guess is that we could see the $50 a barrel level tested soon enough.
But the SG analysts have also spotted warning signs in the copper markets. COMEX copper front-month prices fell 4.52% over the week bringing prices to their lowest level since June 2017.
In particular, the SocGen analysts noticed “short inflows into other trade war exposed commodities with the grain sector printing -$2.4bn outflows, mainly fuelled by new short positions. However, it was the copper market that was the most responsive with $2bn of short inflows (probabilities < 0.000001%): the highest on record (since 2006). The net number of short traders (-18) was the largest since August 2018.”
The less scary narrative comes from the always excellent Michael Pettis, a China-based US academic economist who publishes the excellent Global Source newsletter. Michael has been right about a great many things to do with the Chinese communist superpower, so its worth listening to him on the significance of the RMB cracking the mythical 7 level.
His key number is this: his back-of-the-envelope calculations suggests that even assuming no diversion in trade, a 1-1.5% devaluation of the RMB would be enough to offset the impact of 10% tariffs on $300 billion of goods.
Pettis reckons that this talk of currency manipulation is “mainly about political signaling and reflects the fact that Beijing has very few tools with which to respond to pressure from Washington. Under normal conditions, I would say that while Beijing might want to signal its displeasure with US policies one or two more times, the PBoC is unlikely to take this much further. A weaker RMB does little to boost domestic growth, and in fact, by reducing the household share of GDP in favor of the tradable goods sector, it actually increases China’s reliance for growth on non-productive investment and soaring debt. It also is likely to anger trade partners generally, and not just the US, and this risks worsening the global trade environment, something that would hurt China more. Finally, it runs the risk of unleashing a new wave of capital flight.”
All that said, we’re best to remain cautious, if only because the political beasts that are President Xi and Trump might rattle their sabres over Hong Kong. Thus, a trade spat might be a useful diversion.
But Pettis has a much more important argument to advance, one that I think is much more profound.
Those of us with a strong Keynesian view of the world believe that though trade matters, what matters much more are capital flows. The Bretton Woods system, in part built on caging international capital flows, has collapsed but that’s not necessarily a good thing. In particular, I think we’ve taken it for granted that we have virtually no barriers to moving capital around the world at the tap of a button. That, of course, has huge benefits but it also comes with huge risks. Top-down asset allocation moves can take on oversized importance as global investors blow hot and cold about the short term prospects of a nation and its economy. If Corbyn comes to power in the UK, we’ll discover the downside of these easy capital flows.
That said many economists of both the left and right seem very sanguine about the continued durability of these friction-free global capital markets. At the Amundi Investment Forum earlier this summer, I asked hardened free trade cynic economist Dani Rodrik if we might see the return of capital controls – he doubted they’d work. I’m not quite so sure. If we can call into doubt free trade we can certainly question capital controls. Third world countries continue to use them and I am convinced at least one or two developed world nations might be forced to use them,
In the meantime, we might see capital flows taxed. That at least is the idea behind a column from Michael Pettis in Bloomberg recently. You can read it HERE. His argument is that taxes on capital flows are the only sensible way to balance the trade account. Here’s how it could work, based on a bill working its way through the US Congress as we speak.
“The bill would task the Fed with implementing a variable tax on foreign purchases of U.S. dollar assets whenever foreigners direct substantially more capital into the U.S. than Americans direct abroad, something they have been doing for more than four decades. The tax would aim to reduce capital inflows until they broadly match outflows. Because a country’s capital account must always and exactly match its current account, if the American capital account is balanced, then its current account must also balance, and the U.S. trade deficit would effectively disappear.”