Whack a Mole

In the latest on US trade policy, we are now starting to see the economic consequences of starting a tariff war. Farmers have been complaining that they are being hurt irreparably by the imposition of tariffs in retaliation for the tariffs being imposed on China and our allies. The Trump administration is now proposing to employ $12 billion in emergency funds from the Department of Agriculture to subsidize losses of US farmers resulting from the imposition of retaliatory tariffs, specifically on soybeans, pork, sorghum, corn, wheat, cotton and dairy products, just to name a few.

Market-Commentary-Cumberland-Advisors-Trade

What is clear is that the expenditures are not subject to congressional approval. The administration is employing the Depression-era facility called the Commodity Credit Corporation (CCC) established to fund payments to farmers as part of a three-part program that includes direct assistance, the purchase of surplus agricultural products (1), and trade promotion of agricultural products. Two things are missing so far from the discussion of the bailout program. First, there is no mention of when payments will be made or the process by which these payments will be apportioned and paid. Second, since the funding authority under the CCC is capped at $30 billion, we don’t know if this is just the first tranche of future draws.

Not only should Congressional approval be sought for such a program; but also this is only the tip of the iceberg, because the administration has imposed tariffs on many other products, like steel, autos, and electronics, whose producers will also be hurt. Will a life raft be given to Harley-Davidson? Where will the additional emergency funds to help those firms come from – if they come at all?
We now see that not only will taxpayers pay for the misguided approach to adjusting trade barriers in the form of higher prices of goods at home, but this use of taxpayer funds to rescue farmers evidences the administration’s willingness to divert funds from other priorities to fund its trade war. To be sure, the payments to farmers smell of pure politics, since those hardest hit live in states that supported the president in 2016. Does this imply that help will only be extended through the mid-term elections?

Given that only emergency funds are being used on what the administration claims to be a one-time expense, the political claims of others who are being or will be hurt can’t be far behind. And because funds are limited, the administration will be picking winners and losers as it subsidizes some products but not others that have been targeted for retaliatory tariffs. Will funds to support Detroit automakers and US steel producers be available on the same terms and in as timely a fashion?

A more measured strategy to rationalizing trade relationships, one that permits affected parties to adjust, would seemingly involve first working with allies to resolve differences there and then turn to identifying and addressing critical issues, such as the restrictions that China has imposed that have transferred US intellectual property to their domestic industries. The meeting President Trump had yesterday with European Commission president Jean-Claude Juncker and the kind of process and organization that appears to have been agreed upon as a path forward is exactly the kind of baby step that should be taken first. Negotiations that are coordinated with and supported by our allies are sure to be more powerful and less disruptive than attacking both allies and abusers alike and then backfilling with bailouts. We can only hope that this most recent turn represents a more considered strategy going forward.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


(1) For background on the CCC see https://fas.org/sgp/crs/misc/R44606.pdf


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Fed Independence

In the wake of the turmoil in Washington, DC, over his performance in Helsinki, President Trump also took a sideswipe at the Federal Reserve, criticizing the FOMC’s recent efforts to normalize policy.

He argued that raising rates threatens the expansion and on top of it has contributed to the rise in the value of the dollar, just when the euro was shrinking, the effect of which is to further disadvantage US producers.

Most presidents – though not all – have understood that Fed independence ensures separation from the Treasury and serves as a check on fiscal excesses. When a central bank takes orders from the fiscal side of government, history shows that inflation and economic decline soon follow. Witness the German inflation of the Weimar Republic, the 1992–1994 experience in Yugoslavia, the 1990 experience in Peru when inflation doubled every 13 days, the persistent problems in Venezuela, and the hyperinflation of Zimbabwe, just to name a few.

There have been many times in the past when presidents expressed frustration with Federal Reserve actions, but those criticisms lacked teeth when it came to actually affecting the Fed’s conduct of monetary policy. One noteworthy period when there was a cozy relationship between Fed leadership and the president was during the chairmanship of Arthur Burns. Burns steered policy in such a way to accommodate the fiscal interests of President Nixon, and the result was stagflation in the 1970s and a disastrous experiment with wage and price controls. We experienced an unprecedented inflation that took courageous action by then-Chairman Paul Volcker to break the back of inflation at the cost of a recession, thus proving that the lack of independence represents a severe threat to economic stability and prosperity. Similarly, President George H. W. Bush blamed the Fed for not cutting rates, and that reluctance to act he alleged cost him the election.

Interestingly, the issue of independence came up last week, on Wednesday, in two entirely different contexts and different venues, in both instances during hearings by the House Financial Services Committee. The first occurred during Chairman Powell’s semiannual testimony on monetary policy before the full House Financial Services Committee, when Congressman Hensarling suggested that the size of the Fed’s balance sheet in itself might pose a threat to its independence because of the temptation on the part of Congress to induce or cause the Fed to purchase private sector assets. As evidence he also referenced the fact that raiding the Fed’s balance sheet has already taken place. Two examples he gave were the use of Fed resources to fund the Consumer Financial Protection Bureau and the deployment of some of the Fed’s surplus to fund the Highway Bill. While Congressman Hensarling’s concern is valid, neither congressional action was related to the size of the Fed’s balance sheet per se. The Fed doesn’t act like a private bank, attracting deposits and then making loans. Rather, it purchases assets – in the present case Treasuries and mortgage-backed securities (MBS) – by simply creating reserves. That is, it purchases assets and pays for them with high-powered money – which ends up as reserves on commercial bank balance sheets.

The real threat is simply that Congress has viewed the Fed more and more as a piggy bank whose resources can be tapped to fund pet projects, seemly at zero cost to the budget. This temptation has been stoked, in part, by the Fed’s willingness to purchase newly issued MBS – which in this case were liabilities of another set of now-government entities, Freddie and Fannie, which are in conservatorship and whose liabilities are effectively guaranteed by the Treasury.

If Congressman Hensarling and his colleagues are truly interested in protecting the independence of the Fed, to counter this trend they should restrict the Fed’s asset purchases to US Treasury obligations – except in extreme emergencies, such as envisioned in the Dodd-Frank Act – and encourage the rundown of the Fed’s holdings of MBS as soon as feasible.

The second time the issue of Fed independence was implicitly raised was in an entirely different context during a hearing on digital currencies that took place that same Wednesday before the House Financial Services Subcommittee on Monetary Policy and Trade. The discussion was wide-ranging, but some participants argued that if digital currencies proved to be a more efficient means of payments than cash, then such currencies should be made legal tender. Furthermore, the Fed should get into the retail digital currency business. But what was lost in their brainstorming was the logical implication of the Fed’s getting into retail payments. Fedcoins, by virtue of the government’s backing, would likely dominate private sector digital currencies and would surely supplant demand deposits as a component of payments as well. However, the advent of Fedcoins would also imply a huge increase in the Fed’s balance sheet on the liability side, an increase that would have to be balanced with assets – presumably Treasuries. But banks rely upon demand deposits to fund their lending activities; and to the extent that this funding source was significantly reduced or disappeared, then banking as we know it would also be adversely impacted. The political fallout from this disruption would be large, and we do not know what implications such a change would have for financial stability or the implementation of monetary policy. Worst case is that the Fed would be dragged into consumer lending. So the role of digital currencies in the US economy is, as of this writing, not clear; nor is the structure of Bitcoin and similar currencies as anonymous or safe as proponents would have us believe [1].

The threats to Fed independence from the legislative branch have a long history. Congressman Wright Patman (in Congress from 1929–1976) was longtime chairman of what was then the House Committee on Banking, Finance, and Urban Affairs [2]. A populist, he favored low interest rates and continually threatened to subject the Fed to appropriations and/or audit [3]. His main concern was that the Fed was too independent and lacked transparency in its operations and decision-making [4]. Remember, during that period the Fed did not reveal its decisions, nor did it produce meeting minutes. Furthermore, Fed chairmen and governors made only infrequent appearances before Congress.

Patman’s crusade was picked up by Henry Gonzales, another Texan, who rose to the chairmanship of the House Banking Committee in 1989, and who vigorously sought to make the Fed more accountable [5]. Under Gonzales it was revealed that the Fed kept secret minutes of its meetings, destroyed many meeting records, and concealed information on a fleet of airplanes it operated, just to mention a few examples of covert Fed actions [6]. Gonzales even initiated an unsuccessful proceeding to impeach Fed Chairman Paul Volcker. Under Gonzales’ tenure the Fed began publishing minutes of its meetings.

So attacks on the Fed from both the executive and legislative branches of government are real but have mainly succeeded – appropriately so – in making the Fed’s decision process more transparent. But those efforts have had minimal influence on actually policy decisions. The president may not appreciate that the Fed is a creature of Congress and not the executive branch, and that he has little or no power to force either the chairman of the Board of Governors or the FOMC to do his bidding. Nor can he fire them.

How will the Fed respond to these recent pressures? Some have speculated that attempts to influence the Fed will cause the Fed to overreact and accelerate its tightening policy just to demonstrate its independence. If the past is any guide, however, there is little evidence that the Fed has deviated from what it deems to be the appropriate policy path just to stick it to its critics. While most of the FOMC participants and governors are relatively new to the table, the best guess is that Fed’s culture and history will provide them with the backbone to steady the course and not bow to outside political pressures. The bigger risk is that the economy could weaken sufficiently towards the end of this year to cause a change in policy, especially if this slowdown occurs before the election. A backtrack on policy in that economic scenario would pose a formidable communications challenge for the Fed – to explain the change while not appearing to be bowing to outside pressure, especially from a president who is likely to claim credit for the change in policy. This is where the real short-term threat to Fed independence will come from. Over the longer run, however, the real threats may come from a Congress tempted to look for cheap financing for projects, and we can only hope there that the true issues are understood.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] Anyone who doubts this assertion should just read the recent indictment handed down by the Justice Department in the case of 12 Russians accused of meddling in the US 2016 election. See https://www.vox.com/2018/7/13/17568806/mueller-russia-intelligence-indictment-full-text.
[2] I concentrate here on the period after the 1951 Treasury-Fed Accord and after the Fed stopped pegging interest rates, a policy instituted during WWII that made the Fed effectively subservient to the Treasury.
[3] Having been at the Board of Governors during part of Patman’s tenure in Congress, I can attest to the fact that the mere threat of appropriations or an audit instilled more financial discipline in the Fed’s operations than could be observed in agencies that were subject to appropriations and audit.
[4] See Harrison, William B., “Annals of a Crusade: Wright Patman and the Federal Reserve System,” American Journal of Economics and Sociology, Vol. 40, No. 3, July 1981.
[5] The Committee’s name has changed several times, so for simplicity it is simply referred to as the House Banking Committee.
[6] See history.house.gov/People/Detail/13906.


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Bloomberg Radio Interview: David Kotok Discusses Trade, Business with China, Potential for an Inverted Yield Curve, & Outlook for Growth

David Kotok  joined Bryan Curtis and Rishaad Salamat to discuss trade and recent company moves to downplay levels of business with China. He moves onto the potential for an inverted yield curve and the outlook for growth.

Excerpt: “The Chinese have a very firm position and it appears, will not bend. We started this and they will match us toe to toe.”

LISTEN HERE: https://www.bloomberg.com/news/audio/2018-07-19/secondary-effects-of-trade-war-only-just-surfacing

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


If you like podcasts, check out this one from 2015 featuring David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




Financial Adviser Outlines Uncertainties About the Direction of the Economy

Financial Adviser Outlines Uncertainties About the Direction of the Economy

David Kotok, the chairman and chief investment officer at Sarasota’s Cumberland Advisors, recently shared his insights into the global economy.

Excerpt below:

According to business leaders Kotok spoke to, many endorse the Trump administration’s policies on taxes and deregulation, but are concerned about the possibility of future trade wars.

Read the short blurb at Sarasota Magazine or read the recent commentary they link to here: www.cumber.com/western-trip-part-1/




Western Trip-Part 1

We’re back. During travels in four states (CO, ID, UT, WY) and participating in the Rocky Mountain Summit public conference, two private roundtables, client meetings, and prospect presentations, I encountered hundreds of business-people, econ and financial types, legal and accounting professionals, and others.

Cumberland Advisors - Takeaways

They mostly leaned Republican; most were Trump voters; and most were high-income and high-net-worth individuals.

My Takeaways:

1. They like tax cuts, repatriation, and deregulation.

2. They don’t like uncivil, personal-attack politics.

3. They don’t like attacks on constitutional freedoms like religion or assembly or press. They resent the use of the term fake news.

4. They nearly all fear trade wars and believe they are real. They didn’t, however, fear Trump’s blustering trade war rhetoric.  They worry Trump’s trade war is giving back all the benefits of item 1.

5. Peter Navarro is seen as a powerful influence who has Trump’s ear, and people fear he is sinking the president.

6. They watch Fox, Bloomberg, CNBC – few watch CNN. However, they trust neither Fox nor CNN, which are viewed as polar opposites, and many think neither of them are neutrally honest.

7. They use electronic devices and newsfeeds to glean information, but they increasingly realize how seriously social media and machine learning are manipulating and distorting their information flow. And they don’t like it.

8. They are family-oriented, communal, and charitable. This is Western territory – you help people who need help.

9. They love the outdoors, the environment – horses, fly rods, hiking. They fear global warming, and most believe climate change is the result of human behavior, not just natural weather cycles.

Now to some direct business notes:

1. Some businesses employ undocumented labor, because they have to. The average among privately owned businesses seemed to be about 20% of total hires in the hospitality, maintenance, and construction sectors. Many of these businesspeople will not bid federal jobs because they cannot comply.

2. They are watching cost increases accelerate. This is a theme I heard repeatedly.

3. Those who are subject to global supply chains are starting to see trade war effects.

4. Foreign investment is being delayed or deferred, both outgoing and incoming. I learned of two foreign owned manufacturing facilities in Idaho whose construction has been canceled because of the Trump-Navarro trade war.  Other American owned are repositioning abroad.

5. Many travel to China or have supply-chain business with China. They say Navarro doesn’t get it. Here is a link to a Peter Navarro interview with Maria Bartiromo on Fox. All of his forecasts are now proven wrong. http://video.foxbusiness.com/v/5743778657001/?#sp=show-clips

6. They fear Trump’s ignoring input from political leaders in his own party. Here is a Bloomberg report on Kevin Brady, chair of the House Ways and Means Committee. https://waysandmeans.house.gov/chairman-brady-calls-for-trump-xi-face-to-face-meeting-to-craft-fair-trade-deal-with-china/

My conclusions:

1. Economic growth peaked in the just finished second quarter and after trade war rhetoric became trade war actual. The next six quarters will see the growth rate decline.  Decline in growth was a dominant view.  Some see recession in less than two years.

2. Inflation risk is rising due to the trade war.

3. Failure to solve immigration, DACA, and the status of 12 million undocumented people working in the US is a political failure that is now translating into an economic cost with rising uncertainty premia.

4. The flatter yield curve suggests the bond vigilantes agree with the prospect of a slowing economy.

5. I agree with many economist colleagues that it is going to take a considerable shock to jolt America hard enough that we make a political policy change.

6. The political direction of the country is at a crossroads. The Pelosi–Schumer–Maxine Waters Democrats are not getting traction. The Republican hard right is scaring other Republicans who are seeking solutions, not confrontational combat.

7. I end my four-state Western trip with reinforced deep respect for the many local people I met who are caring and patriotic and are genuinely worried about the behavior of their president but who are not being given an acceptable alternative.

8. An emerging alternative is Mitt Romney, who will win the Senate seat in Utah and be his own national voice. He owes nothing to Trump. He is becoming a deficit hawk.

For investors, Bonds are telling three stories. The Treasuries curve is flattening, the muni curve less so. High-yield and junk spreads are too tight and have no room for error. We would counsel to Avoid junk credit: You are not getting paid for the risk it involves. Avoid long Treasury debt: You are not getting paid for term-structure risk. Use barbells, not ladders, in munis. The middle of the curve is very expensive.

Stocks: Watch out for FAANMG. Stay domestic and exercise caution on internationals. Favor banks, biotech, and staples. And remember, trade war risks are rising every day.

It is nice to be back in Sarasota.

David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Trump Trade War, Soybeans, Danielle DiMartino Booth, Bill Poole

Former St. Louis Fed President Bill Poole who also was an economic adviser to Ronald Reagan has written about Trump-Trade policy and published this profoundly instructive commentary on July 2. He reveals the money conflict of interests that lurk behind some of the tariffs and he proposes a simple solution.  Here is the link: The New Tariff of Abominations?

The Trump-Navarro trade war is only just starting to bite, and the growing list of casualties spans Americans from businessmen, investors, bankers, and lenders of all types to beleaguered US farmers and workers in impacted industries. With Danielle DiMartino Booth’s permission, we are featuring her excellent analysis. She recently devoted a full research note to soybeans. If you are in Iowa or Illinois or other ag states, you are now seeing the start of the damage.

If you are in Maine or Massachusetts, you see it in lobsters. If you are an auto dealer or provide dealer software support, you see it nationwide. If you are building a pipeline and need certain steel, you see it. If you are a healthcare service provider, you see it. If you are administering a college or university, you see the drop in revenue as your student headcount declines. Add cheese and diary products.

The list of impacts grows daily. Trump-Navarro took punches at China and Canada and Europe and landed those punches on the US farmer and consumer. The fallout will get worse. We see GDP growth peaking right now. The next few quarters are likely to see sequentially slower growth. Fiscal pressures are likely to intensify in many states.

How quickly collateral damage mounts and what the resulting suffering will mean for the November midterm elections remain to be seen. Over 40 House Republicans are retiring. But those who observe markets also worry when they realize that Congresswoman Maxine Waters is the ranking Democrat on the House Financial Services Committee and wants to chair that committee if the House Democratic Caucus achieves a majority after the midterms.

Let’s get to Danielle and her brief on soybeans. Danielle has developed a national persona as a regular commentator on CNBC, Bloomberg, and Fox Business and is the publisher of Money Strong, an acclaimed weekly investing newsletter. Danielle is also CEO and Director of Intelligence at Quill Intelligence LLC, where she writes the Daily Feather, a daily briefing on the economy, market trends, inflection points, and transactions. This letter offers 5-minute daily briefings like those she used to prepare for Richard Fisher during the Great Recession, when Fisher served as President of the Dallas Fed and she as his advisor. The Daily Feather is incisive, substantive, and reasonably priced. It is a designed for investors, financial advisors, investment managers, CEOs, CFOs, corporate strategists, policy makers, academics, and indeed anyone who follows the global economy. You can learn more about it here: https://quillintelligence.com/welcome-cumberland-advisors/.

Here is Danielle DiMartino Booth on farmers and soybeans and trade war damage with who wins (Brazil and Argentina) and who loses (you, my dear reader, and me) in the recent Quill Intelligence Daily Feather, “Fireworks Over the Farm Belt”.

VIPs

• By the summer of 2012, top quality Iowa farmland that traded hands for about $4000 an acre in 2006 soared past $15,000 while farm income more than doubled from 2006 to 2013.

• In 2017, China took in 57% of US soybean exports. Early this year, the USDA estimated that within a decade, China would absorb 70% of US soybean exports.

• Accumulated exports of US soybeans to China for the marketing year have fallen 27 million metric tons, 20.5% less than this time last year.

• U.S. soybean prices have now fallen from about $10.50 per bushel in late May to $8.60 as of last Friday’s close.

• Call the U.S. farmer, and Illinois and Iowa in particular, collateral damage in what is now becoming a broader trade battle.

• Next, tariffs will begin to stifle U.S. economic growth as the price of affected goods begins to bite into household paychecks.

As if Illinois didn’t have enough fiscal fireworks to contend with this Independence Day, with market weakness further crippling the state’s pensions, budgeting in Lincoln’s home state will be crimped further by the 25% tariff on U.S. soybean exports to China, which becomes effective July 6th.

Illinois is the top-producing soybean state and exports about 60% of its crop. Half of that goes to China, which equates to $7.5 billion of the state’s economic output. Craig Ratajczyk, CEO of the Illinois Soybean Association, recently warned that smaller and rural communities would be hit the hardest and that the lower-tax-revenue “multiplier effect” would cut beyond lost industry into school and hospital funding.

Though its state’s finances aren’t nearly as fragile as those of Illinois, farmers in the second-biggest soybean-producing state, Iowa, would suffer a similarly damaging setback. Life across the farm belt is already volatile enough with the whims of Mother Nature. Though they are a boon to several South American mega-soybean exporters, tariffs are the last thing American farmers need.

While it’s always been feast or famine for the American farmer (pun intended), farming has been a particularly wild ride these past few decades. By the mid-1980s, the commodity bull market of the 1970s had faded to recession. Crop prices crashed, and farmers folded under the weight of too and $10 per bushel. Imagine the challenge of your main crop’s either doubling in price or halving with zero predictability.

The tables turned in 2006, a year that marked the advent of a glorious era in farming. Soybean prices recovered and by 2007 had broken free of a 30-year price range. A bonus: the price of farmland went haywire. By the summer of 2012, top quality Iowa farmland that traded hands for about $4000 an acre in 2006 soared past $15,000 amid wildly overheated auctions. As per the USDA, farm income more than doubled from 2006 to 2013.

It’s no chronological coincidence that China’s appetite for every natural resource on the planet, including food and grain exports, skyrocketed over the same period. This was especially the case for soybeans, a robust source of nutrition with which to feed a vast population that powered a historic industrial revolution. In 2017, China took in 57% of US soybean exports. Early this year, the USDA estimated that within a decade, China would absorb 70% of US soybean exports.

Did someone mention the vagaries of Mother Nature? As welcome as the Chinese demand no doubt is, it’s been anything but a smooth ride for American soybean farmers. First came the summer drought of 2012, which sent soybean prices to historic highs. The snapback was equally vicious. By 2016, prices had sunk to 50% of their peak levels. And that same prime acre of farmland in central Iowa now goes for about $9000. Farm income has been cut in half.

As for this week’s tariff imposition, it’s apparent China has seen no need to wait out the deadline. Last month, CNBC reported that, “China canceled 136,000 metric tons of U.S. soybean purchases in the week ended May 24…. That brings accumulated exports of US soybeans to China for the marketing year to 27 million metric tons, 20.5% less than this time last year.”

While beleaguered Brazil and Argentina count their blessings as China’s new “it girl” soybean exporters, U.S. soybean prices have fallen from about $10.50 per bushel in late May to $8.60 as of Friday’s close.

Call the U.S. farmer, and Illinois and Iowa in particular, collateral damage in what is now becoming a broader trade battle. If the result is a more level playing field on trade, we can optimistically conclude that American farming communities are taking one for the team. But good sportsmanship won’t pay the bills come harvest time this fall.

In the coming weeks, as second-quarter earnings roll out, we’ll likely hear countless lamentations about the implementation of tariffs on hundreds of products by not just China, but Canada, Mexico, the EU, and others. We hope this too shall pass, and soon.

In the meantime, the tariffs will begin to stifle U.S. economic growth as the price of affected goods begins to bite into household paychecks. You are correct to deduce that the stock market will not like any combination of these factors – lower earnings, slower economic growth, and rising inflation.

But just imagine how much worse it could be. You could be the state comptroller of Illinois where it “Ain’t That America” for residents of this textbook example of fiscal dysfunctionality. Given its broken pensions and reliance on Chinese soybean exports, the state will soon sustain not one, but two fiscal body blows.




Minute By Minute

The FOMC June minutes were released this past week, along with the Committee’s most recent predictions as detailed in its Summary of Economic Projections (SEPs).

Although the press gave attention to the Committee’s views on the implications that the tariffs soon to be implemented might have for growth, in reality the minutes devoted only a couple of sentences to concerns that district contacts had about tariffs. Specifically, “… many District contacts expressed concern about the possible adverse effects of tariffs and other proposed trade restrictions, both domestically and abroad, on future investment activity; contacts in some Districts indicated that plans for capital spending had been scaled back or postponed as a result of uncertainty over trade policy.” Potential impacts on steel, aluminum, and agricultural prices and exports were noted.

While the minutes were largely unremarkable overall, there were a couple of points of emphasis that were different and potentially interesting. For example, the manager of the Open Market Desk pointed out that paydowns and maturing MBS were likely to fall short of the caps that had been established (the max for MBS being $20 billion per month), indicating that reinvestment in MBS was likely to be unnecessary and implying that shrinkage of the MBS segment of the System Open Market Account portfolio would be less than planned. Indeed, as of the end of June, the shrinkage of the aggregate portfolio was about $22 billion short of target, and at the present pace the shortfall will be much greater by the end of July.  Having said that, paydowns could, depending upon what happens to rates, again exceed the target reductions in MBS. So as a contingency, the Desk staff proposed continuing to make small MBS purchases to maintain operational readiness should redemptions exceed the targets and purchases again become necessary.

Additionally, the Committee appeared to have spent considerable time discussing the strength of labor markets and the implications that had for potential wage increases. As for risks, the Committee again noted policy uncertainty, especially with respect to trade policy and the negative implications for investment and business sentiment.

The most interesting discussion, however, in the entire set of minutes was the attention that was paid to the flattening of the yield curve and what, if any, signal that trend may have as a harbinger of a future recession. Several factors in addition to the tightening of policy were seen as possible contributors, including a reduction in the longer-run equilibrium rate of interest, lower inflation expectations, and a lower term premium, in part related to central bank asset purchases. Views appeared to be mixed and relatively split between those who felt that the above factors reduce the meaningfulness of a flattened term structure as an indicator of recession probabilities and those who felt that the flattening curve is still a useful indicator. Staff apparently presented research looking at the usefulness of measures of the spread between the current and expected federal funds rate derived from futures markets as predictors of recessions. In general, the System has continually devoted attention to yield-curve inversions as predictors of recessions, and the general conclusion is that a negative yield curve has led all but one recession since 1955, with a lag of between 6 and 24 months.[1] Bauer and Mertens’ most recent work shows two key things. First, while inversions may signal an increase in the probability of a recession, at the critical threshold of a zero spread, the probability of a recession 12 months ahead is still only 24%.[2] They also note that as of February 2018 the estimated probability based upon the spread that existed at that time was still only 11%, which they viewed as “… comfortably below the critical threshold….”

As for the risks to the economy associated with the potential trade war initiated by the US, it is interesting to look at statistics on US and China trade relative to the size of their respective economies. Current estimates suggest that China’s GDP is about $12.2 trillion, while that of the US is about $19.4 trillion.[3] Of that, US exports of $1.4 trillion are about 7% of US GDP, and imports of $2.4 trillion are about 12.4% of US GDP. Trade is much more important to China than it is to the US. Chinese exports are 17.2% of GDP, and imports (which historically have consisted of raw materials and intermediate inputs to their exports) are about 15.6% of GDP.

US trade with China, especially the deficit, has gotten a lot of attention. However, US exports to China are less than 1% of US GDP, and imports are about 2.5% of GDP. As of this writing, the administration has imposed tariffs on about $35 billion of US China imports, or about 0.2% of US GDP. While these appear to be small numbers, the impacts on certain US industries in many parts of the country, such as soybean farmers in the Midwest, are critically important to their well-being. Unfortunately, what the present approach to trade implies is picking winners and losers who bear the brunt of attempts to rationalize international trade policies, but is based upon the faulty logic that the US must have bi-lateral trade balances  with each of our trading partners.[4]  The political fallout from the coming trade war will be significant, but the immediate worry is not the overall economic impact, which by most measures is small.  Rather the more significant effects will be the impacts that tariffs may have on market psychology and business investment attitudes and decision-making. The emotional impacts may drown the real economic impacts.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] As but a small snapshot see: Bauer, Michael D., and Glenn D. Rudebusch. 2016. “Why Are Long-Term Interest Rates So Low?” FRBSF Economic Letter 2016-36 (December 5); Berge, Travis J., and Oscar Jorda. 2011. “Evaluating the Classification of Economic Activity into Recessions and Expansions.” American Economic Journal: Macroeconomics 3(2), pp. 246–277; Estrella, Arturo, and Frederic S. Mishkin. 1997. “The Predictive Power of the Term Structure of Interest Rates in Europe and the United States: Implications for the European Central Bank.” European Economic Review 41(7), pp. 1,375–1,401; Mertens, Thomas, Patrick Shultz, and Michael Tubbs. 2018. “Valuation Ratios for Households and Businesses.” FRBSF Economic Letter 2018-01 (January 8); and Rudebusch, Glenn D., and John C. Williams. 2009. “Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve.” Journal of Business and Economic Statistics 27(4), pp. 492–503.
[2] See Bauer, Michael D. and Thomas Mertens, “Economic Forecasts with the Yield Curve,” FRBSF Economic Letter, March 5, 2018. https://www.frbsf.org/economic-research/publications/economic-letter/2018/march/economic-forecasts-with-yield-curve/
[3] https://tradingeconomics.com/china/gdp; https://tradingeconomics.com/united-states/gdp
[4] Alan Blinder has a useful discussion of what we know about trade balances in WSJ July 9, 2018.

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Man Bites Dog by Bob Brusca

With all the Trumpian hullabaloo over trade, I want to share with readers a balanced, well-reasoned analysis of US trade issues penned by my good friend Bob Brusca, Chief Economist of FAO Economics. Bob makes it clear that while there are pros and cons to the US’s longtime propensity to run trade deficits, there is one overriding danger in doing so, and there are consequences that are affecting our economy today and will affect it even more seriously in the future.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Man Bites Dog; Dog Gets Tetanus Shot
by Bob Brusca
(Or how our fellow G-7 members learned to whine about trade)

All six of our fellow G-7 members are now complaining about the US and the ‘National Security’ tariffs being imposed by the Trump Administration. I will admit that I do not like this specific strategy. But on the issue of trade confrontation the US’s becoming more aggressive is long overdue. These countries among others have long taken advantage of the US and are provided in general much better access to the US market than US firms are provided access to their markets. In the case of Canada, trade is governed by the NAFTA agreement, for better or worse.

Los Seis Caballeros: The US is an unfair trader?

First let’s look at the complainants: In this corner stands the group consisting of Canada, Germany, France, Italy, the UK and Japan. The US stands alone.

Man Bites Dog Dog Gets Tetanus Shot 01

These countries (summed) have tended to run $200 billion worth of surpluses (US deficits) annually over the past decade on their bilateral accounts with the US (ten-year average is $196.5b, made smaller by the US import contraction in the Great Recession).

Why does this matter?

International economists (full disclosure: I am one) will tell you that having a bilateral deficit does not matter. They will go on to say that whether a country has a surplus or a deficit does not matter. This latter point is ‘evolutional.’ Old economics texts refer to running a current account deficit as ‘living beyond your means.’ That is hardly a statement of ‘neutrality.’ But the real point is this: WHY are so many countries running a surplus vs. the US and why are US deficits so intractable? In the case of the US, where GDP is 70% made of consumption, it is to take advantage of cheap consumer goods made abroad, NOT to invest. As a result the US more easily can finance its fiscal deficits and keep interest rates low. It can carry a higher debt load, and citizens benefit from cheaper goods today as future generations are saddled with the debt whose accumulation permits this state of affairs. Milton Friedman is reported to have said, if someone is willing to sell to you below cost you should buy as much of it as you can. Well, we have been doing that; and living for the short run has consequences. There is still a question of damage and distortion. The damage and distortion include the fact that in this instance there is intergenerational unfairness. We do the excessive consuming while future generations do the excessive paying.

The real point is that our deficits do matter and are bad because they represent consumption not investment. If the US were investing for its future these capital inflows that finance the deficit would finance themselves. But when we only use them to pay off and sustain high fiscal debt or corporate debt and to fuel consumption, then the deficits are bad.

Deficits being good or bad should not be a function of the currency regime. Under the gold standard countries WOULD NOT run deficits because they would have to pay for them in gold. Now that we only pay with fiat money IOUs, economists are no longer so concerned about whether it’s a deficit or a surplus on current account – but that is wrong. The gold standard was too restrictive, but that does not make the anything-goes floating currency regime right regardless of the outcome. Countries still need to mind their balance of payments and to run deficits for the right reason… and duration.

It should be lost on no one that the most fiscally sound countries do not run strings of current account deficits. They run surpluses.

Under a fluctuating exchange rate system, exchange rates are supposed to move to put current accounts back in equilibrium – has this happened?

The Kvetching Six

Man Bites Dog Dog Gets Tetanus Shot 02

We do not even have to look at exchange rates to answer this question. Only the UK metrics are close to a balanced position with surpluses sometimes and deficits other times. Everyone else runs only surpluses (US deficits) all the time on their bilateral accounts.

My position on this [issue] is that this is proof that WTO has got it wrong and these countries are foreign exchange manipulators that do not allow their currencies to RISE (undercutting their competitiveness and increasing their purchasing power). As a result they stay too competitive. The US remains uncompetitive. And US demand serves to stimulate growth in these countries. And, yes, the US gets more and cheaper goods as a result. It also gets higher unemployment (or less labor force participation), lower wages, lower inflation, lower interest rates, and is encouraged to carry more debt financed by foreign capital inflows (the counterpart of current account surpluses).

Of course, I do not even have on this chart some of the Asian countries that maintain an economic agenda of export-led growth.

Under FREE TRADE each country is supposed to produce according to its comparative advantage. But the US is producing less; Asia is producing more; and the US is consuming more as the structural US current account gap leaches US income off and stimulates growth overseas while taking away from growth in the US. US spending stimulates growth abroad as US citizens buy imports (foreigners’ exports) and their exporters thrive on these payments. This is NOT FREE TRADE.

It is also true that the US has fewer commercial policy (tariffs quotas and other restrictions) impediments for foreign goods, making the US an easy export target compared to other countries where US goods DO NOT face the same level playing field.

Trump’s ‘National Security’ tariffs do not remedy any of this, but they do put the rest of the world on notice that the US is finally going to stick up for its firms and that US commercial policy may be used even when the problem is not a specific foreign commercial policy.

You see, it is impossible to force a nation to appreciate its currency. But if it keeps its currency too low and keeps an unfair advantage from that, what recourse is there? Foreigners blame the US. We consume too much and save too little. But it’s the natural thing to do when faced with the choices they give us. Foreigners buy a lot of US-based financial investments, which keeps their own currencies weak. Capital flows into the dollar strengthen the dollar and weaken the currency they come from. In this way foreign holdings of US Treasury securities in particular (allegedly made to beef up needed foreign exchange reserves) are instruments of long-term currency manipulation.

Man Bites Dog Dog Gets Tetanus Shot 03

Looking at the G7 (putting the US back into this group), the chart above shows current account positions as a percentage of GDP by country. From early 1996 through 2008 the US ran the largest deficits relative to GDP. Since then Canada and the UK have surpassed the US. France has run deficits from 2008 (no data before then). Italy is back to running surpluses; so is Japan in the wake of its natural disasters, when it unexpectedly needed to import oil when it had to shut down its nuclear reactors. Germany has a surplus at 8% of GDP and may still be growing it larger.

So how is the US a trade pariah with this record?

The specifics of the Trump action are poorly chosen. The national security ruse is thin gruel, but it is legal and accessible. The US has much stronger grounds to pressure even our closest allies to shape up and be fair.

To be really fair we can step up and shoulder our share of the blame. US economists for years were in denial about the damage that global unfair trade was doing to the economy. They called it ‘fair trade’ or said it was close enough to it. Well, it is not close enough to it. The US balance of payments currently is being repaired by oil and fracking. We should not let the illusion of a smaller trade and current account deficit, because of our selling our natural resources, mask the fact that US firms are not as competitive as they need to be AT THESE EXCHANGE RATES.

There is no foolproof way to get other countries to revalue their currencies. Forcing current-account-surplus countries to make changes is nearly impossible. But Trump’s actual use of commercial policy to go after imbalances caused by other issues may have merit. Trade needs to be fair. Americans have enough ‘stuff.’ We don’t need more cheap stuff; we need jobs. And while there are gobs and gobs of jobs, there are not enough good ones. A weaker dollar would help that. But of course one aspect of Trump’s policy is that the dollar has actually been rising. And this is in part because the Federal Reserve has a program of steadily raising rates.

I hope this discussion puts the trade issues in perspective. One big problem is that no one really can observe and identify an equilibrium exchange rate. Also that an exchange rate is necessarily a bilateral thing – it takes two to tango. And it is often hard to get agreement on what it should be. But over long periods of time we can look back and see what misaligned currency rates have done. The trail of US current account deficits is such a thing. Viewing it as a problem unfortunately gets us caught up in a crossfire in which some push for a strong dollar for political or geopolitical reasons or just for what they think are patriotic issues. And if you are the greatest, best, most productive economy on earth, you will have the strongest currency, and it would not kill you. But if you are no longer that dominant economically and if you still push for such a strong dollar, bad results will follow… as we have seen. So the US situation has been the result of US misunderstandings about the facts regarding its international competitiveness and foreign opportunism. But US deficits are leaching wealth from the US. We are living off of our ‘former greatness.’ Our labor market lacks skills. The dollar can’t be the strongest currency in the world unless our capital is the newest and the best, operated by the brightest. And now the only way we get there is with H1B visas. That is not the answer.

We have many needs as a country. And you can’t start by boasting. You can trash talk before the game, but if you don’t bring it during the game, in the end you will be embarrassed. That is what is happening to the US in the wake of all this strong-dollar talk. We should aspire to a strong dollar someday. But not today. You can’t impose that on an economy that is not ready for it without some very adverse results.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Trump, Trade, Will Rogers

“It was a tumultuous first week of the quarter that has left the markets caught between more truculent tweets on trade from President Trump, and slightly more diplomatic messages from his advisors. Predictably China countered with $50 bln in tariffs of their own against a variety of U.S. imports, while the White House threatened to lump on another $100 bln tariffs to the $50 bln already on the table. Advisors Navarro and Kudlow, along with Treasury’s Mnuchin, said this was not a full blown “trade war,” but were vague as to whether negotiations had even begun, while China’s commerce ministry denied any talks had been launched.” – Action Weekly! Global Edition, April 9

“Trump’s ‘Good’ And ‘Easy To Win’ Trade War Actually Might Be Neither. States that had voted for Obama and then swung Trump’s way could be hit the hardest.” – Huffington Post headline, April 4

“White House Press Secretary Sarah Sanders said Friday that the president doesn’t want to enter a trade war with China, but if he does, he’ll win. Key quote: President Trump ‘absolutely’ still believes trade wars are easy to win. ‘If he is in charge of those negotiations, then absolutely. He’s the best negotiator…’” – Axios.com, April 6

“Donald Trump is right – the United States is not in a trade war with China. At least, not yet. As the rhetoric has flown back and forth between Washington and Beijing, breathless news coverage has made it seem as though the war of tariffs has already begun. It has not – hardly any new duties have been levied. At most, the world is in its July 1914 moment, with the clouds of trade war gathering but shots not yet fired. We’ll know soon enough whether that is indeed the correct historical analogy. For now, the war is just words, and it would be best for the planet if that’s as far as it goes, because the only way to win a trade war is not to fight it.” – Politico, April 7

“Just six words suffice to sum up President Trump’s approach to trade (and, you may mutter, too much else): make threats, strike deals, declare victory.” The Economist, March 31

We thank our friends at TLR (The Liscio Report) for their kind words about our commentaries about trade (and we thank David Blond, Bob Brusca, and Mike Drury for their guest pieces on trade and Trump). By the way, in our opinion TLR is one of the highest-frequency reports (it’s weekly) that might discern some impact on the US economy from the trade war or trade rhetoric. This research publication tracks employment data in each of the 50 states. I read it regularly and recommend it highly. Call 518-827-7094 to obtain subscription information or a trial. So far it is too soon to see any signs of trade war talk-induced change in the employment data. Our view is that it won’t be long before we see the first signs of negative impacts from Trump’s destructive bluster.

That is why the White House has already started to warn about some short-term pain for the sake of long-term gain. Larry Kudlow knows the pain is coming. He has seen the impact on the stock market, and he has seen the dramatic swings in certain commodity prices. He knows that an expectations-induced retrenchment is underway. Why would a farmer order a tractor today to plant a legume crop tomorrow when he is uncertain about future demand and prices? Why would a pig farmer build a new barn? If you made a specialty part for an airplane that was purchased by Chinese users, would you adjust your business model? Would you still order that new robot, or would you delay?

The first negative reactions to a trade war threat are changes in business expectations. And they are happening fast now.

US exports to China are varied and substantial:

“American exports of agricultural and other primary products to China totaled nearly $20 billion in 2016, which accounted for 25 percent of the industry’s exports in that year. There were also significant amounts of exports of aircraft (nearly $15 billion), motor vehicles and parts (about $11 billion) and chemicals (more than $13 billion) in 2016.” – Wells Fargo special commentary, April 5

Remember that these figures represent only exports to China, which receives just 7.8% of total US exports. Also remember that the US economy is 70% services, and services are a minuscule part of exports. The pain mentioned by President Trump and his advisers will be levied directly on the American manufacturing and goods-producing sectors and on American agriculture. My dentist in Sarasota is not impacted, but my friends in the heartland of America are already hurt because of the price changes in their markets. And every 401k in the United States has been hurt by an amount that equals all it gained in anticipation of economic growth and the benefits of tax cuts, repatriation, and fiscal stimulus. Yes, Mr. President Trump, there will be pain. You have brought it upon us.

It is clear that nobody wins a trade war. No credible person can point to net gains. A trade war is never a zero-sum game; it’s a loser’s game on both sides. So the big talk about who wins is actually a debate about who will lose more, and that’s about as dumb a debate as anyone can imagine.

Okay, what happens next? The US would like to see a negotiation and an agreement so Trump can declare victory and tell everybody how great a negotiator he is. He might get to that result with some of his other trade talks, for example those regarding NAFTA or trade with Europe; and he did enjoy a positive outcome in his talks with South Korea.

But with China the test is different.

Chinese policymakers know the US system and thoroughly understand US politics. They know what the midterm elections mean, and they see how Trump has intensified the political activism of the Trump haters while not energizing the Trump lovers. They know that presidents are vulnerable in midterms to start with – history demonstrates that fact. They know that a Democratic party swing in the midterms means a Pelosi-led House and a bill of impeachment on Trump. And they know the midterm elections are only six months away.

The Chinese political leadership doesn’t face midterms. Xi is now president for life if he wants to be and is commander in chief of the armed forces and the head of his political party, which is the only party in China. He is patient. He also knows that in another 5–6 years the Chinese economy will be the largest in the world, and the US will be second. And he knows that China is already the largest if you measure by manufacturing alone rather than including services. He knows that in the US 17% of GDP is produced by the healthcare sector. Xi knows. His advisers know. Many of them were trained in the US. Those of us in the economics field and financial markets know several of those key people. We have met with them and have visited them in China and hosted them in the US.

Rest assured that Chinese policymakers have a multi-year war plan for trade-related conflicts with the US.

We refer the president’s advisers to the Bully Buster Program. The program emphasizes control and prevention. The purpose of control is to reduce occurrences of bullying. The aim of prevention is to promote conditions in which bullying is less likely to occur. You can check it out, too. Read Bully Busters: A Teacher’s Manual for Helping Bullies, Victims, and Bystandershttps://www.researchpress.com/books/455/bully-busters.

By the way, Mr. President, the Koch brothers have read this book, too.

For our market comments let’s just summarize. We remain invested in our US stock market ETF accounts. We think the power of the tax cuts, repatriation, and fiscal stimulus may be blunted by the Trump trade rhetoric, but it won’t be killed. And a midterm election swing will not be enough to repeal those laws. A midterm swing means a stalemate in Washington and an ugly political scene – if one can imagine it more ugly than it is at present. But the economics of the new tax law will not change.

Finally, we want to leave our readers with a bit of wisdom that has been attributed to Will Rogers. We are drawn to this quote because our president is reputed not to read much and to limit his viewing to only one TV channel:

“There are three kinds of men: The ones that learn by reading. The few who learn by observation. The rest of them have to pee on the electric fence and find out for themselves.”




Suncoast FYI talks with Michael McNiven & James Curran about Financial Literacy Day

Dr. Michael D. McNiven,  Managing Director and Portfolio Manager at Cumberland Advisors, joins Dr. James Curran, Dean of College of Business at USF Sarasota-Manatee, to discuss their upcoming event, Financial Literacy Day.

Attendees of Financial Literacy Day: An Update on the Financial Markets & Economy can receive continuing ed credit from the following orgs:

• AFCPE Post Certification (7 credits)

• CFP Board (7 CE credit hours)

For a detailed agenda and registration information, please visit: www.Interdependence.org