A Day Of “Headline Risk” (Look Out Below)

Posted On May 13, 2019 By Dave Gonigam

  • China retaliates in the trade war? Say it ain’t so!
  • Even if there’s a U.S.-China deal, nothing will be settled — here’s why
  • Mysterious “incident” in the Persian Gulf propels oil price
  • How a U.S. attack on Iran could quickly draw in Russia
  • Go figure: California taxes pot to the hilt, revenue craters
  • Readers write: Why are millennials shunning entrepreneurship?

Really? No one saw this coming and suddenly the Dow is down another 600 points in reaction?

China tarrifs

Shortly before U.S. markets opened today, Beijing imposed tariffs on $60 billion of imports from the United States — mostly foodstuffs. Well, they take effect June 1 in the event there’s no “deal” with Washington before then.

As if Chinese leaders were just going to roll over and accept Washington’s move Friday to raise tariffs on $200 billion of Chinese goods from 10% to 25%.

Whatever. You can read the headlines and the reaction anywhere. For our purposes today we think it’s more valuable to step back… revisit some basic realities… and then peer far into the future with the help of someone who knows the Chinese Communist Party inside

First, a reminder: The so-called “nuclear option” is a dud.

The nuclear option is the name some financial pundits give to the idea that Beijing can “cut up Uncle Sam’s credit card,” as it were. China is the largest foreign holder of U.S. Treasury securities, with $1.13 trillion worth. That’s just under 7% of the “publicly held” portion of the national debt — that is, the part that’s not IOUs for Social Security and other federal “trust funds.”

The nuclear option got some renewed buzz this morning when The Drudge Report linked to an article featuring this tweet by Hu Xijin, editor in chief for the Communist Party mouthpiece called Global Times.

China agricultural Tweet

Dumping U.S. Treasuries sounds ominous, to be sure. The law of supply and demand dictates that if Treasury paper suddenly flooded the market, the new supply would suppress the price of those Treasuries. And because prices are the mirror image of yields in the bond market, the yields on those Treasuries would zoom higher — making it far more costly for Washington to keep borrowing and spending in the manner to which it’s become accustomed.

But that’s only a surface analysis. “If China did sell some of their Treasuries, they would hurt themselves,” said Jim Rickards in this space a year ago.

Reason being, “any increase in interest rates would reduce the market value of what they have left.” Again, prices and yields move inversely.

What’s more, Jim says the Treasury Department could strong-arm U.S. banks into buying any Treasuries the Chinese didn’t want to buy. And the Fed could easily reverse its quantitative-tightening policy in a pinch, also soaking up excess supply.

“If China pursued an extreme version of this Treasury dumping,” Jim goes on, “the U.S. president could stop it with a single phone call to the Treasury. That’s because the U.S. controls the digital ledger that records ownership of all Treasury securities. We could simply freeze the Chinese bond accounts in place and that would be the end of that.”

So there you go. Global Times can stamp its feet, but that doesn’t change the reality that China is stuck with the Treasuries it’s got.

Next, a quick refresher on what a Washington victory in the trade war would look like.

Again, we revisit some analysis Jim Rickards shared with us last year. It’s true that Trump’s trade representative Robert Lighthizer is a veteran of the 1980s trade wars. He was an architect of the tariffs that prompted Japanese and German automakers to build factories in the United States.

But there’s no similar outcome in the offing this time. No way does Washington want a bunch of factories in Ohio and Wisconsin that are owned or effectively controlled by the Chinese Communist Party.

Victory this time, said Jim, would mean the Chinese would buy more U.S. goods — soybeans, aircraft, you name it — at the expense of other providers like Canada, the European Union, Brazil and South Korea.

“They just move the order book for soybeans from Canada to Kansas,” Jim explained. “The U.S. trade deficit goes down (even if their deficit with Canada goes up; too bad for them).”

But that kind of deal might well be impossible now. There’s been too much animosity built up between Washington and Beijing in the year since we shared that analysis.

“The impending trade ‘deal’ between China and the United States – if there is one – will be at most a truce that invites further struggle,” says the veteran U.S. diplomat Chas Freeman.

Mr. Freeman was President Nixon’s lead translator during the 1972 summit with Mao Zedong that marked Washington’s “opening” to Beijing. He’s been an astute China watcher ever since.

If U.S. and Chinese negotiators come to terms, “it will be a short-term expedient,” he said in a recent speech, “not a long-term reinvigoration of the Sino-American trade and investment relationship to American advantage.

“No future Chinese government will allow China to become substantially dependent on imports or supply chains involving a country as fickle and hostile as Trump’s America has proven to be. China will instead develop non-American sources of foodstuffs, natural resources and manufactures, while pursuing a greater degree of self-reliance. More limited access to the China market for U.S. factories and farmers will depress U.S. growth rates.”

Not to put too fine a point on it, “The basic lesson Chinese have taken from recent U.S. diplomacy is that no one should rely on either America’s word or its industrial and agricultural exports.”

But that’s all in the future. Today, as noted off the top, markets are in headline-reaction mode.

At last check all the major U.S. stock indexes are down at least 2%. At 2,817 the S&P 500 is 4.2% below its record close notched two weeks ago. Chart-watchers say the next key level to monitor is 2,800.

Among the big movers is Apple — down 4.5% after the Supreme Court gave the go-ahead to an antitrust lawsuit challenging AAPL’s policies in managing the App Store. Elsewhere, Uber is down 10% on its second day of trading.

Gold is making another run at $1,300, the bid now $1,297. Bitcoin, meanwhile, has pushed past the $7,000 barrier for the first time in nearly nine months. Hmmm…

Crude is up more than 1%, to $62.37, after the latest, shall we say, eyebrow-raising headlines from the Middle East.

The Saudi Arabian foreign ministry says two of the country’s oil tankers fell victim to an “act of sabotage” yesterday in waters off the coast of the United Arab Emirates, inflicting “significant damage.”

The foreign ministry didn’t accuse anyone of the attack, but it didn’t have to. The House of Saud is sending a not-so-subtle message to the Trump administration: “OK, you just sent your big-ass aircraft carrier and a squadron of B-52s to the region last week because you think the Iranians are up to no good. Whatcha gonna do about this?”

After all, National Security Adviser John Bolton said last week the deployment sends “a clear and unmistakable message to the Iranian regime that any attack on United States interests or on those of our allies will be met with unrelenting force.” [Emphasis ours.]

We warned last week about the possibility for some ginned-up Gulf of Tonkin-style provocation in the Persian Gulf during the weeks ahead. But this incident doesn’t really rise to that standard. No one in Middle America is going to get worked up about a couple of Saudi Arabian oil tankers.

But the risk remains: “We are very worried about the risk of a conflict happening by accident, with an escalation that is unintended really on either side but ends with some kind of conflict,” British foreign minister Jeremy Hunt told reporters just today in Brussels.

What would that sort of conflict look like?

“Iran’s defensive capabilities are modest, though still robust enough to sink a few ships and damage a carrier,” says retired Army Col. Douglas Macgregor, author of five books about military affairs.

“If provoked,” he writes at The Spectator, “Tehran may simply conclude it has nothing to lose, but it’s not Iran’s capabilities that worry U.S. military planners.”

Uhhh… What does worry them?

“Russia is very unlikely to tolerate an American military intervention against Iran,” is Macgregor’s reply.

“U.S. forces already sit on Russia’s borders and routinely sail close to Russia in the Baltic, the Black Sea and the North Pacific. Iran may well be Putin’s line in the sand.

“Moscow’s space-based assets would share intelligence with Tehran. Russian ground, air defense and aerospace forces would move rapidly into northern Iran. Russian submarines would show up in short order in the Indian Ocean and the Mediterranean.”

And then what?

Col. Macgregor does not say. Perhaps from that point events become simply too unpredictable. Yikes…

How clumsy is the rollout of legal recreational marijuana in California?

Four months ago, Gov. Gavin Newsom’s office issued a budget projection for fiscal 2019 and 2020 — a period running from July 1, 2018-June 30, 2020. Total forecast cannabis tax revenue for the two-year period — $870 million.

Last week, the governor’s office issued revised projections — $647 million. “Only” 25.6% less!

The reason is no surprise if you’ve been reading The 5, but here’s a refresher from Scott Shackford, writing at Reason: “The Golden State has made it such a nightmare for consumers to buy legal recreational marijuana and for vendors to sell it — so much so that the state still has a massive black market. In some communities, according to The Associated Press, half of all marijuana purchases still take place illicitly.”

As we chronicled even before legalization took effect, California lawmakers enacted not only a 15% sales tax but also a flat $9.25 per ounce tax on flowers and $2.75 per ounce on leaves — no matter the market price!

In January we told you about legislation cutting the cannabis tax — at least temporarily through mid-2022. We understand that bill just now made it out of one committee in the lower house of the legislature… but it still has to go through another committee. Hoo boy…

On the subject of millennials launching businesses at a lower rate than previous generations, a reader writes…

“You mentioned college debt and the lack of affordable health care as obvious problems for these young people, but you forgot to mention the third leg of the trifecta of failure.

“These are the childbearing years, and with no support for families like affordable child care, family leave, sick days and so forth — no wonder most of them are still hiding in their parents’ basements playing video games.

“I know from experience with it. My relatives in Canada don’t have these problems, but then again, they don’t live like barbarians the way we do. They wouldn’t put up with it.”

The 5: Well, Canadian-style cradle-to-grave welfare is one solution, to be sure. And we’ve seen anecdotal evidence that similar governance in the Nordic countries has helped to foster entrepreneurship.

But a better solution, we daresay, is a sound monetary system of the sort we (kinda sorta) had before 1971 — when it took only one income to maintain a middle-class lifestyle.

“Maybe you/we is lookin’ under the wrong banner fer them ‘lazy’ nonentrepreneurial millennials,” writes one of our regulars.

“Let’s cross-fertilize the topic with another subject sometimes mistaken for a dirty word — for the last, oh, 120 years or so, what’s the ratio of business started by those darn immigrants as opposed to new businesses stemming from the labors of us true-blue native-born (ahem) citizens?

“Could it be that by keeping a lid on immigration we’re also holding down the new business (and new job creation) numbers?

“But back to the millennials. Perhaps some of them are yonder under that ‘One for one, and all for one (and don’t bother with college)’ banner James Altucher keeps waving. OK, he calls it ‘Choose Yourself,’ but I wanted to expand it a little. Perhaps you could check with him — he might even have some answers on the payroll and self-employment tax questions.”

The 5: We poked him on the broader subject of entrepreneurship, or the lack thereof, shortly after he came aboard here at Agora Financial two years ago — you can read his take right here.

As for immigration, we’re crashing deadline and can’t dig up exhaustive data… but Professor Samuel Staley, who we cited last week, points out immigrants “now start new businesses at double the rate of native-born Americans. Increasingly they are Latinos and Hispanics, who make up the fastest-growing segment of new entrepreneurs.”

Best regards,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

P.S. By the way, the trade war could get cranked up to a whole other level this week and almost no one is noticing.

Saturday is the deadline for the president to decide whether he’ll impose 25% tariffs on imported cars and parts. “About $6,400 would be added to the price of an inexpensive ($30,000) car,” writes syndicated columnist George Will — one of the few people who is noticing.

Just putting it on the record for you. We’ll follow up later this week if this development comes to pass. Wall Street will react badly because it will once again be caught off guard…


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