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- Volatility returns to wall street and Apple pays the price
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Have The Trade Talks With China Turned Into A Zero-Sum Game?
May 14, 2019
“Trade is not the issue – hegemony is, and I frankly don’t know how to feel about this. To be frank, if this were easy, we wouldn’t be talking about it. It’s fun, and we’re interested in it, because it’s a real sticky wicket. This is where we have it, we may lose it, there are consequences to that, and we have to think about that. But like it or hate it, losing hegemony requires a massive restructuring for the incumbent. “
– David McAlvany
Kevin:It’s funny, Dave. Oftentimes we’ll look at the crowd and say they are expecting very, very low volatility. Aren’t they wrong? Or they are crowded into a particular investment when it is overpriced. Oftentimes psychology would tell us that we may be experiencing the same vulnerability without even seeing it. It is easy to criticize others and say, “Uh-oh, you’ve got danger ahead,” without actually evaluating our own situation.
David:When we look at the VIX we had several weeks ago, we talked about the largest short position on the VIX by hedge funds and investors.
Kevin:That was an expectation of virtually no volatility.
David:That’s right. It implies an expectation of zero volatility on the horizon, zero downside in equities. And of course (laughs) last Friday through the earlier part of this week, I guess we have had a little. And you may also recall that when we were talking about the VIX, we were skeptical that the wisdom of the crowd was taking the right side of the trade. I’ve heard this from my dad a thousand times, that the majority is always wrong.
But the majority doesn’t recognize that they are wrong. They believe that they are right. And as you said, they don’t necessarily recognize that they are part of the crowd, it just feels like the right thing to do. And you don’t realize that unconsciously, you just kind of glance around to see if everyone else is doing it. And sometimes you get lost in the crowd, not consciously choosing to be in it.
Kevin:Oftentimes when I am talking to a client of mine about their investment portfolio I will ask what their thought is on the stock market. Oftentimes they will say, “Oh, I’m not in stocks. I’m not in stocks at all. I’m in Vanguard, or some other fund.”
David: You mean you’re in exchange-traded funds or mutual funds which are invested in stocks.
David:But you’re not invested in stocks.
Kevin:And so they don’t feel vulnerable. “And the stock market is over-valued. You definitely don’t want to have stocks. But nothing wrong with Vanguard.”
David:When I think of the VIX and the fact that just the week before last it was at 12.8 and it went as high as 23, and that happened in less than ten days, and yet this move up, almost a doubling, wasn’t supposed to happen. In fact, it was supposed to go the other direction. The vast majority of people were shorting the VIX believing that it would go down from 12 into the single digits.
Kevin:And it was hitting records. That was the record short on the VIX of all time.
David:How does that happen? I think investors crowd into particular themes. There is a vast amount of literature on the subject. It is very interesting, investor psychology, and some of the best work is done by Amos Tversky and Daniel Kahneman. They got the Nobel Prize in Economics in 2002 for their work on decision-making. It is a very complex field and I think all I can offer is the observation that it is very reassuring for investors to seek the solace and comfort of a majority held view.
Kevin:Most people don’t want to think of themselves as part of the majority. Most people would like to pride themselves on being sort of a maverick as far as their decision-making. But actually, there is a comfort in investing with the majority, and that can be very deceptive.
David:There are different ways in which we can be iconoclastic or move against the trend. I know that my wife, if she was ever going to be late for a class in college, she just would not go because she didn’t want to walk into class and be seen as the irresponsible iconoclast who didn’t care about time and was disrespectful of not only the…. So that was her framing of walking into the class.
Kevin:So she threw the baby out with the bath water?
David:But as an artist she is more than willing to buck the trend and do something that breaks down a particular idea and play the iconoclast. So in some sense, she will go along with the crowd. In other senses, she won’t at all. Again, we are very complex.
Kevin:So, it’s context.
David:It is, and it is not as if those investors are looking for evidence that is uniform, or assumptions that are perfectly sound. But when a crowd lines up and they are all in agreement, it is fairly nature to ask the question, “What do they all know that I don’t know?” And so there is this question of, how could they possibly be wrong? Do I want to risk it? Do I want to be wrong, not in the face of evidence, but in the face of consensus? Surely that many people can’t be wrong?
Kevin:I’ve run into this many times when people will say, “I don’t know if I should invest in gold or not. I don’t know anybody else who does it.”
David:That’s a case in point. It’s difficult to do something that not everyone else is doing. And that is typically how behavior occurs within markets. There is a crowding effect. And it is either stimulated by greed or fear, but the crowding effect happens all the same.
Kevin:This last decade has changed people’s belief, also, that the central banks may be all-powerful. Even if they see that maybe the crowded trade is wrong, there seems to be at this point a belief that the central banks have got it and that they are going to continue to have it.
David:Yes, what the central banks want they are going to get, and if they want peace and calm in the marketplace, they can orchestrate it. We discussed that last week with the use of agent-based modeling, the idea that Bookstaber develops in his book, The End of Theory, and 21stcentury determinism by the use of intelligent learning programs and big data. And of course, it is not truly a god-like activity in which people’s actions can be determined by central planners, or what have you. But it is an attempt to set up a limited number of options, and then incentivize the ones you prefer as the planner.
There may be a desired outcome, and I think this is where the problem comes in. We are idiosyncratic. We are not particularly rational. We like to think of ourselves in a certain way. We see ourselves as a certain kind of person. But people are unpredictable. We’re irrational. We operate in ways that, frankly, if you’re talking about computer models, computing can’t fully make sense of who we are and what we do.
Kevin:There is the human element, Dave. You can insult somebody and they can literally take an entire nation to war because of the insult.
David:We entered the trade negotiations with China as if we know what is best for us. Just think about that for a second. We do believe that we know what is best for us, and that is why we have our priorities set, our goals set, and everything else. But again, we are making some assumptions there. We know what’s best for us, and of course, what’s best for everyone else. And that’s the point of a negotiation. We want to enforce our will in such a way that we receive the greatest benefits possible, but we do believe that it is also good for them, or it will be good for them when they come to see it our way.
So we have these desired outcomes. Why is it we don’t simply run an algorithm, an algorithm that processes the complexity of cultural differences, trade imbalances, and what the optimal outcomes would be for everybody? Wouldn’t it be nice? The reality is that the world is not one-dimensional in that way, and it wouldn’t really work. Take, for instance, the approach that we have in our negotiations where we create a checklist. We have nine things we want to accomplish and we feel like we’re making progress if we have gotten through three, four, or five of them, and we’re now just waiting to finish the last three or four.
With the Chinese, in particular, they think, “We agree on everything, or we’ve agreed on nothing.” So if we leave three or four that are undone, and they’re looking at the trade-offs of saying yes to the first five, and they haven’t agreed to the last three or four, they can undo all of them if they don’t get everything done. But as far as we are concerned, it is this linear process of check the box and move on. And it is very confusing when all of a sudden we’re fighting and “You’re going back on your word, you already agreed to that point.”
You can’t put this into an algorithm that says, “Oh, but when you’re negotiating with the Iranians, when you’re negotiating with the Russians, when you’re negotiating with the Chinese, or whoever it may be, here is what has to be done, and it will all be neat and clean.
Kevin:Yes, this irrational behavior is a very human element. Go back to World War II, Stalin’s hatred of Hitler for the betrayal early on in the war caused an amazing amount of irrational actions that cost millions of lives. Last night we were talking about first order questions and second order questions. Let’s take the irrationality out of it. Even if you could process an algorithm between China and the United States, and the desired outcomes for both sides, we don’t necessarily agree on the first order and the second order questions.
David:Yes. There are two kinds of conversations that could be had about almost any topic, and it depends on whether or not you are being very practical, or you’re being more philosophical. So there are a host of second order questions that underlie the work that needs to be done, and it’s on which, frankly, there is very little agreement. What is the purpose of a state? What are the limits of action in international relations where you are not over-stepping bounds? Why and how should you recognize sovereignty or the agency of other countries?
Again, you have those philosophical second order questions. This gives meaning to the more practical first order questions. Policy-makers typically exist in the practical. They don’t spend as much time with the philosophical. That is what you do in your undergrad or graduate school, but once you are in the world and working, again, as a policy-maker, you’re looking at the practical.
We talked about this a little bit a few weeks ago when we covered chartelism and modern monetary theory versus metalism – bimetalism – and the meaning of money. Policymakers want to know about quantities. They don’t really care about the qualitative aspects – the whys. Again, it is, we create it, it has to flow, where is it flowing? It’s all very functional.
Kevin:And if you’re trying to be a statesman and come up with these types of trade deals, or what have you, you have to be able to match the questions. How often have you talked to somebody who has a different belief, and they will just look right through you on something that you assume everybody just assumes. Let’s even look at the One Child policy of China. Here in America we look at things quite different than the Chinese would about a woman giving birth.
David:So if a doctor walks into his office and, for instance, he assesses whether or not there are twins in the womb. You can look at a picture, you can measure the heart rates of each, and you can determine on the basis of development, time to delivery, a rough track. We just had somebody here in the office who was up this morning at 5:30, he and his wife, giving birth. But in this instance we are talking about twins, and you can measure it all, and you do all of this, and there is first order practical practitioner questions. Maybe this is a controversial point, but I think it helps make the issue clear, the difference between first order and second order questions. Has the doctor concluded that of these twins, one of the two babies is viable and the other is not, on the basis of a political policy, like the old One-Child policy in China? Or would you say, is there a greater value assignment to a male child versus a female child, and is that going to be the determination if you were going to have to abort one of these babies?
What about the newer trend? We have this here in the United States. We test for birth defects and then it is kind of optional whether or not you want to carry the baby through to full term. That’s a new trend, and it’s actually really kind of weird because I thought that was something that we saw happen in Germany in World War II, test for the imperfections and get rid of all of the – it’s a weird thing. I have a hard time explaining it to my kids without them getting somewhat frustrated and angry.
So what is viable? See what I’m getting at? As you move from the practical testing, the measuring that occurs for a prenatal doctor visit to the more philosophical questions, the assumptions of why, for what purposes the work is done – there is where you find real debate. That is where you find controversy. You may find metaphysical issues, and you find meta-ethical questions that are infused into the conversation.
So lest we forget when we are talking about trade with China, it’s not just tinker toys, and it’s not just practical applications. You can, on the one hand, as a U.S. citizen, say, “I want the best deal for the U.S.” On the other hand, you should be asking some philosophical questions about what we can expect from other nations and actors, and what does it cost us? Do we live consistently with our own views of how we want to be treated, in terms of how we are treating other people? So again, there are two conversations, one philosophical, one very practical.
Kevin:It’s a way of measurement. Oftentimes when we are asking a question, it’s how do you measure success? In a utilitarian way, an American typically measures things in dollars and cents, so when you read the news from Wall Street they are really looking at these trade discussions for one reason, and that is, “Do we make more money?”
David:Yes, so you have Goldman-Sachs saying this morning, “Look, I think this is going to cost us 2/10ths of a percent for the PCE, the measure of inflation. We should see that up-tick by 2/10ths of a percent, and this is going to be really rough for America. They want to quantify it, right? So how do we want to see the trade discussions as a utilitarian way, just by counting dollars and cents – is it according to the ratios and who gets what? The trade doctor might give us measures of goods and capital flowing to and from various partners, but the numbers don’t speak for themselves in terms of why they are the right measures in the first place, and what the meaning is of those numbers. Does that make sense?
Kevin:I wondered when I read the tweets from Trump, what are we really trying to accomplish? Is this statesmanship by insulting the Chinese? At this point their retaliation would say that maybe there is more to these tweets than just dollars and cents.
David:This is something that you and I often talk about. Sometimes it’s over a glass of Scotch, but we have models that are useful, but don’t necessarily represent the truth.
Kevin:All models are false, but some are useful.
David:But some are useful. So the grid we interpret facts by – these are constructed grids. They allow us to organize and make sense of the world, and there is more than one possible interpretive grid. So how these matrix-like systems are constructed, tied to all of our basis assumptions to the second order questions that end up supporting the practitioner type work – international relations, trade negotiations are no different than the prenatal visit, because there are ideas that govern, prioritize, or even validate the course we are on, and that is where many academics hang their hat.
This is where you can have somebody who is doing research, the ivory tower conversation – it’s the questions about the questions which to a lot of people is boring, but you will find that in many fields, the work shifts to the practical and the measurable very quickly. The practitioner, whether it is medicine or economics or diplomacy, they are no longer assessing second order questions. Those fall off the radar.
And I understand it – not everybody can deal with the abstract, not interested in the abstract. Most people are paid to get stuff done, and that is what we are doing right now, we want to see a diplomatic tour-de-force. We want to get stuff done. Let’s get this deal done. And we are forgetting that there are deeper questions that need to be assessed, and it is dealing with hegemony – our role in the marketplace.
Transition this from the diplomat to the market practitioner. Somebody who is an investor, private or professional, you wade into the trade negotiations thinking, “Look, we’ve got Powell who is at the Fed and is going to support the markets. You have the People’s bank of China. They want to see markets up and these economies growing in their own spheres, and they are going to maintain support in the markets regardless of the political choices being made to affect change with our trade partners. And the market practitioner assumes a certain rationality amongst the trade negotiators, and they look to see the market behave in binary ways. Again, this is the market practitioner saying, “It’s got to be A or B.”
The penchant to think about the world in binary terms – and market practitioners are very good at this, and this is where algorithms are particularly helpful – it’s success or failure. It’s yes or no. It’s present or not present. And then there is a reaction in light of that – we have a deal, we have no deal. There is a meaning to draw from that kind of binary outcome, but the issues are quite different and far more complex, and this is where, I think, for investors that are thinking long-term, the bigger pay-off is to see these secondary or second order questions impacting.
Kevin:I think what we’re trying to say here is, let’s just look at practitioners for a moment. Take the market part out, just look at a practitioner, a central banker. We have interviewed central bankers. Their practice is to try to create peace and calm in an economy by whatever means. It’s lowering or raising interest rates. It’s printing money. That may conflict with a market practitioner whose main goal is to play the volatility in the market – find value at a low value, and sell it at a high value. Then we look at a union member who is looking at the trade negotiations. Their practice is to get jobs for American workers. So even within our own sphere, Dave – central banking, market practitioners, union members – every one of them has a different goal for these trade negotiations and we haven’t even crossed the pond yet to look at what the different practitioner types of goals would be in China.
David:Right. So when you have two rival super-powers with different economic models based on radically different assumptions about the role of the state, the benefits of trade and capital flows, to whom those benefits should accrue, what apparatus should determine those outcomes? There are a host of second order questions and controversies that mean that the first order trade negotiations are a show. Who is the audience? We have our own political audience. Trump has an audience that he needs to appeal to. Yes, we would like to get the deal done, but why does he want to get the deal done?
Kevin:He wants to get re-elected.
David:Well, I think so. These are bigger picture questions, but can we live in a multi-polar world where two or more super-powers operate compatibly without viewing outcomes as zero sum. “If I win, you lose.” So the story behind the story is one that is not “peace on earth, goodwill toward men,” but it is a high stakes, winner-takes-all power struggle. In this sense, like Doug Noland mentioned in his weekly comments over the weekend, it’s like a multidimensional arms race. You have financial, economic, technological, military – all of these factored in. And there is more to the story than, “Is it going to be 100 billion? Is it 20%, 25%?” You can get lost in the mechanical things and not realize that there is something, actually, much bigger going on.
Kevin:There are points in history where we really see punctuation as to what is really going on – World War II, World War I, we could go back to Germany in the 1870s. We can go back all through history, and yes, peace on earth, goodwill toward men – I really think that is most people’s goal most of the time. But when the superpower status is threatened, at that point you start moving more and more toward what for years has been called war, Dave.
David:Right. Well, and we have had this conversation with Harold James. His book, The End of Globalization, points to how the global structure which has been built over the last 40 years is already being pressured. Of course, he wrote this 15 years ago, but he is saying it is under pressure. Russell Napier describes the current trade controversy as the beginning of a new cold war. And he is pointing to the radically different approaches between two state apparatuses.
The reason for the work is different, the objectives are different, the role of the state has been different, and in a weird way we are probably shifting more toward the command and control dynamics of the Chinese. The Chinese have had their 40-year version of glasnost and moved toward market capitalism, but now that seems to have changed a little bit with Xi-Jinping, as things tighten up and greater elements of control, less free markets and more direct control of believers within the economy. That seems to be how the Chinese are transitioning now.
Kevin:It was very big news when Nixon went to China – very big – because China at that point was a third world country that had huge, huge poverty, but there was a renegotiation at that time. One of the things we try to do in this commentary is to go back and look at how things have changed. We did this a couple of weeks ago when we went back to Bretton Woods and we went back to the Saudi control of OPEC and the monopoly of the dollar. Let’s go back now to China, back to the time with Deng Xiaoping was leader right after Mao died.
David:There was a shifting of the tides then, and I think there is a shifting of the tides now. Deng Xiaoping took over after Mao’s death at 76, and it began a process of market reforms that would change the global economy in our lifetime, and as Jim Kim who is the World Bank President made comment last November, it has increased Chinese per capita income 25-fold, it has lifted 800 million Chinese people out of poverty, and that accounted for more than 70% of the improvements globally in terms of poverty reduction.
Kevin:We had a symbiotic relationship with China through those years. They loaned us the money that we weren’t able to earn from our tax revenues, and we spent that money in China, basically, and ran deficits with them, where they had surpluses.
David:So where the tide seems to be shifting is, Xi Jingling is approaching the Chinese position on the world scene, not as an upstart in development as it might have been under Deng Xiaoping 41 years ago, but he is viewing things as a superpower would, worthy of maybe the #1 position, not #3, not #2, and there is more than trade at stake in these negotiations. It is not a question of assuming your place in line and figuring out who you are in the pecking order. To be frank, the negotiations are just one venue in which the U.S. is attempting to ring-fence or corral, and our chief global competitor and rival is the Chinese.
I don’t feel that. I don’t feel any animosity, this is just the way it is playing out. I can appreciate the modern educated man or woman taking offense at this idea, that somehow we win, they lose, because I think in our modern education system peace seems the more normal order of the day. And certainly over the last few decades we have had more peace and less catastrophic conflict, but the modern educated man or woman has just a very little personal experience, matched with very little historical perspective, probably not enough of either, and these modern educated folk might suggest that Trump is a monster, he is stirring up the pot, we’re losing our role of leader in the free world. Isn’t there enough space on the world scene for everyone to succeed, for everyone to win? It kind of comes from this idea that everybody gets a gold star, everyone is special.
Listen, I’m not a Trump apologist, but trade is not the issue – hegemony is. And I frankly don’t know how to feel about this. To be frank, if this were easy, we wouldn’t be talking about it. It’s fun, and we’re interested in it, because it’s a real sticky wicket. This is where we have it, we may lose it, there are consequences to that, and we have to think about that. But, like it or hate it, losing hegemony requires a massive restructuring for the incumbent.
Kevin:This has been a day that has been coming for decades. I think a lot of times people will see this as, “Well, it’s because Trump is president.” Whether they are for him or against him, they will say it’s Trump’s presidency. But the day of the loss of the United States’ hegemony has been coming – or the potential loss of that.
David:We look at all the great hegemons of old. I have this chart at home which organizes all of world history out of a timeline. It is roughly three feet tall and maybe nine or ten feet long, or wide, and it marks the rise and fall of empires. You can see one country all of a sudden starting to gobble up others and they become the dominant theme for 100 years, 200 years, 400 years, 800 years. And then all of a sudden, where they are, covering that three feet, top to bottom, and having covered left-to-right a good 12-18 inches, all of a sudden they shrink back to nothing again.
Kevin:You have a business leader in power right now. Trump is definitely the guy who wants to make the deal happen and grow the business.
David:That’s right. You have the U.S., which generally speaking is a reluctant hegemon. We want to call the shots, we want to have the world’s reserve currency, we don’t want to take orders from anyone else. So we are happy to be number one, but we don’t want to talk about it as if we are an empire. We have a little bit of guilt over that. Maybe it’s a kind of blast from the past, we don’t want to admit that maybe there is some of our past that we don’t like, so we just pretend that we are not number one on the world scene.
Well, we are, but we are a reluctant hegemon. We are an unsure global leader, and I would say that the U.S., if we remain that way, is not likely to maintain its position. Trump, on the other hand, as you mention, is brash. He is brash enough to want to expand the franchise, he wants to grow the business – the business of America. And I don’t know if he is pursuing the right policies in the right way, but what is clear is that our agenda is at odds with the Chinese.
Kevin:Dave, over the last few weeks we have talked about longstanding paradigms. Right now, at the inflection point of change, the Bretton Woods system changed through the years. Of course, we went from the gold standard to the non-gold standard, and now we may be going off of what could be the dollar standard. That’s from a currency standpoint. We talked about the petro dollar and how that was set up in the 1940s with FDR and the Saudi royal family, and how that was changed in the 1970s, or refined and maybe strengthened, with Kissinger under Nixon. And now we are seeing the replacement of this petro dollar.
The Chinese situation – Nixon and China – we had this symbiotic relationship that we talked about for the last 40-some odd years. And now this is changing. They have now grown to a rival superpower status, and they are making decisions in a way that a superpower would.
David:We will have Russell Napier join us in early June to explore the significance of some of the global changes afoot and the calculated approach – if this happens, then this is what it may mean, it doesn’t have to happen. I can tell you from my private conversations with Russell, he has concluded that the outlook for gold in the coming years is very bright, as a safe haven, yes. Maybe even as a growth-oriented asset due to the imbalance of supply and demand, yes, so also a positive factor there. But more on that in a few weeks.
The preview of our conversation with Russell, I think, will run something like this. You have the global monetary system shifting in ways we haven’t seen in 40 years. Now, you can look at little anecdotal things and say, “Is this what this is about, where the Chinese, just since March, have added 480,000 ounces of gold to what they are holding?” Like you said, you had Kissinger and their team putting deals together in the Middle East to stabilize the U.S. dollar. You had Kissinger also, with Nixon, pushing the reform agenda in China – 1978, 1979. It remade the world as we know it. And it may be in the early stages of being remade again, not necessarily to the benefit of a U.S. citizen or investor.
So change the global power structure, with the benefits that flow to the top position, and you may find a lot of our fiscal commitments are too large. Think about this. We’re trying to pay the bills that we have, according to the old system. If our bills are, in fact, increasing, going back to our conversations with Larry Kotlikoff, the idea that over the next 20 years we have unfunded liabilities, not of the 20-22 trillion that we have in current debts, but more like 20 plus another 200 trillion in terms of unfunded liabilities with Medicare, Medicaid, Social Security, things like this.
Kevin:Remember when you interviewed Joseph Tainter? I pulled that book off the shelf the other day,The Collapse of Complex Societies. It doesn’t come, usually, from another country conquering them militarily. They conquer themselves by becoming too large, too complex, and too hard to fund.
David:This is what I’m getting at. You change the global power structure and the benefits that have flowed to us, now all of a sudden it is a different economic sub-structure, and yet we have the long-term fiscal commitments which, in that changed economic environment no longer are sustainable. And that was the conversation with Tainter – great book, The Collapse of Complex Societies. You’re right, it’s the fiscal cost that gets to an unsustainable level, which causes individual agents to just abandon the project. We think of collapse of the stock market in 1987, down 22% in one day. It’s not that way. It is that societies fade away when complexity costs become too great to bear.
One of the other things, a conversation that I want to tie into this broader conversation we are having, Kevin, is with Steve Hankey. Steve has been in probably half a dozen to a dozen situations around the world where he has been called in to solve a problem of super-inflation on its way to hyperinflation. And in fact, he has been there to help solve a couple of hyperinflations, as well. This is the issue, because if the fiscal piece gets out of control and you have to start using the printing press to cover your fiscal obligations, that is a precondition for hyperinflation, according to his model. So let’s have that conversation.
But back to Tainter, it’s not uncommon for an outside cause to contribute to the initial shift in math viability. You might have a famine where all of a sudden you don’t have the food to feed people, and yet the infrastructure costs are there and people just start to migrate. It could be a war, it could be a loss of monopoly over a particular resource, maybe even a monopoly currency system.
Kevin:You and I were talking about interventions in the market, and we also see militarily, strategically, the United States’ foreign policy has been about intervention. You basically put out a fire before it turns into a forest fire.
David:That’s right. When we think of the oil markets and our shift with Iran and the exemptions that were allowed, lo and behold, do you know what the Chinese have said? “Of course, we’re going to continue to buy oil from the Iranians. That’s our business, and stay out of it.” But U.S. foreign policy has had a long record of undermining any interests not compatible with ours.
Kevin:And it has worked quite well up to this point.
David:Fascinating to me, if you look at the 1970s, how we betrayed the Shah of Iran, it has had a lingering effect. But their interests came in conflict with ours. We could not appreciate their sovereignty or why they would want to have certain national objectives, again, not commensurate or in line with our international objectives. Now decades of Chinese growth has brought benefits to the U.S. economy. It has brought benefits to the U.S. consumer. That is unquestionable.
But now the Chinese have a challenge, and they have to focus on their domestic interests. They’re in a challenging spot. They have to either choose unemployment, debt, or wealth transfers, and they all come with a certain cost. They have chosen the way of debt thus far. They are 40 trillion dollars in debt. In the last four months they have defaulted on 5.8 billion of that. That is the year-to-date figure. And out of a 13 trillion dollar bond market, according to Bloomberg on May 7th, they have a lot more that they could default on if things go catawampus. But they have to choose domestic priorities. You see what I’m getting at here.
Kevin:It’s not just China and America. We’re talking about if China is destabilized. It affects emerging markets all around the world. We’re not trying to necessarily say that this is the end of the world, but with the complexity of these trade negotiations and where we are going, we have two different players now. These are not the players from 40 years ago, these are the players from today, and they both, actually, challenge each other power-wise.
David:The Chinese want to grow, and we should want to see them grow, but if we can’t manage the direction of Chinese growth, and again, this is the presumption of the State Department and Treasury, but if we can’t, as a country, manage the direction of Chinese growth, and we see it as interfering with U.S. hegemony, either in regional military matters, or monetary matters, or trade matters, I think we are likely to coordinate the State Department and the Treasury Department toward what we have a long history of doing, which is destabilization.
The challenge is, we are in an era of globalized and interconnected interests. When China suffers now we have the emerging markets which suffer. When emerging markets suffer, along with the rest of the world, guess what the U.S. suffers? Our economic interests have been tied so tightly together in that period of 40 years of globalization and growth, there are knock-on effects, either very good, because of growth that spills from one place to the other, or very bad, depending, again, on choices and the consequences that are meted out from that. Geopolitics today is infinitely more complex than it was prior to, say, the fall of the Berlin Wall.
Kevin:Right. You can’t just have algorithms that solve the problem.
David:And we’re still dealing with the same limitations and dangers we were then. We have people who are people, after all. Think about this. Algorithms don’t stand in for statesmen the way they can in the markets on a very temporary basis, to kind of smooth things over. When you ruffle someone’s feathers, when you offend a particular country, guess what? There is no smoothing effect, no algorithm to buy a little of this, put a little liquidity in there to make it all go away.
Kevin:That’s why I think it is important on this program for us not just to talk to market practitioners. We need to talk to statesmen. We need to talk to central bankers. Robert Jervis – he is coming up, and he is going to be a great interview because this is a man who has looked at statesmanship from a human perspective for longer than just about anybody we know in that field.
David:I started reading a book of his, maybe five years ago, and it dealt with images and international relations, and how countries take the image that they want to project onto the world scene, and it is to convey what they want people to interpret them as.
Kevin:He is almost a psychologist looking at a country’s interests.
David:That’s exactly what he does. He looks at international relations through the lens of psychology. I worked through Images and International Relationsyears ago, and then he came out with another one here recently. It is a group of essays called How Statesmen Think: The Psychology of International Politics. I just can’t get over the importance of some of those themes as they apply to the current controversy between us and the Chinese.
Kevin:Let’s contrast that, then, with the central bankers who have gotten pretty proud of the fact that they can control outcomes. Do you think diplomacy is similar?
David:You have the presumption of the central bank community that they can govern outcomes, and they use carrots and sticks to do that. You have rates that they can change, you have liquidity infusions, you have other methods of either inducement to speculate or if your assets are there dormant in the banking system they can repress them, extract value to the point that you either get them in the system working or they’ll just tax the snot out of them.
Kevin:But you were talking about images that we perceive forward. I think like an American. A Chinese diplomat is going to think like a Chinese diplomat. What is the presumption coming out of D.C. right now?
David:Yes, so you have the presumption of the central banking community. The presumption of our D.C. leadership appears to be that we can get the Chinese on board with our agenda. Again, what is best for us? And Xi seems to want to make it clear that the Chinese have the rest of the world to trade with and they don’t need to take orders from Washington. The back and forth the last few days has been fascinating. Trump says, “Don’t you dare retaliate or we’re going to find an additional 325 billion that we will subject to tariffs.” Xi’s response is one thing and only one thing – retaliation, slapping tariffs on 60 billion dollars of products that are coming from the U.S. exported to China.
Kevin:Apple felt it right away, didn’t they?
David:Of course, because you have 16% of their sales which are oriented toward that part of the world definitely impacted. So you have two strongmen, not on the same page, with perhaps the same vision of sharing the global stage, but in fact, yes, one wants to be number one. Who is that? Well, it’s us, of course. Who is us? Do you see the problem? Everybody wants to be number one. And you have two strongmen not on the same page, and it makes for a scenario that overwhelms. It overwhelms the markets, it even overwhelms the algorithms.
Back to this issue of volatility – we need to be getting used to a lot more, not a lot less, volatility.