The Pence Doctrine

I subscribe to Jim Rickards's Strategic Intelligence newsletter, which combines political with stock market intelligence. Rickards devotes the last issue to the Pence doctrine, based on the speech, embedded above, which the vice president gave at the Hudson Institute last October.  Rickards compares Vice President Pence's speech to George Kennan's Long Telegram, which set the stage for the Cold War containment policy of Truman and subsequent Cold War-era presidents.

Without revealing Rickards's proprietary stock advice, I conclude that investing in China is going to be a bumpier ride than most analysts have thought and that the rationales for the Trump trade war are  more complex and subtle than I had previously thought.   The arguments for free trade are correct, but they are entirely economic. Economics does not justify trade when trade creates a political or military threat. Chinese industrial espionage and its use of economic power to coerce trade secrets from American firms do create broad military threats whose costs are not borne by the firms that do business with China but who benefit from trade.

If economic actors are politically neutral and the Trump administration can wrangle concessions from Germany and China and then go back to free trade in short order, investors will be happy and economically the world will be better off. However,  Vice President Pence makes clear that there are intransigent political and military reasons to curtail trade with China, and these will not go away anytime soon even if the Chinese adopt a policy of reciprocity. (Economically, we are better off adopting a free trade stance even if a trading partner is protectionist. However, if we are selling ee cummings's nipponized "old sixth avenue el" to World War II Japan, it's a different matter.)

That American politicians and businesses have been willing to ignore China's history and ongoing practice of mass murder and political incarceration has been, until now, a moral disgrace. Americans, including me, have ignored torture and mass killing in the interest of a cheap sponge mop.  Pence states that one million Muslims are currently incarcerated in Chinese reeducation camps, where they are tortured and brainwashed.   Beijing continues to murder political dissidents; they continue to suppress minority religions, including  Tibetans and Christians as well as Muslims; they continue to attack free speech. Beijing's socialist state  has killed and continues to kill more human beings than almost any other in history--with a handful of similarly socialist exceptions.

Tech companies like Google and websites like Quora have long been apologists for China's mass murder regime. I was chastised and then I terminated my Quora account after a moderator insisted that my criticism of Chinese mass murder was outside Quora's speech parameters.  

As Vice President Pence points out, the Chinese state is taking control of  American newspapers and TV and radio stations. It runs cloaked newspaper advertisements on behalf of its political interests; it uses American airwaves as propaganda vehicles.  The Chinese mass murder state censors speech and scholarship in American universities.

The Chinese Scholars and Students Association functions as a spying organization against Chinese students here, and information it has gathered has been used to attack families of Chinese students.  It censors movie studies, and it has made direct changes to American-made films.  (Its power to do so comes from selective granting of access to its market.) In other words, Hollywood has been willing to sacrifice American security interests for access to the Chinese market.  It has attacked the New York Times and cyberattacked the Hudson Institute, where the vice president gave the speech.

President Trump, through the concerns enunciated by Vice President Pence, is the first president since Nixon's détente to identify the  threat that China poses. This has not been recognized in Democratic Party-dominated universities, Democratic Party-dominated newspapers, or Democratic Party-dominated media.  

If Rickards is right and the Pence doctrine is going to become foundational to American policy, the trade issue is going to become more complicated rather than less, and we may be in for a protracted cold war with China. 

Trump's Fake Fix for a Bad Economic Policy

Last week, Walter Block, who has come to my classes to speak, published an excellent New York Times piece about Donald Trump's tariff-and-farm-subsidy policies.  I have heretofore been a Times skeptic, and this may just be a case of politics makes strange bedfellows.  The Times, however, has also taken an interest in Heterodox Academy.  Is there reason for hope?

The Tendency toward Self-Destructive False Equivalence

During the past year, I have heard many advocates of protectionism claim that without tariffs trade is not fair.  The Chinese have tariffs, so we need to have tariffs as well in order to make trade fair.  Trade must be equivalent. If they buy from us, we need to buy from them.

This reasoning makes as much sense as this:   Since I buy from Wal-Mart but Wal-Mart doesn't buy from me, I should stop buying from Wal-Mart.  It isn't fair that trade is one way.

That is mistaken, of course. If we buy from the Chinese, but they do not buy from us, the dollar will become weak, and the Chinese currency, the yuan renminbi, will become strong. The Chinese goods will become expensive, and Americans will stop buying them. That has not occurred because of the policies of China's communist dictators.

China's communist dictators believe that if they do not subsidize demand for their manufactured products, then their regime may collapse.  If rural inland farmers who have migrated to the cities find themselves unemployed, then they will riot.  As a result, the communists depress wages.  In accordance with the law of supply and demand, low wages stimulate employment.  The migrant farmers do not realize that their $8,000-a-year paycheck is small.  They do not know that Americans who are less productive than they are earn $40,000 a year.  

The Chinese use a few methods to keep wages low and to make their urban migrants suffer in exchange for social passivity.  These include printing ever-larger amounts of yuan; using much of the printed yuan for valueless real estate, ghost cities, and pet projects;  suppression of the yuan by directly purchasing US dollars; purchasing treasury bonds with purchased US dollars; and tariffs. 

These are self-impoverishment strategies: They make the average citizen poorer because they weaken the yuan.  At poorer wages, employment is stimulated, and citizens are too busy to riot, but most are poorer.

In exchange, Americans benefit from the option to purchase inexpensive merchandise that is cheaper than we could purchase without China's self-impoverishment strategies.  The cost of that is that some manufacturing plants close, but the benefit outweighs the cost.  If every American spends more on manufactured goods, the cost is enormous; if there is a 20% increase in manufacturing employment, the benefit is small. 

Americans follow similar but more moderate self-impoverishment strategies.  For instance, America's Federal Reserve Bank prints lots of paper money and hands it to unproductive Wall Street stock jobbers, investors who are so incompetent that they required a $29 trillion bailout ten years ago and continue to require ongoing monetary subsidization.  

The ongoing subsidization of Wall Street makes Americans poorer, of course, because someone has to pay.  At poorer wages, Americans enjoy full employment, but we don't go as far as the Chinese because our farms have been integrated into the modern economy.

Nevertheless, Wall Street benefits from other self-impoverishment policies. The subprime crisis and excessive investment in technology both have benefited investors at the expense of American workers. However, Wall Street does not benefit from tariffs and trade impediments, which are also a self-impoverishment strategy.

The decision to establish tariffs would ordinarily make Americans poorer; however, do not underestimate the stupidity of the Chinese.  They may decide to make their citizens poorer still by further purchasing additional dollars.  This may result in Americans' becoming richer as the dollar strengthens; however, there will be further disinvestment in domestically produced importable merchandise--the opposite result of what Trump's supporters want.

The tendency toward self-destructive false equivalence is seen on the left as well as among Trump's supporters. Many leftists make this argument: America is the only country to have a political commitment to freedom; isn't that a reason to end the political commitment to freedom?  Well, yes, the rest of the world has a history of gassing dissenters and Jews, and left-wing, social democratic regimes are in that long tradition.  The left has a long history of self-destructive, delusional false equivalence. It is sad that the majority of Trump's supporters have adopted it as well.

The Trade War, Central Bank Contraction, and Stock Market Volatility

Two useful emails today came from Liberty Investor’s Brandon Smith and Daily Proof’s Jim Rickards. 

Based on the correlation between G3 central bank balance sheets and stock prices, Smith  writes that the rising stock market has had had little to do with free markets but rather is the product of central bank asset purchases.  When the central bank sells assets, stock prices will reverse. 

The G3 are the US, Japan, and Europe. 

Smith claims that currently fashionable stock buybacks are the last gasp of paper money stimulus.  The trade war, in Smith’s view, is a mere distraction. 

                                     Source: Brandon Smith, Liberty Investor

Central bank monetary expansion, the result of expansion of central bank balance sheets, underlies the rising stock market that we have witnessed for the past century.  What have been remarkable about the post-2008 period are the enormous quantity of bank credit created, the enormous quantity of assets purchased, and the enormous stock market bubble. 

Central bankers and their shills in the media and academia claim that reducing asset holdings will not matter because so much assets have been purchased.  It is kind of like Bill Gates giving to charity: He is still very rich even after giving away a lot.  The Establishment claims that contraction can be done gradually and in the Goldilocks manner--just right. 

At the same time, additional regulation, including tariffs, can reduce the potency of the narcotic of flexible money by making firms less profitable, i.e., reducing efficiency.   Once a given regulatory system is in place, monetary policy will drive the stock market, but if there is disruption, then there can be sharp change. If the disruption occurs in tandem with monetary contraction, then it seems likely that it can contribute to declines.   

Smith is right that monetary contraction will threaten the stock market; adding tariffs to the mix can contribute, but it is not the underlying factor.  

Jim Rickards has been writing about central bank policy for a long time, but he puts greater emphasis on the tariffs.  He cites Patrick Donahue and Arne Delfs of Bloomberg news, who have written a piece about a warning by German chancellor Angela Merkel of a potential global financial crisis because of the tariffs.  

The Establishment is always careful not to question  central banks, for the state depends on wealth extraction from the productive population using paper money.  In this way both the financial sector and the state are aligned with the central banks. The general population believes the claims of the media and universities that big government is necessary to its well being and low wages are necessary to their happiness--except when the subject of income inequality is raised; then,low wages are a problem that requires bigger government.

Hence, Rickards's comments are compatible with Smith’s claim.  Smith's claim that news about tariffs is coordinated with central bank policy is impossible to substantiate, but the underlying elements are present. 

While stock markets decline because of monetary contraction, tapering, or deleveraging (choose your mumbo jumbo) and contraction saddens Wall Street, the average American has been hurt financially by the long-term, century-long monetary monetary expansion. It has led to declines in innovation rates and the real hourly wage. It also has led to expanding income inequality.

King Kong versus Godzilla: US and Chinese Central Banks Go to War over Trade

Tariffs are a mistaken policy---unless you find a trading partner who's even dumber than you are and is willing to foot the bill for you. President Trump may have done that. The strengthening dollar suggests a deflationary effect of the tariffs arising from Chinese dollar purchases. The dollar gets stronger, Americans can buy more; the yuan renminbi gets weaker, the Chinese can buy less but sell more. American goods will be harder to sell, but Americans will be richer and have more money to spend. If this pattern continues, some of the effects of Fed monetary policy--reduced interest rates--will be counteracted. The stock market may be in for a roller coaster as Chinese and Fed manipulation--King Kong versus Godzilla--battle it out. Americans may at least temporarily benefit. In the long term, we would have been much better off without the manipulation, without the Fed, and with a market-based system free of central bankers and Wall Street subsidization.

I have temporarily reduced my gold holdings on the chance that dollar strengthening continues and gold continues to fall. A few days ago $1240 was a technical resistance point. Gold is now down to $1217, and it looks like the drop will continue.  I suspect that the collapse in the commodity sector will continue down to the point where the Chinese stop subsidizing the dollar, probably when the dollar rises another five to ten percent. 

Will the Trump Trade War Result in a Spike in Gold?

Gold-stock analyst John Doody holds in a Kitco interview that the Trump tariffs will result in job losses. He says that, in turn, the Fed will cut interest rates. The result of further monetary expansion will be a 2001-2011-like upswing in gold prices. The trouble with his thesis is that interest rates are already so darn low that the Fed doesn't have very far to cut even if it wants to cut. I'm sympathetic to his opinion that a trade war will contribute to a declining economy, resulting in increased Fed intervention. The whole house of cards of the post-Reagan era can fall.

Tariffs Make Us Poorer in the Long Run

I was drinking last night in Snyder's tavern in West Shokan, and two friends were defending Trump's tariff program. After four Canadian Clubs, I wasn't about to go into the apples-and-oranges example that illustrates comparative advantage; then, one of the friends emailed this Breitbart column defending the tariffs because products made with the protected metals have been in strong demand. 

Comparative advantage is a simple insight: If someone can do something that you can do, even if not as well as you (i.e., so that they are poorer and less productive than you in all respects), it makes sense to have them do the thing or things at which they are most productive or at which you are least productive if it enables you to spend more time on the things on which you are most productive. The total output goes up (their production plus your greater production), and the surplus can be divided.

Studies of comparative advantage have confirmed that it works in the real world. When you shop at Wal-Mart or Target, you benefit from free trade.

When tariffs are first imposed, it is normal for output in the protected industries to go up in the short-term because the effects of making yourself poorer aren’t yet felt. In addition, today’s economy is accelerating due to the monetary expansion of the Obama years. There is high demand as the monetary cycle peaks, which probably enhances the short-term effect on the protected industries. 

The greater demand for home-based products (what Breitbart calls “firms hit by tariffs”) creates short-term employment gain in those few industries. A year or two after employment goes up in the specific industries, the prices of the protected products that they make go up, so there is less money to spend, and demand in other areas falls, so people lose jobs in computers, plastics, barber shops, and so on.

The tariffs make the protected industries seem to do better (as Wall Street has done since the 1970s because of monetary subsidies), but in a few years everything else turns sour. You will have made yourself poorer.

Here is an article by Deirdre McCloskey on comparative advantage that may be helpful.

Tariffs are one example of short-term or focusing-on-the-obvious-but-ignoring-secondary-effects thinking that the famous book by Henry Hazlitt, Economics in One Lesson, explains. It is an easy-to-read book, and I recommend it. It is available for free here.