Another Roaring Twenties May Be Ahead

We seem to be living in unprecedented times. We always seem to be living in unprecedented times, according to conventional wisdom, mostly because we don’t spend enough time studying history. There’s certainly a precedent for our current times in the past, one that was truly unprecedented back then.

World War I was followed by the Spanish Flu pandemic of 1918, which infected an estimated 500 million people and killed as many as 50 million. Given that the world population was 1.8 billion back then, that implied a 28% infection rate and nearly a 3% death rate. Both stats are currently significantly lower for the COVID-19 pandemic. Today, the global population is 7.5 billion. There have been 20 million cases and 735,000 deaths worldwide as of yesterday.

The good news is that the bad news during the previous precedent was followed by the Roaring Twenties. So far, the 2020s has started with the pandemic, but there are plenty of years left for the prosperous 1920s to become a precedent for the current decade. If so, the driver of the coming boom will be technology-enhanced productivity, as it was during the 1920s.

Before we go there, let’s go back to the late 1700s and recall the grim forecasts of Thomas Malthus. He was the first economist, and he was a pessimist. In other words, he was the first Malthusian. During the late 1700s, he predicted that populations would grow faster than food production; the result would be a regular cycle of starvation and death. He was dead wrong. Agriculture was among the industries that benefited the most from the Industrial Revolution of the 1800s. Technological progress always confounds the pessimists by solving scarce-resource problems. It also fuels productivity and prosperity, as it did in the 1920s and could do again in the 2020s. Consider the following:

(1) Technology during the 1920s. In 1920, 51% of the US population lived in cities, up from 23% in 1870. This remarkable urbanization was enabled by innovations in electricity and plumbing. Electric grids provided clean, bright light without emitting smoke. Urban water networks supplied clean water, and sewer systems removed waste without the pungent odors of chamber pots and outhouses. Telephones allowed people to converse with distant friends.

Henry Ford’s Model T, built between 1908 and 1927, was the first car invented and helped people to live an easier life by making transportation easier and faster. In 1900, just 8,000 motorcars were registered in the US, but there were 9 million in 1920 and 23 million in 1929. Streetcars and subways, unheard of in 1870, were in all the major cities by 1920. Intercity trains were becoming steadily faster and more reliable. Detroit Police Officer William Potts came up with the idea of traffic lights, taking inspiration from railroad traffic signals. General Electric bought the idea for $40,000, and traffic lights soon were everywhere.

Ford’s assembly line innovation boosted productivity in many manufacturing industries, including the processed food industry. National food brands—including Heinz, Campbell’s, Quaker Oats, Jell-O, and Coca-Cola—began to fill cupboards. Refrigerated railroad cars and in-home iceboxes meant that vegetables were available in winter. Restaurants began to proliferate early in the 20th century. When people out and about in their Model Ts got hungry, their options were few, but the first fast-food chain opened its doors in 1919, an A&W (better known today for its root beer). White Castle hamburger stands opened in 1921, and the first Howard Johnson’s restaurant in 1925.

Increasingly, anything not available in a local store could be obtained by a mail-order catalog. The Montgomery Ward catalog was first issued in 1872, the Sears catalog in 1894. By 1900, Sears was fulfilling 100,000 orders a day, and its catalog featured fur coats, furnaces, furniture, and much more—including homes. Sears sold more than 70,000 mail-order homes between 1908 and 1940. The catalog business was helped along by Parcel Post, which arrived in 1913.

Penicillin is considered one of the most important inventions to come out of the 1920s. It was created by Sir Alexander Fleming, Professor of Bacteriology at St. Mary’s Hospital in London, after studying bacteria in 1928. The antibiotic kills or prevents the growth of bacteria.

The bulldozer—used today in all kinds of construction the world over—was invented in 1923 by James Cummings and J. Earl McLeod, originally to dig canals.

Another popular invention found in almost every home by the mid-1900s was the radio. Listening to the radio became a national pastime, and many families gathered in their living rooms to listen to sports news, concerts, sermons, and “Red Menace” news. The phonograph—invented in 1877 and widely used by the 1920s—offered another entertainment option: listening to professional-quality music at home, unheard-of in earlier generations. Outside the home, going to motion picture shows—which were silent until 1927—was a very affordable and popular pastime.

(2) Technology during the 2020s. Today’s doomsters could be confounded by biotechnological innovations that deliver not only a vaccine for COVID-19 but for all coronaviruses. Scientists are investigating a dizzying array of approaches to fight COVID-19. Hopefully, beyond finding a cure or a vaccine, one of beneficial outcomes of all this research will be that scientists learn many more ways to combat illnesses in general and viruses in particular. Typically, it takes roughly a decade for a new vaccine to go through the various stages of development and testing. However, the urgency of the pandemic has mobilized global medical resources as rarely seen in human history. Billions of dollars, provided by both the public and the private sectors, are funding the global campaign to develop tests, vaccines, and cures for the virus.

My colleague Jackie Doherty and I have been writing about disruptive technologies for some time, usually in our Thursday commentaries. (See our archive of Disruptive Technologies Briefings) The awesome range of futuristic “BRAIN” technological innovations includes biotechnology, robotics and automation, artificial intelligence, and nanotechnology. There are also significant innovations underway in 5G for cellular networks, 3-D manufacturing, electric vehicles, battery storage, blockchain, and quantum and edge computing.

As I wrote in my 2018 book Predicting the Markets:

“Economics is about using technology to increase everyone’s standard of living. Technological innovations are driven by the profits that can be earned by solving the problems posed by scarce resources. Free markets provide the profit incentives to motivate innovators to solve this problem. As they do so, consumer prices tend to fall, driven by their innovations. The market distributes the resulting benefits to all consumers. From my perspective, economics is about creating and spreading abundance, not about distributing scarcity.”

Now consider the follow stats on technology capital spending in the US: High-tech spending on IT equipment, software, and R&D rose to a record $1.32 trillion (saar) during Q2-2020 (Fig. 1). It jumped to a record 50.1% of total capital spending in nominal GDP during the quarter (Fig. 2). Equipment and software accounted for 31.1%, while R&D accounted for 19.1% of capital spending in nominal GDP (Fig. 3).

The 1920s ended with a stock market meltup followed by a meltdown. The 2020s may already be seeing a meltup, begun on March 23. We live in interesting, though not unprecedented, times. The Roaring 1920s could be a precedent for the Roaring 2020s. As Mark Twain observed: “History doesn’t repeat itself, but it often rhymes.”

May the Bond Vigilantes Rest in Peace

Bonds I: Eulogy. Let me begin my eulogy for the Bond Vigilantes with apologies to William Shakespeare. The emotional eulogy for Julius Caesar that Shakespeare penned for the character Marc Antony in his play Julius Caesar inspired the words that I would like to share with you on this solemn occasion:

Friends, countrymen, citizens of the world, lend me your ears. I come to bury the Bond Vigilantes, not to praise them. The noble Fed killed its rival, the Bond Vigilantes, because they were too ambitious. If it were so, it was a grievous fault. The Bond Vigilantes sought to marshal market forces to counter the ever-growing power of the government. That cause is noble and good. But while the evil that men do lives after them, the good is oft interred with their bones—so let it be with the Bond Vigilantes. Their well intentioned efforts were doomed to failure. The Fed meant well too, as did Caesar’s assassins. Both comprise honorable men. But men have lost their reason. Bear with me; my heart is in the coffin there with the Bond Vigilantes, and I must pause ’til it come back to me.

Bonds II: Requiem. My friends, I still fondly recall the days when the Bond Vigilantes rode high and mighty. The July 27, 1983 issue of my weekly commentary was titled “Bond Investors Are the Economy’s Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

To this day, every time bond yields rise significantly almost anywhere in the world, I get asked to appear on at least one of the financial news TV networks to discuss whether the Bond Vigilantes are back. Having popularized “hat-size bond yields” and “Bond Vigilantes,” I’ve learned to appreciate the power of coining pithy terms to brand my economic and financial forecasts. Coin a good phrase that accurately describes future developments, and it will appear in your obituary, if not on your tombstone.

The Bond Vigilantes Model tracks the rise and fall of the Wild Bunch. It simply compares the bond yield to the growth rate in nominal GDP on a year-over-year basis (Fig. 1). My model shows that since 1953, the yield has fluctuated around the growth rate of nominal GDP. However, both the bond yield and nominal GDP growth tend to be volatile. While they usually are in the same ballpark, they rarely coincide. When their trajectories diverge, the model forces me to explain why this is happening. On occasions, doing so has sharpened my ability to see and understand important inflection points in the relationship. Here is a brief nostalgic walk down Bond Street:

(1) Getting whipped by inflation. From the 1950s to the 1970s, the spread between the bond yield and nominal GDP growth was mostly negative (Fig. 2). Investors underestimated the growth rate of nominal GDP because they underestimated inflation. Bond yields rose during this period but remained consistently below nominal GDP growth. Those were dark days for bond investors.

(2) Keeping law and order. The Bond Vigilantes were increasingly in command during the 1980s and 1990s. They fought to bring back law and order in the fixed-income markets to the benefit of bond investors. There were several episodes when rising bond yields slowed the economy and put a lid on inflation.

The Bond Vigilantes’ heyday was the Clinton years, from 1993 through 2001. Placating them was front and center on the administration’s policy agenda. Indeed, Clinton political adviser James Carville famously said at the time, “I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

(3) Long siesta. After the mid-1990s, the Bond Vigilantes seemed less active, because they no longer had to be as vigilant. As inflation fell, the spread between the bond yield and nominal GDP growth narrowed and fluctuated around zero. While today the US government faces the problem of persistently big federal budget deficits, it’s interesting to recall that at the start of 2001, a major topic of discussion was how big the coming surplus in the federal budget might get.

During the early 2000s, after the 9/11 terrorist attacks, the Fed kept the federal funds rate too low, and a global savings glut kept a lid on bond yields and mortgage rates. They remained relatively flat even as the Fed started raising the federal funds rate “at a measured pace” of 25bps moves, from 1.00% to 1.25% on June 30, 2004 up to 5.25% through June 29, 2006 (Fig. 3).

(4) Long good buy. The Great Financial Crisis (GFC) of 2008 caused the Fed to implement ultra-easy unconventional monetary policies. The federal funds rate was pegged in a range of 0.00%-0.25% from December 16, 2008 through December 16, 2015. The Fed’s three QE (quantitative easing) programs caused the Fed’s holdings of bonds to balloon from $0.48 trillion during the final week of November 2008 to $4.19 trillion by the start of October 2014 (Fig. 4). Inflation remained remarkably subdued after the GFC. Starting January 2012, the Fed targeted core PCED (personal consumption expenditures deflator) inflation at 2%, but it has remained below that pace during all but 13 months since then (Fig. 5).

The Fed’s QE3 was terminated near the end of 2014, and the federal funds rate was raised for the first time since the GFC on December 16, 2015. Fed officials continued to ratchet rates higher up to 2.25%-2.50% on December 19, 2018. They were expecting to normalize monetary policy (Fig. 6).

Nevertheless, investors, reaching for yield, poured money into bonds. The 10-year US Treasury bond yield fell to 1.92% at the end of 2019 (Fig. 7). It was a long good buy from the peak in its yield of 15.84% back on September 30, 1981 (Fig. 8).

(5) Last rites. The bond yield fell below 1.00% for the first time on March 5, 2020, and has been consistently below since March 20. The World Health Organization declared a pandemic on March 11. The Fed responded to the Great Virus Crisis (GVC) by lowering the federal funds rate by 100bps to zero and implementing QE4 on March 15. On March 23, QE4 was turned into QE4Ever. The bond yield fell to a record low of 0.55% on Friday. The Bond Vigilantes have been buried by the Fed.

Bonds III: The Inflation Scenario. Many investors who profited from the long good buy are now saying “you are dead to me” to the bond market. They are rebalancing more of their portfolios into other assets, such as US stocks, SPACs (special-purpose acquisition companies), precious metals, and overseas assets including currencies, stocks, and bonds.

The end of the long-term bull market in bonds has been declared, erroneously, by market prognosticators for many years. It may not be over just yet. The yield on the 10-year Treasury could still fall to zero. It could even turn slightly negative, as have comparable yields in Germany and Japan (Fig. 9).

Then again, what if a vaccine and effective treatments are discovered to end the pandemic early next year? Never before has the drug industry received billions of dollars to develop such medicines at warp speed. In this scenario, the global economy could recover quickly next year. Inflation could finally jump above the Fed’s 2.0% target as demand for goods and services outstrips supply, especially if global supply chains have been significantly disrupted by the pandemic and by the worsening Cold War between the US and China.

Would rising inflation cause bond yields to soar? I don’t think so. Both monetary and fiscal officials know that rising interest rates could abort the post-GVC recovery. They also realize that a rebound in interest rates would significantly balloon federal deficits and the debt. Net interest paid by the federal government totaled $346.9 billion over the 12 months through June, down from a record high of $384.8 billion during March (Fig. 10).

I believe that the Fed publicly would welcome inflation in a range of 2.0% up to 4.0% as a long overdue offset to inflation running below 2.0% for so long in the past. In this scenario, the Fed might announce that the federal funds rate will be held at zero and that the bond yield will be pegged below 1.00%. In other words, any sign that the Bond Vigilantes might rise from their graves (along with inflation) would be met by the Fed with whatever it takes to keep them buried. This would be wildly bullish for all of the alternative assets to bonds mentioned above, especially growth stocks and precious metals.

My view that the Fed’s attitude toward rising inflation is evolving into one of benign neglect was confirmed by an important August 2 article by Nick Timiraos, the WSJ’s ace Fed watcher, titled “Fed Weighs Abandoning Pre-Emptive Rate Moves to Curb Inflation.” Timiraos reports that the Fed “is preparing to effectively abandon its strategy of pre-emptively lifting interest rates to head off higher inflation, a practice it has followed for more than three decades.”

The Fed first formally targeted inflation in a January 25, 2012 press release titled “Federal Reserve issues FOMC statement of longer-run goals and policy strategy.” It stated: “The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate.” The widespread interpretation was that once the target was achieved, it would be a ceiling.

Timiraos reports that some Fed officials wouldn’t mind if inflation were to run hot above 2% for a while since it has run cold for so long. They want to offset previous deviations on the downside with a stretch of inflation overshooting the 2% target for a while.

Might all of this eventually lead to hyperinflation? I am not in the hyperinflation camp. But if that’s the ultimate endgame of Modern Monetary Theory (MMT), then all bets are off.

Bonds IV: The Dollar Vigilantes. Of course, the death of the Bond Vigilantes could lead to the emergence of other vigilantes in the financial markets. The Dow Vigilantes got what they wanted in response to the freefall in stock prices from February 19 through March 23. They got QE4Ever plus the CARES Act. The result has been trillions of dollars printed and spent by Fed Chair Jerome Powell and Treasury Secretary Steven Mnuchin.

The Gold Vigilantes are certainly expressing their fear and loathing of this unholy alliance between fiscal and monetary policies. But they don’t have the kind of power that the Bond Vigilantes once had to rein in policy excesses. The only market players left with any power are the Dollar Vigilantes. They have lots of fear and loathing of MMT and can do something about it.

They can devalue the dollar relative to other currencies, thus putting upward pressure on import prices, which could revive inflation. Even the Wizards of MMT acknowledge that they should at least think about tapping on the brakes if inflation makes a comeback.

Welcome to Oz, Where MMT Enables the Government to Get Bigger!

We live in surreal times. I’ve previously compared them to the TV series The Twilight Zone. However, a more apt comparison would be with the land that Dorothy and her dog Toto visited in the movie "The Wizard of Oz." When a tornado ripped her house from its foundation, causing it to crash-land in Oz, she emerged safe and sound, looked around in wonder, and famously marveled, “Toto, I’ve a feeling we’re not in Kansas anymore.” Oz had a colorful cast of characters, including assorted Munchkins, the Good Witch of the North, the Bad Witch of the West and her Winkie Guards, and a blustery wizard—not unlike Washington today. And the news these days showcases plenty of national and local leaders behaving like cowardly lions, heartless tin men, and brainless straw men.

The analogy with Oz was first provided by none other than the Wizard of MMT, Professor Stephanie Kelton. In her book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy, she wrote: “Like Dorothy and her companion in The Wizard of Oz, we need to see through the myths and remember once again that we’ve had the power all along.”

Kelton was referring to Dorothy’s power to go back home to Kansas simply by clicking the heels of her ruby-red slippers three times. Similarly, Kelton believes that the US government has always had the power to run huge budget deficits and should be doing so now to cure all our ills. As a result of the Great Virus Crisis (GVC), her theory has taken on a life of its own beyond her wildest dreams. Governments around the world are spending massively on stimulative fiscal policies to offset the recessionary forces unleashed by the GVC.

Most of those contractionary forces have been driven by the extreme government lockdown policies adopted to impose social distancing to slow the spread of the virus. So far, all the government stimulus has provided some support for the global economy. But the virus is still out there, and so are the recessionary forces. As a result, price inflation remains subdued even though much of the ballooning fiscal deficits are being financed by central banks’ purchases of government securities, which MMTers also support.

In Kelton’s dreamland, that’s a perfect outcome, because she and her merry band of arm-linked MMTers believe that the only limit on deficit-financed government spending is price inflation. Sure enough, the US government has responded precisely as she advocates, producing one stimulus program after another. Another one is imminent, sized to the tune of $1.0 trillion, which will most likely cause the Congressional Budget Office to raise its current fiscal 2020 budget deficit estimate from $3.7 trillion to $4.7 trillion…click, click, click (Fig. 1 and Fig. 2). No problem: The Fed will continue to buy more Treasuries…click, click, click (Fig. 3 and Fig. 4).

Melissa and I have written previously about MMT. Our latest analysis, titled “Modern Monetary Theory: In Theory & In Practice,” was in our July 8 Morning Briefing. We wrote:

“Kelton argues that the federal government can and should run large budget deficits as long as inflation remains subdued. MMT opponents’ main objection is that the theory provides a blank check for the government to get much bigger. It provides the government with too much power to allocate resources. Free-market capitalists believe that markets do a much better job of doing so than politicians and bureaucrats. Kelton clearly disagrees. … But whether one is for MMT or against it, Kelton’s book leaves no doubt about what MMT is all about: It’s an agenda for more big government and higher taxes.” In brief, it legitimizes a massive power grab by the government for our own good.

Kelton probably would welcome the opportunity to be Treasury secretary if the Democrats win the White House in November. Ironically, her views already are reflected in the current Republican administration’s fiscal policymaking! By the way, Kelton contributed to the 110-page Biden-Sanders Unity Task Force Recommendations. Other contributing luminaries included former US Secretary of State in the Obama administration and former Senator (D-MA) John Kerry, Representative Alexandria Ocasio-Cortez (D-NY), former US Attorney General under Obama Eric Holder, former White House Chief Economist under Obama Jared Bernstein, and American Federation of Teachers President Randi Weingarten. So Professor Kelton is either in good company or bad company depending on your political leanings.

We concluded our analysis: “But remember, the story was all a bad dream Dorothy had after getting hit on the head. Free market capitalists might exclaim: ‘Pay no attention to the professor behind the curtain!’” We like to think of “The Wizard of Oz” as a long episode of The Twilight Zone.

More Declarations of War Signal US-China Cold War Heating Up

China’s mercantilist trade war against the US effectively started when China joined the World Trade Organization (WTO) on December 11, 2001. The US supported China’s admission to the WTO, expecting that China would abide by the organization’s rules, which mostly promoted free trade among its 144 member nations back then. (There are 164 members currently.) Instead, the Chinese abused their membership by pursuing mercantilist trade policies. They persistently and systematically violated the organization’s trade rules by using their WTO status to unfair advantage.

However, US officials didn’t publicly acknowledge that the US had been duped until Donald Trump became president. During the presidential election campaign, Trump often promised to take effective measures to correct America’s huge bilateral trade deficit with China. He called China one of the “greatest currency manipulators ever.” He declared that he would instruct the Treasury Department to so label China when he became president.

On April 13, 2018, the Treasury Department, in its biannual currency exchange report, scolded China for its lack of progress in reducing the trade deficit with the US but did not find that it was improperly devaluing its currency, the renminbi. Actually, it was the third time since Trump assumed the presidency that the Treasury Department opted not to accuse China of improper meddling. Instead, the administration opted for tariffs as an alternative means to pressure the Chinese to fix the trade problem.

By the way, previous administrations recognized the problem, but chose a less public and lower-key diplomatic approach to get China to change its ways. For example, to kick-start negotiations to resolve the problem, the Clinton administration slapped the “currency manipulator” label on China in 1994. That was well before China was admitted to the WTO.

In other words, the problem has been festering for a very long time indeed. The US merchandise trade deficit with China was $29.5 billion in 1994 (Fig. 1). Even back then, it was almost 20% of the total US trade deficit (Fig. 2). By 2018, it was up to $419.0 billion, accounting for 48% of the total trade gap.

Let’s briefly review the escalating tensions in the Cold War between the US and China:

(1) Peter Navarro is still Trump’s China hawk. Unlike most of President Donald Trump’s early-term advisers, Peter Navarro is still in the White House. Melissa and I profiled him in our March 8, 2018 Morning Briefing, fittingly titled “Meet Peter Navarro.” We wrote that “the White House director of the National Trade Council seems to be gaining influence and may even be up for a promotion.” Sure enough, he since has been promoted to assistant to the President, Director of Trade and Manufacturing Policy, and the national Defense Production Act policy coordinator.

Navarro long has been a critic of China’s mercantile trade practices. In fact, he literally wrote the book on this subject in 2011, fittingly titled Death by China: Confronting the Dragon—A Global Call to Action. Here is an excerpt from the book’s Amazon description: “The world’s most populous nation and soon-to-be largest economy is rapidly turning into the planet’s most efficient assassin. Unscrupulous Chinese entrepreneurs are flooding world markets with lethal products. China’s perverse form of capitalism combines illegal mercantilist and protectionist weapons to pick off American industries, job by job. China’s emboldened military is racing towards head-on confrontation with the U.S. Meanwhile, America’s executives, politicians, and even academics remain silent about the looming threat.” Most importantly, above and beyond China’s unfair trade practices, Navarro strongly suggested that China posed an existential threat to America’s national security.

(2) The President’s 2018 UN speech. In his September 25, 2018 speech before the United Nations General Assembly, Trump said the following about China, focusing on trade: “The United States lost over 3 million manufacturing jobs, nearly a quarter of all steel jobs, and 60,000 factories after China joined the WTO. And we have racked up $13 trillion in trade deficits over the last two decades. But those days are over. We will no longer tolerate such abuse. We will not allow our workers to be victimized, our companies to be cheated, and our wealth to be plundered and transferred. America will never apologize for protecting its citizens. … China’s market distortions and the way they deal cannot be tolerated.”

(3) The Vice President’s 2018 speech. In an October 4, 2018 speech at the Hudson Institute, Vice President Mike Pence discussed the administration’s case against China in far greater detail. He started out by warning: “Beijing is employing a whole-of-government approach, using political, economic, and military tools, as well as propaganda, to advance its influence and benefit its interests in the United States.”

The rest of the speech was a no-holds-barred blistering attack on the Chinese government. He accused the Chinese Communist Party (CCP) of using “an arsenal of policies inconsistent with free and fair trade, including tariffs, quotas, currency manipulation, forced technology transfer, intellectual property theft, and industrial subsidies that are handed out like candy to foreign investment.” He specifically berated the party’s “Made in China 2025” plan for aiming to control 90% of the “world’s most advanced industries including robotics, biotechnology, and artificial intelligence.” He accused China of economic and military aggression abroad. Pence also documented instances of China using so-called “debt diplomacy” to expand its influence. Pence accused the Chinese government of oppressing its own people at home. He stated that the US was taking steps “to protect our national security from Beijing’s predatory actions.”

The S&P 500 plunged 19.8% from September 20 through December 24, 2018. In our October 15, 2018 Morning Briefing titled “Panic Attack #62,” we listed six reasons for the selloff. We included the Veep’s speech: “Also setting the stage for last week’s selloff was a 10/4 speech by Vice President Mike Pence detailing the Trump administration’s long list of complaints against China. It wasn’t just about trade ... Pence’s speech made it clear that the problem is that China aspires to be a superpower at the expense of the US. While Trump seems to be winning his trade wars with most of America’s major trading partners, the conflict with China is likely to worsen because it isn’t just about trade. It is about national security.”

(4) The President’s 2019 UN speech. In a September 24, 2019 speech at the UN, Trump again called out China, berating Beijing as follows: “In 2001, China was admitted to the WTO. Our leaders then argued that this decision would compel China to liberalize its economy and strengthen protections … for private property and for the rule of law. Two decades later, this theory has been tested and proven completely wrong. Not only has China declined to adopt promised reforms, it has embraced an economic model dependent on massive market barriers, heavy state subsidies, currency manipulation, product dumping, forced technology transfers, and the theft of intellectual property and also trade secrets on a grand scale.”

(5) No Phase 2 to follow Phase 1. After an escalating trade war between the US and China during 2018 and 2019, with both sides raising their tariffs on the other, both parties signed a “Phase 1” trade agreement at the start of this year. It deescalated the trade tensions but left some of the toughest issues for a future Phase 2 deal. While Phase 1 focused mainly on Chinese purchases of US goods, improved US access to China’s financial services market, and some intellectual property issues, Phase 2 was meant to tackle far more difficult issues associated with China’s technology transfer policies, industrial espionage, and government subsidies to state-owned enterprises.

On Tuesday, July 14, Trump shut the door on the next round of trade negotiations with China, saying he does not want to talk to Beijing about trade because of the coronavirus pandemic. “We made a great trade deal,” Trump said, of the Phase 1 agreement signed in January. “But as soon as the deal was done, the ink wasn’t even dry, and they hit us with the plague,” he said, referring to the novel coronavirus, which emerged from the Chinese city of Wuhan.

At the White House, Trump also announced that he signed legislation and an executive order to hold China accountable for the “oppressive” national security law it imposed on Hong Kong. The measure approved by Congress gives Trump’s administration the authority to penalize banks doing business with Chinese officials who implement Beijing’s new national security law on Hong Kong. Trump said he has no plans to talk with Chinese President Xi Jinping.

(6) Pompeo weighs in. In a statement on Monday, July 13, US Secretary of State Mike Pompeo said he was aligning the US position on China’s maritime claims in the South China Sea with the 2016 ruling of an international arbitral tribunal in The Hague. This places the US squarely behind the interests of Vietnam, Malaysia, Indonesia, Brunei, and the Philippines, all of which have serious disputes with Beijing.

On Thursday, July 16, Pompeo repeated the administration’s charge that the Chinese government “was aware of human-to-human transmission” of the coronavirus “before they shared this with the world.” The day before, he said, “I’m very confident that the world will look at China differently and engage with them on fundamentally different terms than they did before this catastrophic disaster.”

(7) Raising other barriers. The Senate passed legislation on May 15 that could ban many Chinese companies from listing shares on US exchanges or raising money from American investors without adhering to Washington’s regulatory and audit standards. That same day, the Trump administration issued a new rule that will bar Huawei and its suppliers from using American technology and software, a significant escalation in the White House’s battle with the Chinese telecom giant and one that is likely to inflame tensions with Beijing. The rule change, which is slated to go into effect in September, will block companies around the world from using American-made machinery and software to design or produce chips for Huawei or its entities.

On August 15, companies that bid on US federal contracts must certify that they do not use banned products or services from telecom giants Huawei and ZTE, camera makers Hangzhou Hikvision Digital Technology and Zhejiang Dahua Technology, or radio manufacturer Hytera Communications. Washington cites the risk of sensitive information leaking to Beijing.

Taiwan Semiconductor Manufacturing Co. Ltd stopped taking new orders from Huawei in May and does not plan to ship wafers after September 15. On July 14, Britain announced that it would ban equipment from Huawei from the country’s high-speed wireless network, a victory for the Trump administration that escalates the battle between Western powers and China over critical technology.

Last week, reports surfaced that the White House is considering putting TikTok on a blacklist that effectively would prevent Americans from using the popular video app, as one option to prevent China from obtaining personal data via the social media platform.

(8) Japan paying companies to leave China. On July 18, Bloomberg reported that the Japanese government will pay at least $536 million for companies to leave China: “Japan’s government will start paying its companies to move factories out of China and back home or to Southeast Asia, part of a new program to secure supply chains and reduce dependence on manufacturing in China.”

(9) The Attorney General’s speech. On Thursday, July 16, Attorney General William Barr warned that the CCP has launched an “economic blitzkrieg” to topple the US from its perch as the world’s superpower, laying out the threat as the most important issue of this century and calling for the Free World to join together in a “whole of society approach” against it.

“How the United States responds to this challenge will have historic implications and will determine whether the United States and its liberal democratic allies will continue to shape their own destiny or whether the CCP and its autocratic tributaries will control the future,” Barr said during a July 17 speech in Michigan.

In some ways, Barr’s speech was even more blistering than Pence’s speech in 2018. He got personal: “The General Secretary of the Chinese Communist Party, Xi Jinping, who has centralized power to a degree not seen since the dictatorship of Mao Zedong, now speaks openly of China moving ‘closer to center stage,’ ‘building a socialism that is superior to capitalism,’ and replacing the American Dream with the ‘Chinese solution.’”

As Pence had done in his speech, Barr blasted the CCP’s “Made in China 2025” initiative to dominate high-tech industries like robotics and information technology and electric vehicles, which “poses a real threat to US technological leadership.” The 2025 plan is a “state-led, mercantilist economic model. For American companies in the global marketplace, free and fair competition with China has long been a fantasy.” Barr warned that the “ultimate ambition of China’s rulers isn’t to trade with the United States. It is to raid the United States.”

Barr attacked China’s “ruthless crackdown of Hong Kong.” He said that China is as authoritarian now as it was in 1989 when tanks confronted pro-democracy protesters in Tiananmen Square. He criticized American companies that “have come under Beijing’s influence—even at the expense of freedom and openness in the United States.”

(10) Closing consulates. On Wednesday, July 22, we learned that the US State Department abruptly ordered China to shut down its consulate in Houston “in order to protect American intellectual property and Americans’ private information.” In addition, the Justice Department announced criminal charges against hackers, working with the Chinese government, who targeted firms developing vaccines for the coronavirus and stole hundreds of millions of dollars’ worth of intellectual property and trade secrets from companies across the world.

On Thursday, July 23, Secretary of State Mike Pompeo delivered a blistering attack in a speech titled “Communist China and the Free World’s Future.” Here, in his words, is the key theme of his speech: “The truth is that our policies—and those of other free nations—resurrected China’s failing economy, only to see Beijing bite the international hands that were feeding it. ... Securing our freedoms from the Chinese Communist Party is the mission of our time, and America is perfectly positioned to lead it because our founding principles give us that opportunity.” His main conclusion was unambiguously hostile toward the Chinese government: “The free world must triumph over this new tyranny.”

On Friday, July 24, Beijing retaliated by ordering the closure of the American consulate in Chengdu. So far, the Chinese haven’t retaliated for the US moves to block Huawei from doing business around the world. What if the Chinese do so against Apple, Microsoft, NVIDIA, Tesla, or other American companies?

Peter Navarro certainly has won the debate over China within the Trump administration, hands down.

Fiscal & Monetary Policies Inflating Bubbles While Fighting Virus

Asset prices around the world are melting up. It isn’t just stock prices that are soaring. It’s also the prices of inflation-protected bonds. Precious metals prices are moving higher too. Home values are appreciating as well. Some of these bullish trends may be driven by expectations that the billions of dollars being spent on a vaccine will pay off. Undoubtedly, the main reason for the widespread bull markets in assets is the fact that governments around the world are spending and printing trillions of dollars, euros, yen, and yuan to offset the economic shock from the Great Virus Crisis (GVC). Consider the following:

(1) Vaccines. Typically, it takes roughly a decade for a new vaccine to go through the various stages of development and testing. However, the urgency of the pandemic, which has killed more than 600,000 people worldwide, has resulted in a mobilization of global medical resources rarely seen before in human history. Billions of dollars, provided by both the public and the private sectors, are funding the global campaign to develop tests, vaccines, and cures for the virus.

For example, the Trump administration has launched “Operation Warp Speed” with the goal of delivering 300 million doses of a safe, effective vaccine for COVID-19 by January 2021, as part of a broader strategy to accelerate the development, manufacturing, and distribution of COVID-19 vaccines, therapeutics, and diagnostics. Congress has directed almost $10 billion to this effort through supplemental funding, including the CARES Act.

More than 100 clinical trials of dozens of potential coronavirus treatments are already underway around the world. Yesterday, we learned that the early trial results for two vaccine candidates—one developed by the University of Oxford and AstraZeneca and the other by the Chinese company CanSino Biologics—showed that both were safe and could induce immune responses in participants. But the next phase will be critical to demonstrate that the potential vaccines can protect against infections.

For the Oxford-AstraZeneca and CanSino vaccine candidates, the next step in testing is known as “Phase Three” of human clinical trials. It’s in this stage that scientists will be able to see whether a potential vaccine truly works to prevent coronavirus infections. The newly released clinical trial results showed that the Oxford-AstraZeneca vaccine candidate triggered the production of both antibodies and T cells, which can recognize and attack virus cells.

(2) EU ups the ante. On April 9, Eurozone finance ministers agreed on a new coronavirus stimulus package worth €540 billion, but couldn’t agree on a crucial decision: whether to issue joint debt instruments, called “corona bonds,” that would combine debt securities from the 19 Eurozone countries. Germany and the Netherlands, traditionally more fiscally conservative than Italy and Spain, were holdouts.

On July 21, a new agreement was reached authorizing the European Commission (EC), the executive arm of the European Union (EU), to create a €750 billion recovery fund, which will be distributed among the countries and sectors most impacted by the coronavirus pandemic, and will take the form of grants and loans.

The new deal means that the EU will become a major borrower in global financial markets for the first time. It plans to repay the money by 2058. Nevertheless, the EC intends to propose new taxes on financial transactions and fines on greenhouse gases released by companies. Tech companies can also expect a “digital levy.”

(3) ECB is on the case. Undoubtedly, some of the new bonds will be purchased by the European Central Bank (ECB), which is currently buying government bonds as part of its Pandemic Emergency Purchase Program (PEPP), which totals €1.35 trillion. The PEPP started on March 18 with a commitment to make €750 billion in open-ended asset purchases. It was expanded on June 4 by €600 billion.

The ECB’s balance sheet has soared by €1.62 trillion since the week of March 13 through the July 17 week (Fig. 1). Securities held for monetary purposes rose €552 billion during that period.

(4) Japan writes a blank check to fight the virus. In Japan, Prime Minister Shinzo Abe’s government has rolled out combined stimulus spending worth ¥234 trillion ($2.2 trillion); that boosts its annual budget spending to ¥160 trillion, with new debt issuance totaling ¥90 trillion. To cushion the economic fallout from the virus, the new stimulus programs include handouts to 126 million residents of ¥100,000 (just under $1,000) each.

On July 21, Finance Minister Taro Aso said that the Japanese government’s budget won’t set a spending cap on requests aimed at fighting the COVID-19 pandemic for the fiscal year that begins in April 2021. The budget ceiling is usually set around mid-year by the Finance Ministry to keep tabs on spending requests from ministries for next year’s budget, to be compiled in December.

The government would ask ministries to keep requests for other spending in line with the current fiscal year’s initial budget totaling a record ¥102.7 trillion, Aso said at a Cabinet meeting. The government then would set aside an unspecified amount of budget requests to respond to “urgently needed expenses” to battle the fallout from the coronavirus.

(5) BOJ is on the case. The Minutes of the June 15-16 Monetary Policy Meeting of the Bank of Japan (BOJ) was released on Monday. After easing monetary policy in March and April, the BOJ kept policy settings unchanged and maintained its view that the economy will gradually recover from the damage caused by the pandemic. The BOJ’s balance sheet has soared by ¥64 trillion ($600 billion) since February, through June (Fig. 2).

(6) Another CARES package in the US. The CARES Act was passed on March 27. It provided $2.2 trillion in various short-term support payments as state governors issued stay-in-place executive orders to slow the spread of the virus. It was widely expected that they would gradually lift these restrictions in a few weeks, reopening the economy. The first round of support payments is running out for many households and businesses, while the reopening of the economy has been slowed by rapidly rising cases.

On Monday, congressional lawmakers returned from their recess and started working on a second relief package. They are under pressure to come up with something this week. Though the CARES Act allows the $600-per-week federal boost to state unemployment insurance to be paid through July 31, most states’ weekly benefits are based on a cycle that ends on a Saturday or Sunday, making this week the last one that recipients will get that extra money unless lawmakers intervene fast.

(7) The Fed is on the case. The US federal budget deficit totaled a record $3.0 trillion during the 12 months through June (Fig. 3). After the CARES Act was passed, the Congressional Budget Office (CBO) estimated that it would total $3.7 trillion this year. The CBO may have to add another $1 trillion to $2 trillion to its estimate if the economic recovery stalls and if Congress passes CARES Act II.

No problem: We are all MMTers now! We all believe in the magic of Modern Monetary Theory. In response to the GVC, the Fed embraced the theory and its practice on March 23 with its programs of QE4Ever and No Asset Left Behind (NALB). The Fed already has financed more than half of the currently projected FY2020 federal budget deficit by purchasing $2.1 trillion in Treasury securities over the past year through the July 15 week (Fig. 4).

Among the biggest proponents of MMT are former Fed Chairs Ben Bernanke and Janet Yellen. Last month, they signed a public letter from more than 150 economists that called on Congress to pass another big spending bill to extend and broaden the CARES Act. In a joint July 17 blog post, they commended the Fed’s response to the pandemic: “Broadly speaking, though, the Fed’s response has been forceful, forward-looking, and comprehensive.” In other words, Fed Chair Jerome Powell did what they would have done. We guess that they’ve provided Powell lots of advice in recent months, which he acted upon.

What about the federal deficit? Bernanke and Yellen are all in on MMT: “Following our advice would further increase the already record-level federal budget deficit. With interest rates extremely low and likely to remain so for some time, we do not believe that concerns about the deficit and debt should prevent the Congress from responding robustly to this emergency. … [A]t some point, we will have to think through how to ensure the long-run sustainability of federal finances. The top priorities now, however, should be protecting our citizens from the pandemic and pursuing a strong and equitable economic recovery.”

Read that excerpt again and think about it. Contrarians should be alarmed. What could possibly go wrong with this who-cares-about-deficits approach? Well, let’s see: i) inflation might make a surprising comeback; ii) bond yields might rise; and iii) if the Fed imposes yield-curve control to put a cap on the bond yield, the dollar might take a dive, which could boost inflation.

(8) The PBOC is on the case. The People’s Bank of China (PBOC) continues to flood the Chinese economy with more and more credit during the GVC, as it has ever since the Great Financial Crisis (GFC). Over the past 12 months through June, social financing totaled a record $4.5 trillion, led by a record $2.7 trillion in bank loans (Fig. 5 and Fig. 6). Bank loans are up a whopping $18.9 trillion to a record $23.3 trillion from $4.4 trillion at year-end 2008, when the government started to respond to the GFC with massive credit expansion (Fig. 7).

(9) Bottom line is a bottomless pit. A billion here, a trillion here and there add up to serious money. With the help of MMT, government deficits are a bottomless pit. If they can be financed so easily with easy money without boosting inflation, why do we bother collecting taxes? I would be a big advocate of MMT if my taxes were cut to zero. Let’s give it a try! Why not? Anything is possible in the Twilight Zone.

While MMT hasn’t boosted inflation as measured by consumer prices, so far, it certainly is boosting asset inflation, potentially fueling the Mother of All Meltups (MAMU), which potentially could set the stage for the Mother of All Meltdowns (MAMD).