“On the China business, it’s up in the air. They’re going to be held accountable for it”, Larry Kudlow told CNBC Friday, commenting on a day when US equities were struggling with the prospect of renewed tensions between the world’s two largest economies.
Donald Trump indicated on multiple occasions this week that he may soon take some manner of action against Beijing for what the White House is variously characterizing as a coverup with regard to the origins of the coronavirus. Trump appears convinced it escaped from the Wuhan Institute of Virology, while the accepted theory is that it jumped from animals to humans at a local wet market.
Wherever it came from, the virus has decimated global demand. As such, markets aren’t enamored with the idea of another trade war (or capital restrictions on China). The fragile state of the global economy was on full display Friday when bellwether South Korea reported full-month export numbers for April. They were the worst since May of 2009.
The numbers suggest the country will continue to suffer from lackluster external demand, just as it did during the worst days of the trade conflict.
Moon Jae-in’s government has earmarked nearly $200 billion in stimulus to help the economy along as the world does its best to flatten the virus curve and return to some semblance of “normal”. And yet, export-reliant economies and countries that have benefited from globalization may struggle in the post-COVID world – at least initially. South Korea logged its largest contraction since the crisis in Q1, data out late last month showed.
Weakness in external demand also showed up in China’s April PMIs this week.
“With respect to future tariff decisions and other measures, that’s going to be up to the president”, Kudlow went on to say, during his Friday remarks to CNBC. “How, when, where and why [China will be held accountable] I’m going to leave that up to the president”, he added.
That’s all fine and good, but, again, the world cannot afford an economic escalation right now. Indeed, the narrative from the Oval Office has consistently been that China either is, or intends to, make good on their commitments under the “phase one” trade deal despite the hit from the epidemic.
How that’s possible is anyone’s guess, but that’s not really the point. The point, rather, is that if Trump escalates the situation by slapping more tariffs on China in retaliation for the virus, you can forget about Beijing adhering to the agreement.
Remember, the World Trade Organization now sees world merchandise trade plunging by between 13% and 32% this year due to the pandemic. “Nearly all regions will suffer double-digit declines in trade volumes in 2020”, the WTO warned last month.
And yes, you read that correctly. In the worst-case scenario, the WTO says global trade could contract by nearly a third. That would be almost triple the decline seen during the GFC.
If Trump undermines that further, it could imperil any bounce (“V-shaped” or otherwise) off what is now guaranteed to be the single worst quarter for the global economy in a century in Q2.
Importantly, this assessment has nothing to do with whether or not Trump is right to “punish” China and it’s not to weigh in on the relative merits of anyone’s theories about where COVID-19 came from. Rather, it’s simply to state the obvious, which is that if you reignite a trade war in the middle of a depression, you’re taking a huge risk with consequences that will be impossible to measure.
And speaking of huge risks with unquantifiable consequences, Kudlow also told CNBC that the administration isn’t considering (and I’m quoting the network here) “refusing to pay government debt held by China”.
“Full faith and credit of the United States’ debt obligation is sacrosanct. Absolutely sacrosanct”, Kudlow insisted, adding that the president doesn’t want to do anything to jeopardize the dollar’s reserve status.
The dollar’s status as the world’s premier reserve currency is threatened more by US foreign policy than it is by any deficit, no matter how large. For instance, the constant weaponization of the USD and the US financial system through draconian sanctions aimed at punishing perceived “foes” (sometimes for not very good reasons) along with the 2018 experience (when the rest of the world was again reminded that financial stability outside the US depends almost entirely on the Fed not erring by overtightening during a hiking cycle), are likely to be the key drivers of continued de-dollarization. Not deficits and not “money printing”.
Suffice to say trying to orchestrate some manner of targeted default affecting only China would not just be a logistical nightmare bordering on the impossible (Treasurys are just securities, after all, and China can sell them), it would raise obvious questions for every other sovereign holding Treasurys, including and especially emerging markets (i.e., “What happens if the US gets mad at me?” “Do they just repudiate all of our holdings?” “If so, what does that do to our ability to defend our currencies?”).
It’s worth noting that the latest update (Thursday) shows marketable US Treasury securities held in custody for foreign official and international accounts dropped another $22 billion last month after falling more than $100 billion in March.
Some (most) of March’s decline was down to a fire sale as the world rushed to source USDs amid acute market turmoil. In other words, what you see in the visual is a function of the recent rush for dollars, not some manifestation of geopolitical tension.
Still, I thought I’d throw it out there. That data is far less “stale” than the figures on foreign holdings of US debt released by Treasury.