Not Your Grandfather’s Trade War: The Revenge Of Bad Money, Part 2

By David Stockman

The effect of central banking’s bad money has been to preternaturally bulk up China’s industrial economy and hollow out America’s. It’s as if some accelerated form of economic plate tectonics had broken off large chunks of the US industrial midwest and southeast and implanted them in the Pearl River Delta (Guangzhou), the Yangtze River Delta (Shanghai) and the Bohai Economic Rim (Beijing, Tianjin, Hebei).

This historically abrupt transplantation happened after 1987 because in a world of virtually unlimited central bank credit, there is no settlement process. Deformations do not get culled out on a regular basis by the mechanisms of the free market. Instead, under the tutelage of the state and its central banking branch they metastasize indefinitely until they finally hit a politically-inspired wall of resistance.

At the present world historical moment that wall of resistance is bedecked with an Orange Comb-Over. That is to say, Donald Trump’s real mission has been to crush the 30-year old toxic symbiosis under which mercantilism in China and financialization in the US functioned as two mutually reinforcing peas in a pod.

In effect, bad money caused the substitution of massive household debt and drastically inflated financial assets for the wealth and output of America’s lost industrial provinces. At the same time, and in conjunction with the militant mercantilism of China’s all-powerful post-Maoist state, it generated today’s upside-down global economic order.

We are referring, of course, to the fact that as a relatively poor, developing economy, China became the de facto $4 trillion banker to the rich, developed world. Accordingly, the 21st century to date has risibly mocked the rules of 19th century gold standard capitalism: It’s as if economically backward India had been the banker and the booming industrially advanced regions around London had been the borrower.

The absurdity of this arrangement—–China’s reckless debt-besotted Ponzi functioning as the world’s putatively solvent and sober banker and capital exporter—is lost on the Wall Street/Washington ruling classes owing to the scourge of financialization. That is, they have become so addicted to measuring economic health through the S&P 500 that they are oblivious to the vast economic deformations that bad money has wrought.

In that respect, there is a certain flavor of free market ideologues who contribute—perhaps inadvertently—to the mainstream blindness. Their argument goes that America is such a wonderful place that global capital comes beating on its door.

So if you want to enjoy the fruits of vast capital inflows you need to run large trade deficits; and presumably forever, world without end. It’s just an accounting identity!

Then again, the laws of compound arithmetic do put a damper on the theory of eternal deficits. Since the last US surplus on its international investment account in 1988 ($21 billion), the balance has plunged southward on a virtually uninterrupted basis and now stands at negative $8 trillion.

A polite word for the orange bars in the graph below is “US international indebtedness”, and it has been rising at a 21.5% annual rate for 28 years. Another 28 years at that rate and the US would owe the world $2 quadrillion, and at just one-half that rate it would still be a $150 trillion debtor by 2045.

Obviously, Stein’s Law of unsustainability (it tends to stop) would come into play long before either eventuality, but our point involves more than just arithmetic.

To wit, the US economy’s (positive) +$300 billion net investment balance with the rest of the world in 1980 (you can see it by squinting) represented about 10% of GDP. That figure was not unusual or unreasonable for what had been the world’s leading export economy and creditor nation during the previous six decades (since 1914).

But America most surely did not become rich by plunging deep into debt with the rest of the world thereafter—-such that by 2017 its net investment position amounted to (negative) -42% of GDP. What the academic free traders forget is that bad money and free trade do not play well together; the former destroys price signals and blocs market clearing adjustments.

So doing, it attempts to violate Stein’s Law. But now we know in fact, rather than just in theory, that it’s impossible.

At length, you get Donald Trump instead, and you get his half-baked advisor, Peter Navarro, on bubblevision this morning explaining that protectionism is the new route to free trade!

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