For the purposes of this report, I am not in the business of commenting on Donald Trump’s short comings as a human being. My interest in politics only relates to asset prices. Trump is a very unique politician. If we think of AngelaMerkel, Theresa May or even our own Leo Varadkar, we think of managers. They generally are trying to chart a steady course. They make no tangible promises and are happy enough to go along with the political / diplomatic / economic consensus. And that consensus is generally formed and propelled by ‘mainstream’ media.
UNITED STATES AND TRUMP
For the purposes of this report, I am not in the business of commenting on Donald Trump’s short comings as a human being. My interest in politics only relates to asset prices. Trump is a very unique politician. If we think of Angela Merkel, Theresa May or even our own Leo Varadkar, we think of managers. They generally are trying to chart a steady course. They make no tangible promises and are happy enough to go along with the political / diplomatic / economic consensus. And that consensus is generally formed and propelled by ‘mainstream’ media.
Trump came into politics to do stuff, to be the greatest president ever. He makes very specific promises and doesn’t give a shit about the consensus. To him, the ‘mainstream’ media are his competitors in forming consensus. This makes him very interesting to us. He sets target or goals and then tries to achieve them. This makes it possible to take a view on what his polices will do to asset prices. To this end there are two important policy areas that we should consider – international trade and national debt.
Trump on International Trade
This century the United States has imported on average about $500Bn more annually than it exports. Trump has set out to change that. In the broadest terms here is how he can achieve this:
1. Increase Exports
- Cut US production costs (government taxes on labour / regulations etc)
- Cut his selling prices for exports. In other words a weaker dollar.
2. Decrease Imports
- Impose trade tariffs on imports
- Increase the price of imports. In other words a weaker dollar.
Trump has done some work on reducing regulations and taxes. He is also in the process of imposing trade tariffs. His treasury secretary, Steve Mnuchin said in Davos this year – “Obviously a weaker dollar is good for us as it relates to trade and opportunities." This statement was more or less retracted quite quickly. However I agree with Mnuchin, a weaker Dollar would be good for the administration policies.
Trump on US Debt
During his election campaign he said he would get rid of the national debt in eight years. He also said that we would re-negotiate the national debt. It is virtually impossible for the US to pay down its debts in any time frame. This means that a ‘deal’ is definitely on the table. The details of Trumps plans to solve the US’s debt problem are irrelevant. All we need to know is that any ‘restructuring’ or ‘buy back’ plan involves a weaker dollar.
Sovereign debt default always causes a collapse in bond prices and a massive loss of purchasing power in the currency. It will be no different for the United States, but the global ramifications are hard to quantify. Trump appears to be accelerating the US’s move towards bankruptcy. He is borrowing money like there is no tomorrow, insulting and antagonizing his creditors, and has publicly stated that he will do a deal on national debt when required.
It is worth taking a moment to consider how much he is borrowing. The US Treasury Department says it borrowed $519Bn in 2017. It expects to borrow $955Bn this year and top $1 Trillion for the next 2 years after that! He is increasing US Debt by roughly 5% per year as interest rates are rising.
There is another important consideration – the Federal Reserve. In the last 10 years when the US government borrowed they found a willing lender in the Fed. The Fed are no longer lending to the government. In fact the Fed is competing with the Treasury. Traditionally, every month the Fed rolls over maturing debts. For example, if $5Bn of debt is due for payment from the government to the Fed, the Fed would just ‘roll it over’ to an extended date. Now the Fed is demanding payment in full. So the Treasury has to find another willing sucker to rollover it debts in addition to the new money it is borrowing anyway. This is what Quantitative Tightening means.
It might be useful to just list out some of the issues facing the world’s greatest borrower:
- The US increases borrowing
- Fed stops lending
- Interest rates going up
- Fed starts Quantitative Tightening – ergo US needs new rollover suckers
- Trump insults creditors, China, Germany
- Trump is on the record as saying he will re-negotiate debt
It is hard to draw firm conclusions or make useful predictions in terms of timing a US bankruptcy. However, we can say that the ‘greatest ever’ president of the US styles himself as the “King of Debt”. I think he will in the future attempt to re-negotiate US Debt and why not? Everything else is up for negotiation.
The most important thing about Trump is not that he bullshits or lies. He acts! The question is how will the rest of the world react to a default?
THE REST OF THE WORLD
Europe’s bank bailout is still a work in progress. This bailout is sometimes called the ‘Greece Bailout’ in our own home grown fake news. In June Euro zone member states approved a final package to allow Greece to exit the bailout program involving debt payment extensions on some €100 billion of bailout loans and a final €15 billion program loan from the European Stability Mechanism, the EU’s crisis management tool. But as research by the European School of Management and Technology in Berlin has shown, 95 percent of the bailout funds that were supposedly "given" to Greece actually went straight back to private creditors. It really should be called the ‘Deutsche Bank et al’ bailout.
Otherwise Europe remains bogged down with its’ own troubles. An American debt default would severely test the political machinery of the EU.
China has a different set of problems to deal with. First it has a huge internal debt problem. The Bank for International Settlements and the IMF have been putting out warnings about Chinese internal debt for a number of years now. As if this wasn’t enough to deal with now Trump has given them a few more headaches by introducing tariffs on Chinese imports. Trump is on a winner here because he imports a lot more from them than they do from him ($500Bn v $150Bn). This is a very tough situation for China. It will take time for them to find new non US customers for their products. In the short term at least I think Trump will have some success at rebalancing trade with China. While this will be somewhat difficult for China, they can handle it. A United State debt default will be a different kettle of fish.
Japan is next in line for threatened tariffs. Like China they have plenty to worry about without Trump adding to their woes. But as China can, Japan can handle a few extra tariffs. But a debt default would hurt.
CONCLUSION – WILL WE GET A DEFAULT? WHAT WOULD IT LOOK LIKE?
Global debt is growing. Interest rates are turning upwards. Central Banks are moving towards quantitative tightening. I am grossly simplifying here just to make a point. Most Central Banks are still printing money, but they are signaling a change in course to follow the Federal Reserve. They talk about ‘normalizing’ interest rates.
The current debt resolution pathway has been guided by politicians and bureaucrats. This is an ‘extend and pretend’ policy, or a ‘kick the can down the road’ approach. There may be logic to this in terms of political election cycles. It is like bandaging over a footballer’s broken leg without re-setting the bone and thinking that after his need for painkillers has passed he will be able to play again.
A Trump resolution is more likely to involve re-setting the bone. This man of action is most likely willing to cut the Gordian knot. Debt will have to be extinguished. What will it look like? The following bullet points show what generally happens in a single country default.
- Debt Instruments, that is sovereign bond prices, collapse by as much as 80%
- Stock prices shoot up in local currency terms
- The currency collapses
- Main street prices for normal goods shoot up
- Interest rates go up
- Governance changes – becoming generally more autocratic.
- Precious metal prices in the local currency skyrocket
A debt default by the United States will more than likely trigger defaults globally. Asia and Europe will have to follow. Savers and holders of fiat currencies will take the brunt of the losses as debts are finally extinguished. Asset prices, as priced in precious metals, will collapse.
I understand that what I am saying sounds implausible or extreme. But, since the dawn of civilization from our first city states to our largest empires man has always tried to print money. That there will be a reset is not in doubt. When it happens and exactly what form it takes is hard to forecast. My guess is that Trump will be an accelerant in this process.