As we stand at the dawn of a new year, it behooves us to ask if there is a cycle change going on. The tremendous volatility seen in US equity markets is perhaps a sign of something bigger that the markets are dealing with. The reality is that all changes in the world are reflected in markets in some shape or form.
If you think about it, the biggest change in this still nascent century began with convulsions in the US equity market, a change that has gone on to dominate the entire world. Think back to 2001-2002. That period was the nadir of the telecom-technology bust. It looked as if America was going the way of Japan. That America was looking for a way to break out of those doldrums.
1.Enter China
Is that why President George W. Bush finally allowed China to become a member of the World Trade Organization? President Bush was aware of both the rewards & risks to America of that decision.What would he have done had the American economy been as robust as it was during the 1995-1999 period? We don’t know but we are inclined to believe that the search for a road to a stronger recovery finally tilted his decision towards allowing China to enter the WTO.
As we all know now, that decision changed the world economy. China had a plan and they implemented it with focused single-mindedness and discipline. As a result, China is now the second largest economy in the world and a military power as well. The latter part did not become obvious in the first few years. The 2002-2008 period was a period of global growth & global liquidity that came from the US Federal Reserve. It was the golden era of Emerging Markets, an era that also spawned a massive credit bubble in America.
2.American Crisis & Trap for China
Then came the bust of the credit bubble and the Great Recession of 2008. It was an American problem but it ended up creating massive trouble for the rest of the world, especially China. The American economy, as a whole, got out of it quickly in a span of a few months. Not China. By 2008, China was hooked on growth coming from export jobs and a slowdown was a scary prospect for the Chinese leadership. So instead of managing the crisis, they poured enormous monies into the Chinese economy to keep the growth going. As a result, today China has an enormous debt to GDP ratio as well as a huge investment bubble. That has made China even more dependent on exports to US.
The US Federal Reserve helped the US Economy recover as a whole. To do so, they went literally crazy in expanding the Fed’s balance sheet to over $4 trillion. That led the US Stock market to rise over four-fold from 666 on the S&P 500 in March 2009 to 2940 in October 2018. However, the benefits of this upsurge only went to a minority in America, the minority that invests for capital appreciation and not to the majority that depends on income growth. As a result, wealth inequality rose to harmful levels and the industrial states of America went into a severe decline.
That brought in Donald Trump. The income & wealth inequality in America, not just between people but between regions of America, finally found a voice in Trump’s campaign. It was almost as if the fly-over states & the income-dependent middle class had chosen him as a champion to fight their battle. And President Trump has remained true to his commitments to this base.
And that means a reversal in business, manufacturing & capital flows from the rest of the world back to America.
3. Target China – a la Japan
People forget that America is an empire, not as visibly or de jure as others before but de facto nonetheless. People forget that America did not move to help England against Germany in 1930s UNTIL England essentially signed over its global naval bases to America. Meaning America took over England’s global hegemony, the English Navy’s global hegemony BEFORE helping England. Simultaneously America began strangling a rising militaristic Japan to dissuade Japan from competing in the Pacific. Finally Japan had no choice to agree to US hegemony or go to war. America won that war and occupied Japan.
Japan then began an industrial emergence that led to worldwide dominance of Japanese multinationals and erosion of US companies. It looked as if Japan had become a financial superpower. The problem was Japan’s rise & illusory power was critically dependent on access of American markets.
A newly elected American President was committed to restoring US hegemony. Faced with unrelenting pressure & the threat of losing their US exports lifeline, Japan acquiesced and signed the 1985 Plaza Accord. That was the beginning of the end of Japanese challenge to America. The accord put Japan into an economic & currency bubble that burst in 1989. To this day, Japan has not found a way to come out of the ensuing deflation or its demographic trap.
President Trump seems as committed to meeting the economic & military challenge from China as Presidents Reagan & FDR were against Japan. His timing seems perfect. China went to an extreme in adding stimulus to protect Chinese economy & labor from the 2008 crisis. China went to a mercantile extreme in locking up Asian & African countries into its One Belt One Road master plan. Chinese President announced a plan to make China the power in high technology by 2025.
They did all this while falling into a Debt Trap & a Renminbi Trap while still in the grips of a demographic trap. All this while falling more & more dependent on exports to America & Europe. What they do not yet realize is that President Trump has literally converted American political & military establishment to his anti-China position. Vice President Pence & the Republican establishment are now more anti-China than even Trump. And the Democrat establishment has always been against allowing China to export freely to America.
So 2019 brings a major new cycle of America slowly putting pressure on China from virtually all sides. This is not without high costs to America but we feel the American people now understand that their own future is at risk from China. So while narrow trade deals might be struck here & there, the pressure from America will only increase.
4. Europe
Despite all the criticism, President Trump’s message about nationalism is beginning to resonate even in the stronghold of TransNational Bureaucratic rule, the European Union. Angela Merkel, the champion of such central EU rule over weaker European countries, is leaving. Macron of France is at serious risk of losing his seat and France seems ready for its own rebellion against EU. A breakup between France & Germany would end the central EU rule. We don’t think the rift would actually go that far. Instead, we think, Germany & EU will recognize that France has to be dealt with kid gloves and that might give more room for Italy too.
In any case, the German hegemony within EU might begin to weaken as German exports to the rest of EU slow down. And that, by itself, will lead Germany to question the level of support it provides to the rest of EU.
5. A Power Shift – From Production to Consumption
What is the common factor between China & Germany or Germanic Europe? These are regions that generated massive amounts of wealth by production. That created large flows of income, wealth, capital & power to these countries & regions from countries & regions that are mainly consuming economies. This generation of power by exporting regions began with China’s entry into the WTO in 2001-2002.
Now, we think, a new cycle is beginning. A cycle in which consuming nations/regions will take back wealth and capital from production powerhouse nations/regions. This change is mainly courtesy of President Trump and his election. It is a message that has now gone home in both America and the world. As we said, the new Democrat leadership in the Congress is even more hawkish in this respect despite their passion against President Trump. The idea that foreign nations are stealing wealth from America by exploiting their own low wages is beginning to get accepted in American consciousness.
This is a structurally negative change for both China & Germany, the largest production & export oriented economies in the World. And it is a generally positive but a mixed blessing for America which is simultaneously the biggest consumer & the biggest manufacturer in the world. This duality is best viewed via the prism of oil. A big fall in Oil & Gasoline prices is a huge positive for the American consumer that is 70% of the US Economy but a major negative for states in America whose economies are dependent on oil production.
And this change is linked to another major change underway with the World’s money. Just as the cycle of production dominance coincided with the US Fed & later ECB-Japan central banks increasing monetary liquidity, this new cycle of consumption dominance will coincide with the US Fed & the ECB removing liquidity by reducing their balance sheets.
We don’t know what this dual cycle change will mean for the World. After all, we had no idea how much wealth & power China would gain from a seemingly simple thing like WTO membership.
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