Trade Wars, Stranded Assets, and the Stock Market (Wonkish)

Yet you go to trade war with the capital you have, not the capital you’re eventually going to want – and stocks are claims on the capital we have now, not the capital we’ll need if America goes all in on Trumponomics.

Or to put it another way, a trade war would produce a lot of stranded assets.

.. The costs of protectionism, according to conventional economic theory, are not that tariffs caused the Great Depression, or anything like that. They come, instead, from moving your economy away from things you’re relatively good at to things you aren’t.

American workers could sew clothes together, instead of importing apparel from Bangladesh; in fact, we’d surely produce more pajamas per person-hour than the Bangladeshis do. But our productivity advantage is much bigger in other things, so there’s an efficiency gain – for both economies – in having us concentrate on the things we do best.

.. So, what would a trade war do? Suppose the US were to impose a 30 percent tariff across the board, with other countries retaliating in kind so that there’s no improvement in the U.S. terms of trade (more technical stuff I don’t want to get into.) How much would this reduce trade? It depends on the elasticity of import demand; a reasonable number seems to be around 4. This would mean a fall in imports from 15 percent of GDP to around 5 percent – a 10-point reduction. And that in turn means a reduction in US real income of around 1.5 percent.

.. even a trade war that drastically rolled back globalization wouldn’t impose costs on the economy comparable to the kinds of movement we’ve seen in stock prices.

But the costs to the economy as a whole might not be a good indicator of the costs to existing corporate assets.

.. Meanwhile, the factories that do exist were built to serve globalized production – and many of them would be marginalized, maybe even made worthless, by tariffs that broke up those global value chains. That is, they would become stranded assets. Call it the anti-China shock.

.. Of course, it wouldn’t just be factories left stranded by a trade war. A lot of people would be stranded too. The point of the famous “China shock” paper by Autor et al wasn’t that rapid trade growth made America as a whole poorer, it was that rapid changes in the location of production displaced a significant number of workers, creating personal hardship and hurting their communities. The irony is that an anti-China shock would do exactly the same thing. And I, at least, care more about the impact on workers than the impact on capital.

Paroling the Spanish Prisoner (Wonkish)

one of the issues that came up was the recovery in Europe, which is real and in some ways a bigger story for the world economy than the continuation of the Obama expansion here. An obvious question, which Anil raised, was whether this recovery calls for a reconsideration by Euroskeptics like myself.

.. we underestimated the political cohesion of the single currency, the willingness of political elites to suffer enormous economic pain in order to stay in the monetary union.

.. During the good years money poured into Spain, fueling a huge housing bubble. This fed inflation that made Spanish industry uncompetitive, leading to a huge trade deficit.

.. over the period 2008-2018 Spain suffered an enormous cumulative loss of output it could have produced: 33 percent of potential GDP. That’s as if the U.S. were forced to pay a price of more than $6 trillion to, say, remain on the gold standard.

.. the politics of the euro have been far more robust than us Anglo-Americans could have imagined.

How Democracies Perish

Everybody agrees society is in a bad way, but what exactly is the main cause of the badness?

Some people emphasize economic issues’

People like me emphasize cultural issues. If you have 60 years of radical individualism and ruthless meritocracy, you’re going to end up with a society that is atomized, distrustful and divided.

Patrick Deneen ..  new book, “Why Liberalism Failed,”

.. democracy has betrayed its promises.

  • It was supposed to foster equality, but it has led to great inequality and a new aristocracy.
  • It was supposed to give average people control over government, but average people feel alienated from government.
  • It was supposed to foster liberty, but it creates a degraded popular culture in which consumers become slave to their appetites.

.. “Because we view humanity — and thus its institutions — as corrupt and selfish, the only person we can rely upon is our self. The only way we can avoid failure, being let down, and ultimately succumbing to the chaotic world around us, therefore, is to have the means (financial security) to rely only upon ourselves.”

..  Greek and medieval philosophies valued liberty, but they understood that before a person could help govern society, he had to be able to govern himself.

People had to be habituated in virtue by institutions they didn’t choose — family, religion, community, social norms.

.. Machiavelli and Locke, the men who founded our system made two fateful errors.

  1. First, they came to reject the classical and religious idea that people are political and relational creatures. Instead, they placed the autonomous, choosing individual at the center of their view of human nature.
  2. Furthermore, they decided you couldn’t base a system of government on something as unreliable as virtue. But you could base it on something low and steady like selfishness. You could pit interest against interest and create a stable machine. You didn’t have to worry about creating noble citizens; you could get by with rationally self-interested ones.

.. Liberalism claims to be neutral but it’s really anti-culture. It detaches people from nature, community, tradition and place. It detaches people from time. “Gratitude to the past and obligations to the future are replaced by a nearly universal pursuit of immediate gratification.”

.. Once family and local community erode and social norms dissolve, individuals are left naked and unprotected. They seek solace in the state. They toggle between impersonal systems: globalized capitalism and the distant state. As the social order decays, people grasp for the security of authoritarianism.

“A signal feature of modern totalitarianism was that it arose and came to power through the discontents of people’s isolation and loneliness,” he observes. He urges people to dedicate themselves instead to local community — a sort of Wendell Berry agrarianism.

.. Every time Deneen writes about virtue it tastes like castor oil — self-denial and joylessness.

.. Yes, liberalism sometimes sits in tension with faith, tradition, family and community, which Deneen rightly cherishes. But liberalism is not their murderer.



A Hedge-Fund Titan Puts Away the Punch Bowl

Ray Dalio of Bridgewater sees Americans’ debt as a coming drag on growth and markets

.. While he doesn’t see another crisis in the offing, he does see the same underlying stresses at work: Americans have accumulated far more debt than they have assets and income to support.

.. Not only will this drag on growth and markets, it will leave the economy acutely vulnerable to higher interest rates. The relevant parallel, he says, is not the early 1930s, when the economy imploded, but the late 1930s when the Federal Reserve tightened monetary policy and inadvertently extended the Great Depression. Today, the central bank must balance the short-term need for higher interest rates to contain inflation against the long-term need for low rates to work off the debt overhang and sustain high asset prices.

.. “It may not be a problem in the next year or two, but the risk of not getting it right increases with time.”

.. “We ‘finance people’ see the world very differently from the way economists do,”

.. The views of finance people tend to be shaped more by trading experience than by formal economics. They assign much more weight to financial factors such as debt, asset prices and cash flow than do economists who emphasize “real economy” factors such as employment and investment

.. Finance people are wary of how macroeconomic data obscures crucial details of individual companies and households. Some economists do think like finance people, such as former Fed Chairman Alan Greenspan, but they are in the minority.

.. since the 1970s, inflation-adjusted interest rates have steadily declined while investors have accepted ever lower compensation for risks such as bankruptcy, recession and volatility (i.e. the “risk premium” has declined). This directly raises asset values and indirectly lifts growth by spurring borrowing.

.. His team estimates this has contributed three percentage points a year to stock returns since the 1970s while boosting private and government debt to 325% of gross domestic product.

.. In 2007, Mr. Dalio’s team concluded that the cost of servicing Americans’ debts was growing faster than their cash flows, creating the conditions for a crisis.

.. By slashing short-term interest rates to zero and buying bonds to push down long-term rates, it engineered the right combination of economic growth, debt write-offs and low interest rates necessary to start the painful process of “deleveraging,” or working off all that debt.

.. it can’t raise them much either, or debt servicing​would swamp cash flow and asset prices would sink. Thus Mr. Dalio foresees years of low interest rates, and while he thinks stocks are appropriately valued, he thinks returns to a typical stock-bond portfolio over the next decade will be around zero after inflation and taxes.

.. his biggest worry is that lower corporate taxes and higher stock prices do nothing for the bottom 60% of households who own almost no assets and whose stagnant wages are the mirror image of expanding profit margins, feeding resentment and political polarization. Says Mr. Dalio: “If we do have an economic downturn, I worry we will be at each other’s throats.”