RUSH INTO BONDS IN THE USA
The rush into Government issued Bonds in the US is continuing. Investors are heavily weighting their portfolios to Bonds in the expectation of future lower CPI inflation and because there is fear everywhere that the China US trade war will get worse and thus adversely affect the global economy.
Long term interest rates are falling dramatically with the 10 year bond yield in the US dropping to just 2.133%. As BOOM pointed out last week, the well paid and lauded central bankers of the advanced economies have held their interest rate settings way too high for way too long. ALL of them got their interest rate settings wrong 12 months ago so we are now playing catch-up.
All of this seems to have reached the point of panic so BOOM expects this to stop in the not too distant future. Why? Because the effects of the “trade war” are being exaggerated and because it will soon become so cheap to borrow in the US that consumers who have steady jobs will respond and will start racking up more credit, buying things they don’t need to impress people they don’t like. A lot of those things will be made in China, by the way.
And the Federal Reserve will soon be forced to lower their key overnight interest rates rather dramatically. They will have no choice as they must avoid yield curve inversion at all costs.
During this “trade war”, the Chinese Sovereign Bond Yield Curve has moved downwards a little but not by much in comparison to the downwards trajectory of the US Yield Curve. The Chinese are clearly adamant that they will stay the course and win. Their other financial markets have remained stable with their currency and stock market declining only marginally.
TRADE WAR IMPACT EXAGGERATED
So what impact will this “trade war” have on world trade and Global GDP? It is a fact that previous such episodes in modern history have had very serious impacts. This is the rationale for the buying panic in the bond market. However, the structure of the advanced economies is now quite different to what it was in the past. The most important difference is that they are now much less dependent upon merchandise trade and increasingly more dependent upon trade in services. That means that tariffs on goods (trade wars) no longer have as much effect as in previous historic eras.
Total World trade is about 45% of Total Global GDP. So it is important to grasp that 55% of world GDP occurs inside domestic transactions. That puts trade into perspective.
Then there is the services component. This varies from nation to nation. In Singapore, for example, the export of services accounts for 32 % of their trade total (of goods and services). In the EU, it is about 31%. In the USA, it is 26 % and in China, it is about 20% (but worth noting that percentage has doubled since 2010). Overall, world trade in services is about 25 % of the total of goods and services. So goods make up the rest — 75 %.
Thus, we can calculate that total world trade in goods is about 33 % of Total Global GDP.
Tariffs only affect the trade in goods and, as we have calculated, global merchandise trade is only 33% of Global GDP so a decline in the trading of goods globally of 10% (massive) resulting from the China-US tariff war would shave off just 3.3% of Global GDP. If Global GDP is growing at 3.3% annually (the current IMF estimate), then even in such a dire trade situation there would not be a Global Recession. Nations would soon adjust and sell many of their goods to other markets. Meanwhile the trade in services would continue, barely affected.
RELAX — IT WILL PASS
So BOOM says — relax, this is certainly a storm on the high seas but it is not a giant typhoon. Stay calm and watch for the inevitable end to this squall as it blows through and the US comes to its senses (after it has exhausted all other options). After that, we will all be left with record low interest rates, low CPI inflation and low growth prospects. None of those are worthy of panic.
And remember- the US financial sector as measured by the ETF on the New York stock exchange (coded as XLF) has barely budged during the turmoil. Investors in the US financial sector are clearly not worried by the Trade War Hullabaloo in the mainstream media.
SOME FACTS (RARE THESE DAYS)
China exports about $ 2 Trillion of Goods per year and imports $ 1.5 Trillion.
China exports about $ 240 Billion of Services per year and imports about $ 460 Billion.
The USA exports about $ 1.5 Trillion of Goods per year and imports $ 2.2 Trillion.
The USA exports about $ 760 Billion of Services per year and imports about $ 510 Billion.
BUSINESS AS USUAL
Meanwhile, the US is currently conducting business as usual for the Trump Presidency, seeing itself as the long term victim of historical circumstance and responding with threats and intimidation. In just the last week, they have threatened increased tariffs and trade sanctions on Mexico, India, Turkey, all of the nations of the European Union, Cuba, Iran, China, Russia and Venezuela. That’s not a bad list for just one week. If BOOM has missed any, please accept apologies for inaccuracy. Thankfully, the week has passed without any overt military threats.
China is starting to get a little annoyed by this schoolyard bullying and has decided to punch back by floating the idea that they might stop exports of Rare Earth Metals. They mine and process the vast majority of these key metals. These are critical to the US and there are no other viable sources outside of China on the planet except for a small company in Australia. That small company has a processing plant in Malaysia that is accumulating a large amount of toxic waste so there is a limit to its expansion.
BOOM predicted this with great accuracy in the BOOM Editorial THE RARE EARTHS ROADBLOCK dated 17th December 2018 —
Quote: From a Report by The Dutch Ministry of Infrastructure
“The supply chain of critical metals is extremely complex. Not all theoretical reserves are technically (or economically) extractable, and with ore grades declining, mining requires an increasing volume of water and energy. Furthermore, mining is often associated with significant environmental and social costs”.
China has the US over the proverbial barrel here. Rare Earth metals cannot be mined and processed quickly. And they are very critical to the US military machine. They are used in making magnets, motors, weapon systems, electronics, solar panels, windmills, washing machines, vacuum cleaners, cars, loud speakers, computer hard drives, cameras, telescopes, lights, cinemas, refining crude oil, aircraft engines, glass, X Ray and MRI Scanners, television screens, computer screens, refrigeration and electric vehicles.
Perhaps Donald and Co should have called BOOM before embarking upon their current “war” with China?
In economics, things work until they don’t. Until next week ………… Make your own conclusions, do your own research. BOOM does not offer investment advice.
Return to the BOOM Main Website – BOOM Finance and Economics at http://boomfinanceandeconomics.com/
EMAIL: gerry [@]
HOW MOST MONEY IS CREATED
BANKS CREATE FRESH NEW MONEY OUT OF THIN AIR
(but they always need a Borrower to do so)
THERE IS NO SUCH THING AS A DEPOSIT
BANKS PURCHASE SECURITIES, THEY DON’T MAKE LOANS
BANKS DON’T TAKE DEPOSITS, THEY BORROW YOUR MONEY
How is Most New Money Created ?
LOANS CREATE DEPOSITS — that is how almost all new money is created in the economy (by commercial banks making loans).
From the Bank of England Quarterly Bulletin Q1 2014 —
“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.“
“Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves”.
Quarterly Bulletins Index
Most economists are unaware of this and even ignore the banking & finance sectors in their econometric models.
On 25th April 2017, the central bank of Germany, the Bundesbank, released a statement on this matter —
“In terms of volume, the majority of the money supply is made up of book money, which is created through transactions between banks and domestic customers. Sight deposits are an example of book money: sight deposits are created when a bank settles transactions with a customer, ie it grants a credit, say, or purchases an asset and credits the corresponding amount to the customer’s bank account in return. This means that banks can create book money just by making an accounting entry: according to the Bundesbank’s economists, “this refutes a popular misconception that banks act simply as intermediaries at the time of lending – i.e. that banks can only grant credit using funds placed with them previously as deposits by other customers”. By the same token, excess central bank reserves are not a necessary precondition for a bank to grant credit (and thus create money).”
The Reserve Bank of Australia (Australia’s central bank) has also contributed to the issue in a speech by Christopher Kent, the Assistant Governor on September 19th 2018.
“…… the vast bulk of broad money consists of bank deposits”
“Money can be created …….. when financial intermediaries make loans”
“In the first instance, the process of money creation requires a willing borrower.”
“It’s also worth emphasizing that the process of money creation is not the result of the actions of any single bank – rather, the banking system as a whole acts to create money.”
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