Trumps

Recipe For Disaster

Richard Duncan

h5p://www.richardduncaneconomics.com
 MACRO WATCH
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and Government Policy to an>cipate their impact on economic
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 Its Too Soon To Know, But
We simply dont yet know what economic policies
President Trump will put in place.
However, based on his campaign promises and what
weve learned since the elec>on, theres real cause for
concern.
A combina>on of tax cuts, increased government
spending and policies that curtail trade would be a recipe
for disaster because it would push up interest rates and
crush the highly leveraged US economy.
Five things will determine which way interest rates will
move and, therefore, the direc>on of all asset prices
and the economy overall.
 Heres Why Interest Rates
Are So Important
The global economic bubble came very close to
collapsing into a new Great Depression in 2008.
That disaster was prevented by ultra loose Monetary
Policy.
Central banks slashed short term interest rates to 0%
and then printed trillions of dollars worth of new
money and used it to buy nancial assets.
That strategy allowed credit to expand and caused
asset prices to soar, thereby rea>ng the global
economic bubble and staving o economic collapse.
What happens next will depend on interest rates.
 10-Year US Government Bond Yield
vs. Credit to GDP Ra\o
1980 to present
16.00% 400%

14.00% 350%

12.00% 300%

10.00% 250%
But, now, if interest rates
8.00% rise, credit will contract 200%

6.00% and the economy will crash. 150%

4.00% As interest rates fell, credit became 100%

2.00%
more aordable. Credit expanded and 50%
Credit Growth drove Economic Growth.
0.00% 0%
1980Q1

1982Q1

1984Q1

1986Q1

1988Q1

1990Q1

1992Q1

1994Q1

1996Q1

1998Q1

2000Q1

2002Q1

2004Q1

2006Q1

2008Q1

2010Q1

2012Q1

2014Q1

2016Q1
10-Year US Government Bond Yield (le^ axis) Debt to GDP (right axis)

Source: The Fed

 US Total Debt = Total Credit
US$ millions, 1952 to 2016
70,000,000

60,000,000 $65 Trillion

$10 trillion higher than
50,000,000
the pre-crisis peak.
40,000,000
Credit Growth Drives
30,000,000
Economic Growth.
20,000,000 1964 = $1 trillion
10,000,000
2016 = $65 trillion
0
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Q2 2016
Source: The Fed
 Household Net Worth
US$ Billions, 1980 to Q3 2016 $90 Trillion
90,000

80,000 And, as Interest Rates fell,

70,000 Asset Prices rose. A^er 2008,
60,000
QE pushed up Net Worth by
$35 trillion (+60%). Rising
50,000
asset price created a Wealth
40,000
Eect that boosted consump\on
30,000 and economic growth in the US.
20,000

10,000

0
1955
1956
1958
1960
1962
1963
1965
1967
1969
1970
1972
1974
1976
1977
1979
1981
1983
1984
1986
1988
1990
1991
1993
1995
1997
1998
2000
2002
2004
2005
2007
2009
2011
2012
2014
2016
Source: Fed
 Household Net Worth
as a % of Disposable Personal Income
%, 1951 to 2016
700
This ra\o of Wealth to Income is near
650
record high levels because very low interest
600 rates and QE have pushed up asset prices.
550

500

450

400
If interest rates now rise, asset prices will spiral back down, crea\ng
a nega\ve Wealth Eect that will push the economy into crisis.
350
1951-10-01
1953-10-01
1955-10-01
1957-10-01
1959-10-01
1961-10-01
1963-10-01
1965-10-01
1967-10-01
1969-10-01
1971-10-01
1973-10-01
1975-10-01
1977-10-01
1979-10-01
1981-10-01
1983-10-01
1985-10-01
1987-10-01
1989-10-01
1991-10-01
1993-10-01
1995-10-01
1997-10-01
1999-10-01
2001-10-01
2003-10-01
2005-10-01
2007-10-01
2009-10-01
2011-10-01
2013-10-01
2015-10-01
Source: Fed
 The Five Factors
That Will Determine Interest Rates
1. The Governments Budget Decit.
2. The US Current Account Decit
3. Quan>ta>ve Easing by central banks outside the US.
4. The Ina>on Rate
5. The Chinese RMB Exchange Rate vs. the US Dollar.
 1. The Budget Decit
President Trumps plans to cut taxes and increase
government spending on the military and
infrastructure are quite likely to cause the
governments budget decit to increase very
signicantly.

 US Government Budget Surplus or Decit ()
US$ Millions, 1960 to 2021 es\mates, (Fiscal Years ending Sept 30)
400,000

200,000
Es\mates
0

-200,000

-400,000
The budget decits are currently
-600,000 projected to average $519 billion a year
-800,000 from 2017 to 2021. Those projec>ons
-1,000,000 dont include the large increase in the
annual decits that is likely to result
-1,200,000
from President Trumps proposed
-1,400,000
tax cuts and increased govt. spending.
-1,600,000
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018 est
2020 est
Source: Oce Of Management & Budget
 2. Capital Inows
Before Bre-on Woods broke down, trade imbalances
and capital ows between na>ons were very limited.
But now they have become very large.
Capital inows into the United States have become
an enormously important source of funding for the
US Budget decit.
The larger the capital inows are, the easier it is to
nance the governments budget decit at low
interest rates.
 The US Financial & Capital Account
US$ millions, 1960 to 2015
900,000
$807 bn
800,000

700,000 Capital Inows into

600,000 the United States.
500,000
$463 bn

400,000

300,000

200,000

100,000

0
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
-100,000

Source: Bureau of Economic Analysis

 Mirror Image
The Capital Inows are the mirror image of the
Current Account decit.
When the Current Account Decit grows larger, the
Capital Inows also grow larger, making it easier to
nance the budget decit.
But, when the Current Account Decit shrinks,
Capital Inows also shrink, making it more dicult to
nance the budget decit at low interest rates.
 The Current Account = The Financial and Capital Account
US$ millions, 1960 to 2015
Property
1,000,000
Bubble
800,000
Mirror Image
600,000

400,000

200,000

0
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
-200,000

-400,000
1987 Stock
-600,000 Market Crash

-800,000
Capital Inows have a powerful eect on US asset prices.
-1,000,000

Financial & Capital Account Current Account

Source: Bureau of Economic Analysis

 Capital Inows May Shrink
Trumps plans to force US companies to bring their factories
back to the US, to renego>ate trade deals and/or to impose
trade taris on China and Mexico would all cause the US
Current Account decit to shrink.
A smaller Current Account decit would cause the capital
inows into the United States to shrink, too.
Less capital inows would mean less demand for US
government bonds.
That would push up interest rates and pop the asset price
bubble.
So, we must keep a close eye on the US Current Account
Decit because it will determine the size of the capital
inows.
 3. Quan\ta\ve Easing
Quan>ta>ve Easing is the third factor we must
watch.
Clearly, when the Fed prints money and buys
government bonds, that pushes up the price of the
bonds and pushes down their yields.
Addi>onal QE from the Fed now looks unlikely, at
least in the near term. (Were going to have scal
s>mulus instead of monetary s>mulus.)

 Other Central Banks
However, we must also monitor the Quan>ta>ve Easing being
carried out by other central banks around the world because
QE overseas impacts US interest rates, too.
Currently, the ECB, BOJ and BOE (combined) are prin>ng the
equivalent of roughly $500 billion every three months.
They use that new money to buy their governments bonds.
That pushes up the price of their bonds and pushes down
their yields.
Lower yields in Europe, Japan and the UK are now punng
downward pressure on US government bond yields.
However, if those central banks print less money in the
future, US interest rates would probably rise.
 Half A Trillion Dollars Per Quarter
The BOJ and the ECB are now carrying out
Quan\ta\ve Easing on a very large scale.
Here are the details:
Global QE
US$
Exchange US$ billion US$ billion
Per Month Rate per Month per Quarter

BOE 70 billion over 8 months 8.75 billion 1.3 11.4 34.1

BOJ Yen 80 trillion per year Yen 6.67 trillion 100 66.7 200.1

ECB Euro 80 billion per month Euro 80 billion 1.13 90.4 271.2

Total 168.5 505.4

Source: Central Banks

 US$8.15 trillion
Government Debt Cancelled Thus Far
Central Bank Holdings Of Government Debt
Converted into US Dollars, billions

US$ Exchange Rate US$ billions

BOE 375 billion 1.3 488
BOJ Yen 368 trillion 100 3,700
ECB Euro 1,326 billion 1.13 1,500
Fed $2,462 billion 2,462

Total 8,150

This total is scheduled to increase by US$1 trillion over the next 6 months.

Source: The BOE, BOJ, ECB, Fed

The Amount Of Government Debt Cancelled* So Far
Central Bank Holdings Of Government Debt
As a % of Total Government Debt:

BOE 25%
BOJ 35%
ECB 12%
Fed 13%
Source: RD es>mates
* Eec>vely Cancelled

Note: The numbers for the BOJ and ECB are slightly overstated because some of
the assets they have acquired are corporate bonds (but only a small part). The
importance of the Feds QE is understated because in addi>on to owning US$2.5
trillion of government bonds, the Fed also owns $1.7 trillion of asset-backed
mortgage debt.
 4. Ina\on
Ina>on also aects interest rates.
If the ina>on rate goes up, the demand for bonds
will go down unless the yield oered on those
bonds increases.
No one will lend money for 3% if the ina>on rate is
5%.
In recent years the Ina>on Rate has been
excep>onally low despite all the money that the
central banks have been prin>ng.
 1.6% in
Oct. 2016

Source: St Louis Fed

 What Could Cause Ina\on To Rise?
Ina>on has fallen since the early 1980s because
increasing trade with low wage countries has pushed
down US wages and the price of consumer goods.
Now, however, if the US imports less from low wage
countries, the price of manufactured goods will rise, US
wages will rise, and ina>on will rise.
Forcing companies to bring their factories back to the
United States or imposing trade taris on imported
goods would cause ina>on to increase.
Increased government spending could also cause
ina>on to pick up.
 5. The Chinese RMB
Finally, the value of the RMB could also impact US interest rates.
The United States will import nearly Half A Trillion Dollars worth of
goods from China this year.
If the RMB con>nues to weaken against the Dollar, those imports
will become cheaper and put downward pressure on US ina>on
rates.
If the RMB were to strengthen (which is unlikely), then that would
put upward pressure on US ina>on.
Of course, if the US puts trade taris on Chinese goods, that would
cause a spike in the US ina>on rate, which would push up US
interest rates.
By the way, in 2015 the US imported $483 billion of goods from
China and exported $116 billion of goods to China, resul>ng in a US
trade decit with China of $367 billion - or roughly $1 billion a day.
 Chinese RMB per Dollar From 2006 to 2013,
1980 to December 2016 the RMB appreciated.
10.0
But, now, it is falling
9.0 The Great China Boom again.
was fuelled by a very
8.0
weak currency. It
7.0 fell for decades un\l
1994.
6.0

5.0

4.0

3.0

2.0

1.0

0.0
01/1980

01/1982

01/1984

01/1986

01/1988

01/1990

01/1992

01/1994

01/1996

01/1998

01/2000

01/2002

01/2004

01/2006

01/2008

01/2010

01/2012

01/2014

01/2016
Source: CEIC
 The US Trade Decit Is To Blame
President Trump believes the US trade decit has
been responsible for the loss of manufacturing jobs
in the United States and the downward pressure on
US wages that has occurred over the last several
decades.
I agree.
Ive wri-en about the harm the US trade decit has
done to the United States and about the
destabilizing impact its had on the global economy
in all three of my books.
 The Dollar Crisis
Here are the opening lines from my rst book, The
Dollar Crisis:

The principle aw in the post-Bre-on Woods
interna>onal monetary system is its inability to
prevent large-scale trade imbalances. The theme of
The Dollar Crisis is that those imbalances have
destabilized the global economy by crea>ng a world-
wide credit bubble.
 Not Easy
However, unwinding the US trade decit is going to
be very dicult.
Over the past 35 years, that decit has become THE
driver of global economic growth.
In fact, the en>re global economy has been
constructed around unbalanced trade.
At this point, the a-empt to eliminate the US trade
decit could very easily cause the global economy to
collapse into a new Great Depression.
100,000
US Current Account Balance
US$ Millions, 1960 to 2015
0

-100,000
From the early 1980s,
-200,000
the US Current Account
-300,000
Decit became
-400,000 THE driver of global
-500,000 economic growth. As long
-600,000 as the decit expanded,
-700,000 the global economy
-800,000 prospered.
-900,000
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Source: Bureau of Economic Analysis
 The Undesirable Consequences
of Elimina\ng The Trade Decit
1. If the US reduces its imports, the global economy will shrink.
2. If the US eliminates its $1 billion a day trade decit with
China, Chinas economy could collapse into a depression
that would severely impact all of Chinas trading partners,
and poten>ally lead to social instability within China and to
military conict between China, its neighbors and the US.
3. If the US Current Account decit returns to balance, the
global economy will suer from insucient Dollar liquidity,
which could cause economic stagna>on or worse.
4. A reduc>on of imports from low wage countries would
cause US ina>on to rise, which would push up US interest
rates.
 US Imports & Exports
US$ Millions, 1990 to 2015
3,000,000
When the US buys less from
2,500,000 the rest of the world, the
rest of the world buys less
2,000,000
from the US.
1,500,000

1,000,000

500,000
If US Imports fall,
US Exports will fall, too.
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Exports of goods and services Imports of goods and services

Source: Bureau of Economic Analysis

 The Undesirable Consequences
of Elimina\ng The Trade Decit
1. If the US reduces its imports, the global economy will shrink.
2. If the US eliminates its $1 billion a day trade decit with
China, Chinas economy could collapse into a depression
that would severely impact all of Chinas trading partners,
and poten>ally lead to social instability within China and to
military conict between China, its neighbors and the US.
3. If the US Current Account decit returns to balance, the
global economy will suer from insucient Dollar liquidity,
which could cause economic stagna>on or worse.
4. A reduc>on of imports from low wage countries would
cause US ina>on to rise, which would push up US interest
rates.
 China's Exports & Imports
US$ Millions, 1990 to 2015
2,500,000 When China Exports less,
it Imports less. And when
2,000,000
China imports less, commodity
prices fall, hur\ng the
economies and currencies of the
1,500,000
commodity producing
countries all around the world. Exports

1,000,000 Imports

500,000

0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Source: CEIC
 If Chinas Economy Implodes
Chinas economy is already verging on crisis. It has massive
excess capacity across prac>cally every industry. So, product
prices are falling, companies are loss-making and the banking
system is stued with unrecoverable loans.
If Chinas trade surplus were eliminated, the nega>ve impact
on Chinas economy would be devasta>ng.
In all likelihood, China would experience a severe depression,
that could threaten the rule of the Communist Party.
China might respond militarily just as Japan did at Pearl
Harbor arer the US imposed an oil embargo on Japan in 1941.
No one should underes>mate the damage that could result
from an economic crisis in China.
 The Undesirable Consequences
of Elimina\ng The Trade Decit
1. If the US reduces its imports, the global economy will shrink.
2. If the US eliminates its $1 billion a day trade decit with
China, Chinas economy could collapse into a depression
that would severely impact all of Chinas trading partners,
and poten>ally lead to social instability within China and to
military conict between China, its neighbors and the US.
3. If the US Current Account decit returns to balance, the
global economy will suer from insucient Dollar liquidity,
which could cause economic stagna>on or worse.
4. A reduc>on of imports from low wage countries would
cause US ina>on to rise, which would push up US interest
rates.
 Global Liquidity Would Dry Up
When the world was on the gold standard, global liquidity
depended on the discovery of new gold mines. Some>mes
there was too much gold (16th Century Europe, which caused
ina>on) and some>mes not enough (late 19th Century
America, which caused dea>on).
But under The Dollar Standard, global liquidity is determined
by the quan>ty of Dollars in the global economy; and the
principal way in which Dollars are injected into the global
economy is through the US Current Account decit.
If the US Current Account Decit were eliminated, the supply
of Dollar liquidity would be too >ght to support economic
expansion.
That would probably result in global economic stagna>on or
worse.
 The Undesirable Consequences
of Elimina\ng The Trade Decit
1. If the US reduces its imports, the global economy will shrink.
2. If the US eliminates its $1 billion a day trade decit with
China, Chinas economy could collapse into a depression
that would severely impact all of Chinas trading partners,
and poten>ally lead to social instability within China and to
military conict between China, its neighbors and the US.
3. If the US Current Account decit returns to balance, the
global economy will suer from insucient Dollar liquidity,
which could cause economic stagna>on or worse.
4. A reduc>on of imports from low wage countries would
cause US ina>on to rise, which would push up US interest
rates.
 The Undesirable Consequences
of Elimina\ng The Trade Decit
5. The elimina>on of the Current Account decit would
cause a sharp reduc>on in capital inows into the US,
which would also cause US interest rates to rise.
6. Higher interest rates would cause credit to contract and
the US economy to go into recession.
7. Higher interest rates would also cause a sharp fall in US
asset prices. That, too, would also cause the economy
to go into recession.
8. Higher interest rates could cause a wave of credit
defaults in the US and around the world, poten>ally
leading to a new systemic nancial sector crisis.
 A Be5er Way
For all of these reasons, Im very concerned that it
will not be possible to eliminate the US trade decit
without causing the global economic bubble to
implode into a new great depression.
Rather than a-emp>ng to eliminate the decit, it
would be wiser for the Trump Administra>on to
allow the decit to persist, but to pursue policies
that would increase aggregate demand in the
countries the US trades with and also in the United
States itself.
 A Be5er Way
For instance, the US could enact policies that would
force China to increase wages in its manufacturing
sector. That would increase Chinas demand for US
goods without causing a crisis in China.
At home, the US government could sharply increase
its investment in new industries and technologies.
That would boost US purchasing power and growth
and, that investment could be nanced at very low
interest rates thanks to the dea>onary pressures
and the capital inows resul>ng for the US trade
decits.
 Conclusions
The proposals outlined thus far by President Trump
suggest that:
1. The budget decit would grow larger (due to tax
cuts and increase government spending);
2. The current account decit would shrink (due to
renego>a>ng trade deals, bringing US factory jobs
back to the US and possibly trade taris);
3. And ina>on would pick up (due to increased
government spending, higher US wages, pressure
on China to push up the RMB and, possibly, taris).
 A Recipe For Disaster
If those policies really are adopted, they would be a
recipe for disaster because they would push US
interest rates signicantly higher and that would
pop the global economic bubble.
If it pops, it may be possible to reate it again with
even larger amounts of Quan>ta>ve Easing.
On the other hand, it might not be, in which case the
world could be plunged into a new Great Depression.
In that scenario, massive wealth destruc>on would
only be the beginning of our problems. Our poli>cal
ins>tu>ons would probably not survive the strain.
 MACRO WATCH
A video-newsle-er analyzing trends in Credit Growth, Liquidity
and Government Policy to an>cipate their impact on economic
growth and asset prices

h-p://www.richardduncaneconomics.com


To Subscribe to Macro Watch at a 50% discount, visit the
Macro Watch website, click the Subscribe tab and, when
prompted, use the discount coupon code: nancial