09 Aug Updates, Part 2*

“Axis of the Sanctioned” (June 21^st TLR)

The theme of “Axis of the Sanctioned” was that “The enemy of my enemy is my friend.” It warned that that this 4^th Century strategy articulation has important applications today. Those applications have been compounding.

The U.S. has taken hostile actions – deploying destructive sanctions and escalating tariffs – against Iran, China, Russia, North Korea, Venezuela, Syria and Cuba (and also against countries that formerly were America’s allies, including India and Turkey and a number of others). This naturally has led America’s foes to team up … and to actively pursue their own alliances …, and is forcing America’s friends to take sides. What choice have they? Countries and companies either have to be “for” the U.S. or “against” the U.S. in what is fast becoming a contest for global economic and hegemonic dominance. Iran, China, Russia, North Korea, Venezuela, Syria and Cuba already have been labeled “enemies” by America. They accordingly have no choice but to align/ally themselves against America. And that’s precisely what they’ve been doing.

Iran has been pressuring shipping in the Strait of Hormuz. This has forced the U.S. to commit further, increasingly costly military resources to the Middle East where it already is facing challenges in Syria, Iraq and Afghanistan as Al Qaeda and ISIS (and the Taliban) rebuild their networks and Russia works with Turkey and Syria to undermine U.S. interests. Not coincidentally, North Korea at the same time has been increasing its missile testing … as well as its rhetoric. China, in turn, has launched retaliatory economic measures to address America’s ratcheting up of tariffs, perhaps presaging the beginnings of a Currency War (discussed below). Russia remains focused on interfering with forthcoming U.S. elections (as FBI Director Christopher Wray recently told the Senate Judiciary Committee). It simultaneously is focusing on gaining further influence in the Middle East and in maintaining political and military pressure on its former satellites in Eastern Europe. Critically, Russia and China have been engaging in joint military exercises – a dangerous turn of events. Russian and Chinese aircraft also have been probing South Korean and Japanese air defenses – an unexpected development. And Russian aircraft and naval vessels have been continuing their probing of NATO defenses. As Walter Russell Mead explained in his August 5^th piece in the Wall Street Journal entitled “Why Russia and China Are Joining Forces,” “From Venezuela to Syria to Serbia, [Russia and China] are working to frustrate the [United States]. They are also increasingly cooperating in sub-Saharan Africa and have found ways to reduce their competition in Central Asia.”

“The enemy of my enemy is my friend.”

America’s sanctions are taking a terrible economic toll on both Iran and China. Because American threats have prevented Iran from selling its oil on international markets and American tariffs have reduced China’s ability to sell its products internationally, the two have now found that their economic interests are aligned. Iran accordingly has been sending oil to China and receiving Chinese products in return, without the need to fund those transactions in US Dollars. Theirs is a natural fit. Dennis Wilder, a former CIA and White House official, noted that “China is not going to do the US any favors. This is the price you pay strategically. You cannot tell China on the one hand to be aligned with you on Iran and North Korea and at the same time decide you’re going to retard or destroy some of their corporations.” Russia is in a similar position to China and has taken similar steps. It is actively seeking to build alternatives to the US Dollar. Russia and China accordingly have agreed to use Rubles and Yuan in their bilateral trading and, in an ominous development, India has agreed to pay Russia in Rubles for defense sales.

Other countries are taking note. As Bloomberg reported on August 2^nd, Saudi Arabia is sending an ever-larger portion of its oil exports to China. As a further example, Chinese Foreign Minister Wang Yi toured South American countries last month in an effort to increase China’s trade with Brazil and Chile and to meet with other BRIC leaders in Brazil. At the same time, Columbia’s President was meeting with Chinese President Xi Jinping in Beijing. China is now Brazil’s biggest trading partner and the second largest trading partner to all of Latin America. And, despite pressure from the U.S., the EU is looking increasingly to Russia for its natural gas supplies. Walter Russell Mead adds: “Mr. Trump’s critics argue that Washington can’t afford to alienate longtime allies as adversaries coalesce against the U.S. They also warn that the institutions that constrained great-power competition are decaying at an accelerating pace. And businesses around the world need the kind of policy predictability that Trump-era diplomacy is steadily eroding.”

“Be Careful What You Wish For” (July 19^th TLR)

No one should be surprised if the world teeters topples plunges from a Trade War into a Currency War. Since the Great Recession, Central Bankers have been uncannily successful at coordinating the world’s interest rates and liquidity levels, a juggling act that required deft synchronization, exceptional international public relations, and a cooperative global polity. Synchronization depended on harmonized national economic growth rates. That ended with the 2017 JOBS Act. Its fiscal stimulus supercharged the American economy and led the Federal Reserve to unilaterally increase interest rates. Doing so strengthened an already too- strong Dollar, raising the comparative costs of American goods and services, thereby increasing America’s trade deficit. Meanwhile, the international public relations coup of “whatever it takes” became un-credible. Central Bank policies can go only so far and the prospect of a Hard Brexit and the American Trade Wars sent shivers through the global economy. Doubts now have emerged about the depth and quality of Central Bankers’ toolboxes. Finally, there no longer is a cooperative global polity. Globalization and trade harmony ended with America First and the sanctions and tariffs imposed by the Trump Administration. With Central Bankers no longer having the ability to control global markets, that task now falls to Central Governments. Global domestic economic defenses now require the institution of countermeasures … and governments may find currency manipulation to be an appropriate defensive weapon. They can stimulate demand for their country’s goods and services by lowering the value of their currencies, putting more into circulation and/or by buying other countries’ currencies. That’s what’s being discussed threatened. The U.S. Treasury has fired the first salvo, quite a serious one: It’s labeled China a “currency manipulator” …, and done so despite the International Monetary Fund’s determination only a few weeks earlier that the Yuan’s value is in line with China’s economic fundamentals. The People’s Bank of China promptly responded to the manipulator label, saying that China “has not used and will not use the exchange rate as a tool to deal with trade disputes” and advised the U.S. to “rein in its horse before the precipice, and be aware of its errors, and turn back from the wrong path.”

Make no mistake. A Currency War would be a significant escalation, several levels of economic and global risk above a Trade War.

With a weakening global economic outlook existing prior to the most recent Currency War talk, the European Central Bank indicated that it is preparing to cut rates and restart quantitative easing. Doing so would reduce the relative value of the Euro. The Bank of Japan also is preparing for new rate cuts. That would have a dampening effect on the relative value of the Yen. The Bank of Australia already cut rates in June and July and New Zealand’s Central Bank and the Reserve Bank of India both did so this week. The Federal Reserve similarly cut rates at its July meeting and, at the same time, ended a relatively short period of Quantitative Tightening. The Fed remains under enormous Presidential pressure to cut rates further and to also commence a new round of Quantitative Easing. Given the Brexit situation and the actions of other Central Bankers, the Bank of England probably won’t be far behind.

As described in “Be Careful What You Wish For,” President Trump has been wishing for a weaker Dollar. He continues to do so, tweeting: “China dropped the price of their currency to an almost historic low. It’s called ÔÇÿcurrency manipulation.’ Are you listening Federal Reserve?” Whether or not the Fed heeds his plea for lower interest rates, if he so desires Trump can cause the Dollar to weaken by selling Dollars in global currency markets – that is, he can turn the U.S. into a currency manipulator. Because the Trump Administration’s Treasury Department now has labeled China a currency manipulator, the U.S. also can impose additional sanctions on China. Clinton Administration Treasury Secretary Larry Summers has frequently expressed his belief that weakening the US Dollar would create a huge risk for the U.S. economy: “When you signal you don’t want your currency to be strong, when you trash your own country for competitiveness, you raise the borrowing costs for every American homeowner and every American company…. [N]o nation can devalue its way to prosperity. That’s ultimately about the quality of its institutions, the hard work of its workers, the entrepreneurship of its business. Those are the fundamental things we should be trying to foster.”

Be careful what you wish for indeed! And, lest anyone forget, Currency Wars can create the most unexpected of consequences.

Finally (from a good friend)

*┬® Copyright 2019 by William Natbony. All rights reserved.