The Deadly Math Of America's Faux Prosperity

Authored by Tom Luongo,

Record Deficits, Stronger Dollar Equals Record China Trade Deficit

Sometimes math is a real bitch.   Donald Trump is a smart guy.  I know he knows math.

Too bad he’s ignoring it.

Here’s the gig.  The title says it all.  Government spending is rising rapidly.  More actual money is flowing into the US economy.  Where is that spending going?  To buy cell phones, computers, cars, office supplies and all the rest.

It doesn’t matter if the purchase is made at Best Buy through a Purchase Order, the money still goes to stuff built and imported from China.  The second order effect is that even if it goes to subsidize a farmer in Iowa or a defense contractor in California, that money winds up in the hands of a consumer who does what?

Goes to Best Buy and buys a new TV.  This isn’t rocket science folks, it is simple cause and effect.

More money chases those goods.  Despite the naysayers, Apple is selling a crap-ton of $1200 phones…. built where?  China.

So, the budget deficit thanks to record spending is fueling the very trade deficit with China that Trump is complaining about daily.

Here’s the math.

Big Badda Boom

First up is the budget deficit numbers through nine months of fiscal year 2018, courtesy of Zerohedge.

This resulted in a June budget deficit of $75 billion, better than the consensus estimate of $98BN, and an improvement from the $147 billion deficit in May and as well as slightly less than the deficit of $90.2 billion recorded in June of 2017.This was the second biggest June budget deficit since the financial crisis…

…The June deficit brought the cumulative 2018F budget deficit to over $607BN during the first nine month of the fiscal year, up 16% over the past year; as a reminder the deficit is expect to increase further amid the tax and spending measures, and rise above $1 trillion.

The post has a ton of charts to illustrate the point, but it’s mostly unnecessary.  The US Treasury is issuing debt at an astounding rate to cover this budget.  Spending goes up as tax receipts do thanks to lower tax rates and increasing growth.

More Ticky, More Washy

The second part of the title is the latest figures released on the trade deficit with China.

Trump and Navarro Will Hate This Chart

Taking this one step further we have the exploding interest payments on the $21 trillion pile of debt the US Treasury has racked up.  $1.18 trillion of which is owed to….?

China.

As anyone who runs a house knows, when you get a raise what happens to your debt load if you increase your spending to match the raise in earnings?

Nothing.  It stays the same.

If you are smart, your debt is all fixed-rate, so your monthly outlays stay the same.  But, guess what?  A lot of the US’s debt is inflation-linked TIPS (Treasury Inflation Protected Securities).

TIPS are basically a variable-rate mortgage against your labor folks.

So, debt-servicing costs are rising quickly with the slightest rise in interest rates.

Because when you paying 1% on $100 a rise to 2% doesn’t hurt much.  But, when that 1% marginal rise in interest rate is on $20,000, now its real money.  In your household you cut back on spending.

Does the government do that?  Nope.

Keynesian thinking dominates economic thought.  Even Chicago School guys like Chief Economic Advisor Larry Kudlow are effectively Keynesian when it comes to money issuance.

So, inherent in this equation is the increasing interest payments on a portion of the US’s debt held by China.  That’s not something tariffs can fix.

Yuan Moar?

The third part of the math is the Yuan.  China, to combat a slowing credit growth as the Fed pulls back on dollar liquidity is devaluing the Yuan to keep its banking system liquid.

Cheap yuan means cheaper Chinese goods.

Hybrid war tactics like tariffs and monetary policy adjustments are double-edged swords.

For countries that don’t prepare themselves they are left vulnerable to shifts in central bank credit creation.  The severity of that vulnerability, however, can be managed by the opposing central bank.

Remember last month when the TIC report told us that Russia dumped half of its US Treasury holdings?   It caused the yield on the 10-year note to rise above 3.00%, threatening a major technical breakdown which momentum traders could have piled onto and caused a whole lot more pain for the Treasury Department.

And that was only just under $50 billion worth.

China doesn’t have to start with such a drastic measure.  In fact, Russia held off on this course of action for the past four years.  In fact, after the Ruble crisis of 2014/15, Russia reloaded its stock of US Treasury ammunition.

China, however, has started the Yuan devaluation process along with loosening monetary policy to support its domestic banking sector.  And expect this to continue as communications between the Trump administration and China’s Ministry of Finance is on hold.

For President Trump, the math is clear.  And will continue to be clear.  And it is saying, “Stop blaming others for your problems.  Clean up your own house, first.”  In the short-term Trump will look like he’s winning this trade war.

Capital inflow to the US will support this policy.  China’s stock markets will underperform the US’s. But, that will be a function of safe-haven flows, not because the US’s finances are structurally sound.

The People’s Bank of China will respond with liquidity injections that will look increasingly desperate and will result in a wave of defaults and a slow-down.

The dollar will rise and the trade deficit will persist.  So will the budget deficit.

Because math.

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