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From: Thomas Jr., Landon
Sent: 11/29/2016 6:33:42 PM
To: Jeffrey Epstein [jeeyacation@gmail.com]
Subject: Fwd: My Thoughts on Currencies
Importance: High
The smartest/most amusing piece of research I have read so far on Trump/global economy. You
should pass on to DJT brain trust on economy/markets
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Date: Tue, Nov 29, 2016 at 10:51 AM
Subject: My Thoughts on Currencies
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My Thoughts on Currencies
Stephen L Jen (London)
November 29, 2016
Bottom line. Some retracement in the market trends we've seen since
November 8 makes sense, in light of the magnitudes of the moves as well as
the upcoming event risks (Italian referendum, OPEC meeting, and the
FOMC meeting). But I think none of these events will likely surprise the
markets, and President-Elect Trump will likely continue to drive the
markets, extending the recent trends. By the way, he has left the US
Treasury Secretary post last to be filled, and it is the most important
appointment for the markets as it will both reflect and influence key policies
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on trade, tax cuts, and infrastructure spending. (1) The doves at the Fed
have been silenced as, under President Trump, the US policy mix will likely
be less lop-sided and the emphasis will be on Arrow 3, with Arrow 1 being
downgraded. I think the effective demotion of the Fed has just begun. Its
independence will likely be challenged, as it should be, in my personal
view. November 8 marked the beginning of the end of the financial
repression in the US. (2) Generating outsized economic growth will be key
to settling several important inconsistencies in macro. I will elaborate on
this point below. But the market trends witnessed since November 8 will
not be sustained unless Mr Trump's policies indeed lead to significantly
higher nominal GDP growth. (3) The mainstream media remain negative on
Mr Trump, but this will keep the hurdle low, and in turn pressure President
Trump to deliver early in 2017 and thus for him to impress favourably. A
shift away from identity politics, in my view, based on my personal
experience from Taiwan, should lead to positive economic
progress. Investors won't need to wait long for there to be more concrete
announcements on the various parts of Arrow 3, including both the content
of the policies as well as their sequencing. (4) FWIW, my two policy
recommendations to the reformers are (i) design an effective global taxation
scheme to properly tax multi-national corporations and (ii) adopt industrial
policies to help countries focus on their comparative advantages. The US,
UK, Japan, and Italy are all prime candidates to do (ii). (5) The dollar is
already moderately over-valued, but this will not prevent it from
strengthening further, especially against the EM currencies. Think in terms
of 'growth alpha' and 'growth beta.' Much of EM, including China since
February of this year, have not possessed 'growth alpha' and have continued
to rely on 'growth beta' vis-à-vis the rest of the world. I struggle to think of
key reforms that EM countries have embarked on in recent years: even
countries like France and Italy have undertaken more reforms than most EM
countries. Squeezed by (i) a more hawkish Fed, (ii) a China that will
continue to soft land, and (iii) a potentially more inward-looking US, EM
will struggle without 'growth alpha.' I think we may be entering into a
period of differentiation among the EM markets: those that have 'growth
alpha' will be rewarded while those that continue to rely on 'growth beta'
will not. (6) The world according to Trump will be more Darwinian for
countries and less Darwinian for US citizens.This notion applies to investing
in EM, to countries' growth prospects, and to international competition —
(potentially) very different from the last few years, when 'the Fed was the
only game in town' and everyone and everything floated higher by central
bank liquidity... In any case, the dollar should be in a good position to
thrive, I think.
Economic Olympics. The markets are no longer driven only by the Fed and
central bank policies, but by forward-looking policy inclinations. The 'false
economy' that central banks have nurtured will gradually be replaced by real
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economies. In my view, Mr Trump's victory will have many social,
geopolitical, and economic consequences, but for investors I think he will
start a period of 'Economic Olympics', whereby the federal governments
around the world will take more responsibility and be more proactive to help
their 'national teams' to become more competitive in this globalised
world. (1) Free trade is in theory good for economic growth. But there are
other policies (such as well-directed R&D, efficient investment, an effective
educational system) that are also extremely important for long-term growth,
but have been ignored in the past 15 years because of the globalisation
fad. A slowdown in trade globalisation might not be bad for the global
economy, if policy makers replace this engine of growth with other
structural improvements. But while globalisation is more about 'growth
beta', other types of structural reforms are about 'growth alpha' and
federal/central governments around the world will need to make a greater
effort at leading the economies to prevent them from falling behind. This is
like a government-led program to win Olympic medals, without doping by
central banks. (2) A client kindly brought to my attention an interesting
report done by the Harvard Business School that touches on the idea
mentioned above (Problems Unsolved and a Nation Divided: the State of
US Competitiveness 2016'). In it, several sensible and consequential points
were made: 'The pressing need for a national economic strategy... Given
the significant challenges facing the American economy, the U.S. needs a
national economic strategy more than at any other time in recent history. A
strategy is an integrated set of priorities that builds on strengths while
acknowledging and tackling weaknesses... The U.S. lacks an economic
strategy, especially at the federal level. The implicit strategy has been to
trust the Federal Reserve to solve our problems through monetary
policy... A national economic strategy for the U.S. will require action by
business, state and local governments, and the federal government. All
three levels have a crucial role to play in restoring competitiveness... Taking
leadership in improving U.S. competitiveness is a pressing imperative for
business leaders. _Many companies have failed to invest enough in
improving the business environments in the regions in which they
operate...' This report from the HBS also reiterates some recommendations
they made in 2012: `[Our] Eight-Point Plan consists of the following policy
recommendations: simplift the corporate tax code with lower statutory rates
and no loopholes; move to a territorial tax system like all other leading
nations '; ease the immigration of highly-skilled individuals; aggressively
address distortions and abuses in the international trading system; improve
logistics, communications, and energy infrastructure; simplift and
streamline regulation; create a sustainable federal budget, including reform
of entitlements; and responsibly develop America's unconventional energy
advantage.' Interestingly, Mr Trump has discussed many of the same
points. I personally think that, so far, identity politics has distracted from his
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message on economic reform. It is likely, I believe, that the focus of the
general public will be moved to these critical economic reforms. (3) I repeat
a point I've made in the past, that because the mainstream media and most
scholars are still so skeptical of Mr Trump's policies, the hurdle for him to
clear and impress positively is very low. Ironically, such general hostility
will probably work in favour of the Trump Administration. 5 days after the
surprise election victory, the press declared that Mr Trump's transition plan
was in hopeless disarray, only for Mr Trump to announce one cabinet
appointment every day — ahead of the schedule of Presidents Obama and Bill
Clinton when they got elected. (4) We will likely see a less radical President
Trump. We have already seen this on various issues (the Wall, prosecuting
Ms Clinton), and my guess is that the trade policy will be more restrictive,
but the changes will be nuanced at the same time. The appointment of the
next Treasury Secretary will convey an important message. (5) I personally
think that various countries will likely adopt industrial policies, as a
substitute for slower trade globalization. Already, the UK's PM May
announced an ambitious industrial strategy, with a focus on technology. The
government is committed to investing in R&D through the Industrial
Strategy Challenge Fund. Regular readers of our work should also know
that that is what I would recommend for Japan to consider. I just came back
from a trip to Singapore, and understand that the government there is also
struggling to find the best strategy to deal with the next phase of economic
development, now that the growth model based on trade and finance may be
coming to an end. I think the US should also contemplate its own industrial
policy. The title of this section is 'economic Olympics' to convey the notion
that the world is in competition, not just along the axes of cheapness of
labour and technology. There are different disciplines (analogous to the
various sports in Olympics) in which any country can excel, if the efforts are
appropriately focused. Instead of being mediocre in many events, countries
should seek to win the gold medal in their best events...
5%-plus nominal GDP growth in the US in 2017? There are several
inconsistencies in the market trends: (1) a strong dollar and strong US
equities; (2) protectionism and a strong dollar (Mexico, for example, has
gotten 10% cheaper so far this month, and China is also cheaper. The
greater the threats of protectionism against these countries, the cheaper are
their costs of production...); (3) higher yields and strong equities; (4) Mr
Trump does not like Chair Yellen or the Fed but he still needs and prefers
low interest rates. The only variable that can address these inconsistencies is
3-4% real economic growth and 5%-plus nominal GDP growth in the
US. While it is unlikely that 5% nominal GDP growth is sustained over
time, the atmospherics will stop the talk about `r-star' and help support
interest rates in the US. 2017 may very well see 5%-plus nominal GDP
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growth, and, in the event, the 10Y UST yield at 2.34% would not seem too
high.
The dollar will continue to smile. Previously, we made the suggestion that
the US dollar is on the right side of the Dollar Smile against the majors, but
it is on the left side of the Dollar Smile against the EM
currencies. Reaganomics-Lite should be positive for the dollar, even if the
US' twin deficits could widen. 'America First' means that there will be a
bifurcation in economic prosperity, that economic strength in the US will no
longer translate, with the same elasticities as before, into prosperity in many
parts of EM. (1) The dollar has begun a consolidation phase this week. But
my guess is that it will be temporary and shallow, partly because the data
(ISM and NFPRs) will be sufficiently strong to justify another Fed rate hike
on December 14. The weekly claims data remain extraordinarily strong,
while the second derivatives in the data in much of EM have ceased to be
positive. (2) Further advances in the dollar, however, will of course depend
on the policy announcements and delivery by the Trump Administration, as
well as an apparent lack of an economic strategy in other countries. (3)
Yield differentials have helped the dollar advance vis-à-vis the JPY and the
EUR. However, I should note that the EMU economies are not doing that
badly, though credit demand remains weak. PMI remains well above 50 and
inflation has bounced away from zero. The main factor — other than yield
differentials - weighing on the EUR is the risk that we will see more political
uncertainty in Europe. (4) I came across an editorial arguing that Mr
Trump's protectionist policies would hurt the dollar's international
standing. While this may be a popular view — that the US, as a savings
deficit nation, needs a globalised world to finance its external balance —I
contest this conclusion. I think it will be extremely difficult for the
international status of the dollar to be supplanted, even with Mr Trump as
the President. The dollar losing its hegemonic status has been a popular
thesis by many academics over the last twenty years — precisely the period
when the dollar's international and reserve currency status has risen. In
many ways, the sturdiness of the dollar's global status has surprised some
people, because globalisation is supposed to lead to a multi-polar world
where the US loses its dominance. That is certainly true for the real
economy, but exactly the opposite has happened for the dollar. This is a
point I've tried hard to make over the years, that financial globalisation is
uni-polar, even though trade globalisation is multi-polar. Look at how the
rise in the dollar is hurting, disproportionately, the high-yield and EM
currencies. Further, which currencies might replace the dollar? The EUR
itself is still in an existential crisis; nothing needs to be said about the JPY;
China could not even dare opening up its capital account. In fact, Beijing
has just issued even more 'strict controls' on overseas investment, after
experiencing some USD207 billion in outflows in Q3 2016. Just because
President Trump's prospective trade policy may not be politically correct
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does not imply that there will be a demise of the dollar, or that fewer people
in the world would speak English in protest. If anything, I'm worried that a
sharp rally in the dollar could trigger another financial crisis in EM... Don't
get me wrong, I do not believe the dominance of the dollar is good for the
global financial/monetary system. But it is a trend that is difficult to reverse,
unless the structural integrity of the EUR is enhanced, and the foundations of
the RMB market are improved. Increasing returns to scale have made
English/dollar popular, and it will be increasingly difficult to challenge their
roles as the world internationalizes. (5) The BIS recently published an
interesting and important paper (`The Dollar, Bank Leverage and the
Deviation from Covered Interest Parity,' by H.S. Shin et al., BIS WP 592)
on how a stronger dollar could lead to a tightening in lending conditions in
the rest of the world, including EM. ' 111 he value of the dollar plays the role
of a barometer of risk-taking capacity in capital markets. In particular, it is
the spot exchange rate of the dollar which plays a crucial role... [7] he
strength of the dollar is a key determinant of bank leverage... Our results
point to the financial channel of exchange rates, through which fluctuations
in the strength of the dollar set in motion changes in capital market
intermediation spreads that respond at a high frequency._ [Ili is when the
domestic currency appreciates, financial conditions in that country loosen,
and CIP deviations narrow... [A] strengthening of US dollar has adverse
impacts on bank balance sheets, which, in turn, reduces banks ' risk bearing
capacity.' The findings of this paper are consistent with two of the points
made above, that we may re-enter a phase that is not that positive for EM
currencies and that the dominance of the dollar as an international currency
is having unintended consequences for the rest of the world, out of line with
the local fundamentals.
Trump and Europe. Political and social pressures have returned to Europe,
and could continue to accentuate the centrifugal forces in the region. There
are many risk events on the horizon, including the Austrian Presidential
election on December 4 (the worry here is a victory for Mr Norbert Hofer of
the far right party), the Italian referendum on Constitutional reform on
December 4 (while a 'no' outcome is largely priced-in, an actual 'no'
outcome may trigger a series of events in Italy that might pose some
downside risks to Italian banks and in turn other European banks), the Dutch
parliamentary election on March 15, 2017 (the worry here is further
advances by the far right party led by Geert Wilders), the first round of the
French presidential election on April 23 and the second round on May 7, UK
local elections on May 4 (this will be the first major electoral test for PM
May), and finally German regional elections on May 7 and 14 and the
parliamentary election in September. (1) I don't think the direction of
causality runs from Trump to Europe, but that the underlying forces
propelling both Brexit and Trump are the same forces that are pushing the
political centre of mass to the right in Europe. This direction of causality is
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i
important to appreciate, I think, because if one believed that the direction of
causality is the opposite, that Trump causes other changes that would have
been avoidable if Ms Clinton had won, one would come up with the wrong
conclusions on what to do to stop the global shift in sentiment. (2) The
Economist had a special edition last week on the rising nationalism in the
developed West, as if it's an unfounded, random and sinister event that
needs to be suppressed by all means necessary. For various reasons, the
political left is in decline in the developed West. Look at the UK's Labour
Party and the US' Democratic Party. In France, only 1 out of 20 people
approves of Hollande's performance. (3) The Presidential race in France is
now between the Centre Right (Mr Fillon from the Republican Party) and
the Far Right (Ms Le Pen from National Front). The pendulum in Europe, in
my view, will swing to the right, and possibly overshoot, as pendulums tend
to do... which is not good, but an unavoidable consequence of the pendulum
having overshot to the left in the past... In any case, with the Republican
primary being out of the way, the campaign will start in earnest, with the
first round of the Presidential elections to take place in April and the second
round in May. FWIW, Mr Fillon looks like a stronger candidate than Mr
Sarkozy to challenge Ms Le Pen. France, under Mr Fillon, could very well
enter a period of economic reform and rejuvenation, I am guessing. In short,
Mr Fillon's victory last weekend could be a major positive for France, I
think.
The trouble with macroeconomics. The rebellion against the establishment
has also begun in the nerdy field of macro economics, led in part by Prof
Paul Romer of the Stern School of Business. He, of course, has made
enemies in the field with his view — a view I share: 'For more than three
decades, macroeconomics has gone backwards. The treatment of
identification now is no more credible than in the early 1970s but escapes
challenge because it is so much more opaque. Macroeconomic theorists
dismiss mere facts by feigning an obtuse ignorance about such simple
assertions as "tight monetwy policy can cause a recession." Their models
attribute fluctuations in aggregate variables to imaginary causal forces that
are not influenced by the action that any person takes. A parallel with string
theory from physics hints at a general failure mode of science that is
triggered when respect for highly regarded leaders evolves into a deference
to authority that displaces objective fact from its position as the ultimate
determinant of scientific truth.' Group think has become a serious
impediment to advances and renewals in this important field. Misguided
policies have also had significant consequences for people's lives around the
world.
Trade globalization. There will likely be a shift from unconditional,
uncontrolled, and unmanaged trade globalisation, i.e. 'free trade', to 'fair
trade,'. Trade globalisation of the type that we have just experienced
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exchanged rising economic and political inequality for overall
prosperity. We have simply reached a point where this rising inequality is
no longer sustainable in democracies. This is not too different from what
Beijing has been struggling with — to slow down the headline economic
growth rate in exchange for more balance in various parts of the economy, in
order to allow its development to be more sustainable. The parallels in the
West seem quite clear to me. Fighting against this shift in the West, as most
mainstream media seem to be doing, is tantamount to those in China who are
fighting against the economic slowdown. (1) TPP is effectively dead, even
though there are some who are urging that TPP goes ahead without the
US. But I think multilateral trade pacts are in jeopardy. The Trump
Administration still wants to have trade arrangements, but they will be
bilateral and done with countries deemed friendly to the US. (2) The UK is
in a great position to deal with the Trump Administration because all the UK
needs is a bilateral trade arrangement that won't take as long to work out,
compared to a multilateral trade arrangement. The UK just went from the
'back of the queue' (which was an insulting declaration by President Obama,
conspicuously using the word 'queue' to make sure the Brits understood
him) to the 'front of the line.' (3) China was never a part of the TPP
discussions. In fact, TPP was designed from day one to marginalise China,
to replace the current trade arrangement based on WTO rules to something
that puts China at a disadvantage. This is why Beijing is not unhappy with
the Trump Administration's desire to terminate the TPP discussions. (4)
'America First' does not only mean 'world second,' that the US will take
actions to benefit the US even if these policies come at the expense of the
rest of the world. It also means that policies will be aimed at addressing the
inequality and inequity in the US, even if it means that the overall effects on
the US may be negative. (5) In sum, I don't think trade globalisation will
reverse. But it will slow down dramatically and be substituted with a
different web of bilateral arrangements. I think this is a positive
development, as the previous model of global growth was unsustainable,
even if it generated the biggest aggregate prosperity for the world. (6) The
next US Treasury Secretary will likely be instructed by President Trump to
label China as a currency manipulator. While this would be a verdict
without basis, in my view, such a finding could be used as an excuse to
escalate the talks of protectionism.
Some musings... (1) President Obama just awarded his last round of
Presidential Medals of Freedom (America's highest civilian honour) to
Michael Jordan, Ellen DeGeneres, Robert de Niro, and others. Many of
these award recipients were vocal critics of Mr Trump. My views on
politics really don't matter... But for what it is worth, the reason why I have
been more vocal than I should have been about Brexit and the US Elections
is related to my own personal experience. I have witnessed how a previous
harmonious society could very quickly degenerate into a permanent state of
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ethnic hatred, through identity politics. This happened in Taiwan, where I
grew up. When I was a child, I was fluent in Mandarin and Taiwanese, as
most of the children I was friends with were not recent immigrants from
Mainland China like my family was. There were no social conflicts, as far
as I recall, until the pro-independence movement riled up those who
considered themselves 'Taiwanese' against the 'Mainlanders' like
myself Some of my Taiwanese childhood friends are no longer on speaking
terms with me, simply because I'm a 'Mainlander.' Taiwan's economic
development came to a sudden halt, as people were in a constant state of
feeling mistreated by the other group. The pendulum would swing from one
side (green) to the other (blue), each time a President is found to have
committed blatant and large-scale corruption. The politicians won, but the
people lost. This is one reason why I deeply resent identity politics and fear
that the proponents don't truly understand how dangerous this game really
can be. In contrast to the prevalent view, I believe indentity politics are
themselves divisive. Economic cycles and political cycles come and go, but
people can hate each other for generations. Look around the world; I think
we can find plenty examples of irrational hatred between ethnic groups,
ironically because one group felt they were wronged by another and the
political discussions got hijacked by overly zealous politicians. (2) I love
Michael Jordan and have nothing against Ellen DeGeneres, but think Robert
de Niro made a fool of himself in that video. While this may not interest
President Obama, Mr Joe Sutter just passed away: he was the 'Father of the
Boeing 747', the lead engineer that designed and built the first B-747 in
1969. Maybe one day someone will do a movie about him, and the actor
playing him could win the Presidential Medal of Freedom... (3) An artist in
China made a sculpture of a black swan (see the photo below), which was
placed in a shopping mall in Beijing on the other side of the street from the
headquarters of CSRC (China Securities Regulatory Commission) — the
government agency in charge of the securities markets and the agency that
intervened to support the Chinese equity markets. This sculpture was
quickly removed by government agents, within 3 hours of it being placed
there. Months earlier, there were two sculptures of bears (mama bear and a
baby bear) that were placed outside the same mall, and they were also
removed quickly... Maybe I was wrong for belittling artists and
entertainers: they may have the power to bring down the USD9 trillion
equity markets in China with a small sculpture...
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Landon Thomas, Jr.
Financial Reporter
New York Times
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