The Death of Globalization

With so much attention focused on U.S. stock markets, it seems timely to pivot away from stocks for the moment and consider the global perspective. Globalization may be dying in terms of trade and supply chains, but financial markets are inextricably linked in ways that relatively few understand.

King Dollar Still Rules

The dollar still dominates the global financial system despite the cracks in the foundation and the valid criticisms. If there’s a dollar problem in Eurodollar banks, it’s sure to echo from Tokyo to Shanghai and New York. And problems in those locales affect everything else.

I’ve just returned from separate visits to India, Japan and Jekyll Island, Georgia. India has the largest population in the world, has the fifth largest economy, is a nuclear power and a key member of BRICS. Japan is the fourth largest economy in the world and is a key geopolitical ally of the United States in its faceoff with China. Jekyll Island is a lovely ocean resort but is best known as the site of a secret meeting in 1910 where the Morgan, Rockefeller and Warburg interests dreamed up the Federal Reserve System.

I continually urge people to get away from their desks, stop staring at screens and go out and talk to real people. There’s no substitute for walking the streets around the world (including the poorest areas) if you really want to know what’s going on.

While India, Japan and Jekyll Island could hardly be more diverse and geographically scattered, they share a common thread. It’s their economic linkage through the U.S. dollar. The following are some impressions I gathered during these visits that reflect the volatile situation facing markets today.

A Reasonable Response to Tariffs

India and Japan had the most reasoned response to Trump’s new tariff policies. Trump quickly backed off his high “reciprocal” tariffs (27% for India and 24% for Japan) and reverted to his blanket 10% tariff on all imports for every country in the world except China.

Responses varied from retaliation tariffs (proposed by Canada, China and the EU) to a much more reasonable approach of simply asking the White House for a meeting to sit down and discuss the issue amicably with a view to lowering tariffs in both directions. Japan and India fell into this latter category and are being rewarded by being included among the first countries that will actually have that opportunity. (Mexico has also taken the moderate route by engaging in discussions rather than retaliation).

There will be some give and take. Some U.S. tariffs on certain items are likely to remain in place. But the optimal solution is not to cut down on U.S. purchases from those countries but for them to buy more from the U.S.

That trims the U.S. trade deficit without reducing world trade and so constitutes a win-win resolution with both India and Japan. India will likely buy more military hardware and semiconductors from the U.S. Japan will likely buy more agricultural goods including soybeans and beef. The result will be higher growth in the U.S.

Bilateral deals like this have losers. Taiwan may miss out on some semiconductor sales (although they are investing hundreds of billions of dollars to build semiconductors in the U.S.). Russia may miss out on military sales to India although they will remain a major energy supplier. Still, the U.S. is done being the “consumer of last resort” to the world and wants to increase its profile as a seller. Trump’s policies move the U.S. in that direction.

Take Care of Your Own

There is little question that the new U.S. tariff policy will hurt some countries around the world. Not to sound harsh, but that’s their problem. Trump’s job is to make America great again. President Xi’s job is to make China great again. Chancellor-in-waiting Merz’s job is to make Germany great again.

The U.S. cannot carry the world on its back. If other countries (rich or poor) took Trump’s growth-oriented approach instead of free riding on America, the entire world would be better off. That’s certainly the view from the White House and is a good guide to U.S. policy going forward.

Defenders of China point to the fact that Chinese exports are not a particularly large percentage of their total GDP. (Germany is the worst offender by that metric). The problem with that data point does not come from the Chinese export number; I’m sure that’s roughly correct. The distortion comes from the GDP denominator. Chinese GDP is overstated by 100% (at least) perhaps more, and China may already be in a recession.

The reason is that China shows about 45% of its GDP as investment, mostly in the form of government backed construction. I’ve been to the ghost cities in China and seen more on the horizon. I got mud on my boots on the construction sites (except I was wearing Italian loafers). There is real steel, glass and copper in the buildings and it takes real labor to build them. That all counts as GDP.

But they’re all empty. If you used GAAP or international accounting principles, you would write that investment down to zero immediately. You can’t put a ghost city into inventory. Buildings age rapidly and take enormous amounts to maintain. I saw this in the Congo in the early 1980s. They had a commodity boom in the 1970s and wasted much of the money on skyscrapers and other showcase projects.

By the time I arrived there, the windows were falling out and rust stains ran down the sides of their showcases. The same thing will happen in China. Once you make that accounting adjustment for wasted investment, GDP shrinks, and the Chinese export/GDP ratio goes up exponentially. China is much more dependent on exports for any real growth than most analysts realize. Trump and Scott Bessent have this right.

It All Depends on Conditions

Tariffs are not automatically good or bad for an economy. Their impact depends on initial conditions when the tariffs are imposed. Tariffs are a tool that should be applied judiciously. A country that overinvests and under consumes will be hurt by tariffs. The tariffs will increase investment and restrain consumption, making the imbalance worse. That’s what happened to the U.S. under the Smoot-Hawley Tariffs in 1930 and later.

A country that over consumes and underinvests will benefit from tariffs. That’s the situation in the U.S. today. The tariffs will increase investment as foreign and domestic investors build new plants behind tariff walls. Tariffs will channel consumer dollars from consumption into savings, which is also desirable. In the end, consumption will expand not because of cheap imports but because of high-paying U.S. jobs.

China is in the category that overinvests (much of it wasted) and under consumes. China’s best strategy would be to lower its own tariffs and allow its people to spend their savings on imported goods from the U.S. and EU along with their own production. That would reduce China’s trade surplus with the U.S., increase China’s GDP and improve the well-being of its own people. It would also make an excellent opening move in any effort to get the U.S. to reduce its tariffs on China.

The U.S. is making good use of tariffs. China is doing the opposite. China may be fighting to a draw in the rhetorical war, but it will definitely lose the trade war. Japan, India and Mexico are models of how to make progress. China is the poster child for how to fail.

Global supply chains will no doubt be disrupted by the tariff and trade wars now erupting. Reconfiguring supply chains will be a one-to-two-year transition. But once it’s done, the new supply chains will prove durable. Volkswagen blundered badly by putting its new Audi Q5 plant in Mexico. Their U.S. sales are booming right now (beat the tariffs!) but will fall off a cliff once dealer inventories are drained and tariffs apply. Still, that’s a management blunder not a global disruption. Supply chains are adaptable with a lag. U.S. soybeans will soon be on their way to Japan if China doesn’t want them.

As an aside, Elon Musk’s shelf life in the White House pantry will soon expire. Musk sparked a pointless feud with White House trade and manufacturing czar Peter Navarro. I know Peter fairly well (a conversation with him is like a graduate level oral exam but that’s another matter). When Elon attacked Navarro, he messed with the wrong guy. Navarro took a bullet for Trump by serving four months in a federal penitentiary rather than answer a subpoena that sought to pierce the veil of executive privilege between the two. That’s the kind of loyalty Trump respects. Navarro also happens to be right about tariffs despite Musk’s whining.

The Silent Financial Crisis

With regard to the Federal Reserve System that emerged from the swamps around Jekyll Island, the Fed has fallen into complete irrelevance. They have modest impact on the short-end of the yield curve (Treasury bills) but have no material impact on the intermediate- and long-end of the yield curve (Treasury notes and bonds).

U.S. national debt and spending will never be brought under control. But sustainable growth can be stimulated by sound fiscal policies, if not by the Fed. As long as nominal growth is greater than nominal debt increases, then the U.S. debt-to-GDP ratio will shrink. That’s the simple formula behind Scott Bessent’s Three Arrows plan and it can feed on itself in a virtuous circle.

What the Fed and the Treasury have done (mostly under Biden) is to create a global dollar shortage, which is now morphing into a global liquidity crisis. China is not dumping Treasuries because they’re distancing themselves from the dollar. Quite the opposite. China is selling Treasuries because they’re desperate for dollars and can’t get them from Japanese banks who have their own problems with carry trade unwinds.

The liquidity crisis then goes back to European banks who can’t fund in Eurodollars and U.S. hedge funds who can’t find collateral to support their derivatives basis trades. India is not immune.

The best description of a financial crisis I’ve ever heard is that “Everybody wants his money back.” We’re dangerously close to that situation right now. If it gets worse, trade, tariffs and stock markets will be a sideshow. Watch Treasury yields and foreign exchange markets if you really want to know what’s going on.