Trump’s Devastating Trade War Weapons

The news last week was dominated by breathless headlines about the new trade war between the U.S. and China. But this trade war has been brewing for years and came as no surprise to readers of my newsletter, Project Prophesy. In fact, the new trade war is simply a continuation of the currency wars that began in 2010.

I’ve warned for over a year that President Trump’s threats of tariffs should be taken seriously, while most of Wall Street discounted Trump’s talk as mere bluster. Now the trade wars are here as we expected, and they will get much worse before they are resolved.

The most powerful analytic frame today for understanding political and macroeconomic developments is the sequence from currency wars to trade wars and then ultimately shooting wars.

Currency wars arise in a condition of too much debt and too little growth. Economic powers try to steal growth from their trading partners by devaluing their currencies to promote exports and import inflation.

This can work in the short run, but the benefits are strictly temporary because trading partners retaliate by devaluing their own currencies. The tit-for-tat devaluations leave everyone worse off because of the uncertainty and transaction costs imposed.

Once it becomes clear that currency wars are a failure, nations resort to trade wars. These begin with tariffs imposed by one nation on another to protect domestic industry and reduce trade deficits. As with currency wars, the problem is retaliation. Victims of tariffs impose their own tariffs and the world is worse off.

We’ve seen this pattern before in the 1920s and 1930s. It began with currency wars (1921–-1936), then trade wars (1930–-1939) and finally a shooting war in the Second World War that began in Asia in 1936, spread to Europe in 1939 and subsumed the U.S. in 1941.

The present currency war began in 2010. The new trade war began in 2018. Let’s hope a new shooting war or even a third world war does not follow in sequence.

Trump is like a five-star general in the currency and trade wars. It’s important to understand his weapons and tactics. Trump likes to threaten to get results but often does not follow through on his threats.

Recently he threatened to withdraw the U.S. from the World Trade Organization (WTO), the primary multilateral body for settling trade disputes and a successor to one of the original Bretton Woods institutions (along with the IMF and World Bank) established in 1944.

But Trump’s threat to withdraw from the WTO will not be carried out. It’s in the bluff category, strictly for show.

The fact is Trump is turning trade policy upside down without withdrawing from WTO by using other tools at his disposal.

There has always been an exemption from the application of WTO rules where national security is involved. It’s just that past presidents have never used the authority because they are globalists (Republicans and Democrats).

Trump’s method is to weaponize national security considerations in the context of trade disputes. The U.S. has always had ways to stop trade flows and restrict direct foreign investment based on national security considerations.

Trump’s three main “weapons,” mostly unknown to everyday Americans, are IEEPA, CFIUS and Section 301 of the Trade Act of 1974.

IEEPA stands for the International Emergency Economic Powers Act. Enacted in 1977, it allows the President to regulate commerce after declaring a national emergency. He can declare this emergency “to deal with any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States.”

CFIUS stands for the Committee on Foreign Investment in the United States. It began under President Ford in 1975. CFIUS gives the Executive Branch power to monitor the impact of foreign investment in the United States, and determine if it jeopardizes national security. It can block acquisitions of U.S. firms by Chinese companies, for example.

Section 301 of the Trade Act of 1974 is the “nuclear option” when it comes to trade wars. I don’t want to get too deeply in the weeds here, but Section 301 gives the president broad authority to impose sanctions and penalties. It gives the president a free hand to impose billions of dollars of damages if not more on China.

So Trump has the best of both worlds. He can threaten the WTO, but doesn’t actually have to withdraw because he can get everything he wants anyway using IEEPA, CFIUS and Section 301. The globalists are freaking out but can’t stop him.

Unlike previous globalist presidents, Trump is a nationalist. And he’s using these powers like crazy to push his agenda. The Congress can’t stop him because all of these weapons are statutory; they were already passed by Congress in the 1970s and 1980s. These statutes delegate expansive powers to the president.

What’s new is not the law but the way the law is being used.

During the Weimar Republic hyperinflation in 1922–23, paper money became worthless and was swept down sewers (left, below) or fed into furnaces as fuel (right, below). The currency wars continued with French devaluation (1925), U.K. devaluation (1931) and U.S. devaluation (1933). When the currency wars failed to produce growth, the trade wars erupted with the Smoot-Hawley tariffs (1930) and similar tariffs from U.S. trading partners. After currency wars and trade wars failed came shooting wars in Asia (1936) and Europe (1939). The same pattern is repeating today with a new currency war (2010) and trade war (2018).

There is legislation pending in Congress right now to amend CFIUS. The name of the bill is the Foreign Investment Risk Review Modernization Act, or FIRRMA. This amendment to CFIUS will give CFIUS greatly expanded powers to stop Chinese takeovers of U.S. crown jewels in technology, telecommunications and the defense sector.

This new law shuts the Chinese (and anyone else Trump doesn’t like) out of the market to acquire U.S. tech and defense stocks. Once you remove the biggest buyers from the market, prices will plunge to “re-price” to the new reality.

With the trade wars and pending legislation in mind, what are my predictive analytic models telling us about the prospects for a stock market crash in the tech and defense sectors?

Right now my analytical tools are telling me that FIRRMA is close to a sure thing to become law, but Wall Street is underestimating the impact of this on takeover activity and stock prices to tech and defense companies.

FIRRMA has been attached to the National Defense Authorization Act (NDAA) for fiscal 2019 (starting Oct. 1, 2018). However, Congress will be in recess most of the time after July 26 for vacations and midterm election campaigning.

NDAA is “must pass” legislation. This means Congress has to pass this before the end of September unless they enact a continuing resolution. I estimate two possible outside dates for this to become law and go to the president for signature: Sunday, Sept. 30, 2018 (with no continuing resolution), or Thursday, Dec. 13, 2018 (end of this session of Congress).

Of course, markets won’t wait until then to react. Sooner than later, Wall Street will see this coming and start to discount the impact. FIRRMA has bipartisan support from liberal Democrats and conservative Republicans. It’s as close to a “sure thing” in D.C. legislation as you can get.

China will not take this lying down. They are fighting back in the trade wars using currency war weapons as shown in the chart below. They will also retaliate directly by restricting U.S. investment in China’s technology, another blow to global tech stock prices.

China is fighting back in the trade wars by returning to the currency wars. When Trump imposes a 25% tariff on Chinese imports, this increases the costs of Chinese goods to U.S. consumers. But China can retaliate by cheapening its currency (CNY) against the U.S. dollar (USD), which reduces the costs of Chinese imports to U.S. consumers. That’s exactly what China has done the past few weeks with a bigger yuan devaluation than the August 2015 “shock” devaluation, as shown in the chart below. The CNY/USD devaluation offsets the tariffs. The trade and currency wars continue and will get worse.

The trade and currency wars are like a hurricane aimed directly at tech and defense stocks. Wall Street does not see this coming, so there’s an excellent opportunity to profit by positioning in advance.

Regards,

Jim Rickards
for The Daily Reckoning