Aftermath

by James Rickards

  Yet their political instincts are eerily similar. In 1912, Roosevelt ran as a third-party candidate for president on a program he called the New Nationalism. This program attacked cronyism and political corruption on the part of Democrats and Republicans. One of the main planks of Roosevelt’s platform declared that “to destroy this invisible Government, to dissolve the unholy alliance between corrupt business and corrupt politics is the first task of the statesmanship of the day.”9 Trump was slightly less articulate when he yelled, “Drain the swamp.” Still, there was no mistaking the shared sentiment.

  The point of this historical comparison is that Trump is not a unique figure, he’s a type, the true nationalist, that Americans have not seen in the White House in over a century. Before Roosevelt there were other presidents, James Knox Polk (1845–49), and Andrew Jackson (1829–37), who fit the nationalist mold. President George Washington (1789–97) would arguably have no objection to an “America first” motto. It’s as if America needs a jolt of pure nationalism once a century or so to maintain her identity and destiny against the multilateral lure. Trump is that jolt for the twenty-first century.

  Today’s most potent political divide between nationalists and globalists is on the matter of borders. This goes beyond clichés about Trump’s border wall with Mexico and stepped-up immigration enforcement. Borders can be physical, legal, or psychological. Trump and the globalists are fighting over all three.

  The touchstone of globalism is a borderless world. This means a free flow of capital, people, goods, services, and ideas around the world without regard to national boundaries, national source, or national destination. The globalist vision treats the nation-state as at best an inconvenience, and at worst a threat to the full realization of their vision.

  Unspoken in the rush to a heroic new world of free capital flows, free trade, free-floating exchange rates, and frictionless migration is the fact that national governance will not be diminished, it will be displaced. National parliaments and congresses will be little more than town meetings called to deal with parochial issues. The momentous issues involving capital, labor, applied technology, and fiscal and monetary policy will be decided globally by various institutions such as the IMF (for monetary policy), OECD (for tax policy), UN (for climate change), and the G20. This leadership is mainly unelected and self-perpetuating. Some G20 leaders occasionally have to run in national elections, yet these are orchestrated so the globalist agenda wins regardless of which party leader is selected. Globalists know how unpopular their agenda is when starkly stated. So, the globalists resort to spurious arguments regurgitated by a press that shows no interest in examining underlying premises.

  The globalist case for “free trade” is putatively based on the early-nineteenth-century theory of comparative advantage articulated by David Ricardo, the preeminent classical economist. Ricardo’s theory began with a view that countries should not try to be self-sufficient in all aspects of manufacturing, mining, and agriculture. Instead, countries should specialize in what they do best, based on advantages in labor, capital, or natural resources, and let others also specialize in what they do best. Then countries could simply trade the goods they make for the goods made by others. All sides would be better off because prices would be lower as a result of specialization in goods where one trading partner has a natural advantage.

  Yet the factor inputs that make up comparative advantage are not static. What happens if Country A attracts capital from Country B with tax and other incentives, then builds high-tech robotics side by side with basic manufacturing and cheap labor? Now Country A has all the jobs and technology, and Country B has no jobs, a trade deficit, and retains only its direct foreign investment or portfolio investment in Country B.

  This may seem like an extreme example, but it bears a close resemblance to the relationship between China and the United States, where the U.S. advantage in capital formation was siphoned off by China, so that China ended up with the comparative advantage in labor and capital and a huge bilateral trade surplus.

  Comparative advantage is not only mobile, it is created from thin air. Taiwan had no comparative advantage in semiconductor manufacturing in the 1980s. Yet the Taiwanese government made a political decision to create the state-sponsored Taiwan Semiconductor Manufacturing Company. The Taiwanese government nurtured Taiwan Semiconductor with tariffs and subsidies in its early days when it was most vulnerable to foreign competition. Today, Taiwan Semiconductor is a publicly traded company and the largest semiconductor supplier in the world. The company would never have attained that status without government help. This is a good illustration of why comparative advantage is not static. If the theory of comparative advantage were static, Taiwan and Japan would still be exporting rice and tuna fish instead of cars, computers, TVs, steel, and semiconductors.

  Free-floating exchange rates, a flawed legacy of University of Chicago professor Milton Friedman’s early-1970s faux–free market prescriptions, are another globalist scheme. Floating exchange rates were originally intended as a substitute for the pre-1971 gold standard that Friedman despised. Friedman liked the idea of elastic money to give central bank planners the ability to fine-tune the money supply to optimize real growth and price stability. Gold was considered inelastic and not suitable for the fine-tuning discretionary monetary policies needed.

  Friedman’s hope was that gradual changes in exchange rates would raise or lower relative prices between trading partners, and these changes in terms of trade would reverse trade deficits, mitigate trade surpluses, and restore equilibrium in trade without shock devaluations of the kind the United Kingdom experienced in 1964 and 1967. Friedman’s laboratory approach ignored the real-world behavior of financial intermediaries, such as banks and hedge funds, that create leverage and derivatives. Financialization dominates and amplifies the smooth exchange-rate adjustments Friedman envisioned. What followed was borderline hyperinflation in the late 1970s, and a succession of asset-bubble booms and busts in Latin American debt (1985), U.S. stocks (1987), the Mexican peso (1994), Asian debt (1997), Russian debt and derivatives (1998), dot-com stocks (2000), mortgages (2007), and derivatives again (2008). On two of those occasions, 1998 and 2008, global capital markets came to the brink of total collapse.

  If free trade, open capital accounts, and floating exchange rates are empirically deficient ideas, why do the Davos elite embrace them? The answer is that these theories serve as a smokescreen for the elites’ hidden agenda. That agenda is to promote global growth at U.S. expense, to diminish the power of the United States in world affairs, and to enhance the power of rising nations, especially China.

  America historically prospered with high tariffs to protect its industries. From Alexander Hamilton’s plan for infant manufacturing to Henry Clay’s American Plan, the United States has always known how to protect its industries and create American jobs. Trump is returning to that American tradition. Trump refrained from imposing tariffs in 2017, his first year in office, based on the advice of his then national security team, including National Security Advisor General H. R. McMaster, Secretary of State Rex Tillerson, and Secretary of Defense James Mattis. The national security team urged President Trump not to start a trade war because the U.S. needed Chinese help to avoid a shooting war in North Korea. However, China did not do all it could to apply pressure on North Korea. Solid intelligence showed that China helped North Korea to cheat on sanctions imposed by UN resolutions. As if to rub salt in the wound, China’s 2017 trade surplus with the United States was $275 billion, the highest ever.

  Once China’s lack of cooperation on North Korea became clear, Trump saw no harm in confronting China on trade, a policy he’s advocated since the summer of 2015, during the early days of his campaign. As a result, a trade war Trump has been planning since his 2015 campaign erupted in full force in early 2018.

  In the midst of this new trade war, CFIUS returned to center stage as a potent weapon. On January 18, 2018, Reuters reported a decision by CFIUS not t
o approve acquisitions of U.S. target companies by privately owned Chinese conglomerate HNA until HNA provided more detailed information on the true identities of its shareholders.10 HNA had earlier acquired material stakes in Hilton Hotels and Germany’s giant Deutsche Bank. HNA did disclose that over half its shares were owned by two charitable foundations, based in China and the U.S. respectively. Yet the beneficiaries and controlling parties of those foundations remain opaque.

  Then on March 12, 2018, in one of the most aggressive applications of CFIUS ever, the White House vetoed a hostile takeover of U.S. semiconductor giant Qualcomm by Singapore-based Broadcom, a deal valued at $117 billion. This action was usual in two respects. It was a hostile takeover, so there was no agreement in principle between buyer and seller for CFIUS to consider, and therefore no opportunity for mitigation by the parties. And the U.S. Treasury’s public statement said that its reasons for rejecting the deal were “in significant part … classified,” but made reference to the fact that Broadcom’s Singapore base was largely under the control of “third-party foreign entities” understood to be Chinese. Now, the Trump administration had weaponized CFIUS, which became a frontline weapon in a burgeoning trade and financial war between the United States and China. This was a far cry from the doormat role CFIUS played in the Uranium One case.

  On August 13, 2018, President Trump signed into law new legislation designed to strengthen the role of CFIUS and to force it to give greater weight to national security considerations compared to the prior open borders approach to direct foreign investment. This new law was the Foreign Investment Risk Review Modernization Act, FIRRMA, co-sponsored by Republican senator John Cornyn and Democratic senator Dianne Feinstein. FIRRMA greatly expands the types of transactions requiring CFIUS approval and introduces new categories subject to review, including “critical materials,” and “emerging technologies.” FIRRMA creates a white list of “identified countries” that would not be subject to the new strict scrutiny due to their friendly relations with the United States, including parties to mutual defense treaties. Ironically, this is just a more stringent and legally enforceable version of the analytic approach the dirty dozen introduced to CFIUS ten years ago. That approach was brushed aside when CFIUS approved Uranium One.

  Investment Secret #1: Tariffs and trade surpluses are back in style. Prepare for a more mercantilist world.

  Investors should prepare for a more mercantilist world in which trade surpluses and gold accumulation are ends in themselves. This means that tariffs, demands for reciprocity, and tax provisions that favor domestic production will be the norm. This makes a stark contrast with the multilateral free-trade regimes favored by globalists since the end of the Second World War and pursued vigorously since the end of the Cold War.

  Major powers never completely abandoned mercantilism; it was always just below the surface, as developed economies paid lip service to free trade. A global trading system always required some constraint on surplus countries in addition to the financial pain typically inflicted on deficit countries. John Maynard Keynes made this point emphatically at Bretton Woods in 1944, but his proposed mechanisms for surplus adjustment were ignored by the United States.

  China and Germany are the worst trade offenders. Germany exploited the euro and the European Central Bank to run surpluses with its trading partners in the Eurozone periphery. This amounted to a kind of vendor finance scheme that lasted until Spain, Italy, and Greece almost went broke in 2010. Germany then refinanced its Eurozone customers with IMF and U.S. help, at the expense of social spending in the southern tier, to restart the game. China used cheap labor, a cheap currency, low-cost domestic finance, and wasted investment to gin up its own surpluses with the United States. What is new is that the United States under Donald Trump is refusing to play the free-trade game any longer. The United States will match China, Germany, South Korea, and other surplus giants tariff for tariff and subsidy for subsidy.

  American investors should look for new domestic champions in steel, autos, renewable energy, and transportation. Global growth may slow, but profits at companies such as Boeing, SolarWorld, Mission Solar, Nucor, U. S. Steel, and General Motors all benefit from a protected U.S. domestic market, still the largest in the world.

  Accumulation of physical gold and silver is the hallmark of mercantilism. American and Canadian gold and silver mining companies will be bolstered by continued strong global demand driven by China and Russia. Their stock prices will also be bolstered by a wave of merger and acquisition activity, as large miners absorb juniors to achieve economies of scale.

  The emerging neomercantilist world is one that would be congenial to Alexander Hamilton and Henry Clay. America will play to its strengths even as China, Russia, and Germany play to theirs.

  CHAPTER TWO

  Putting Out Fire with Gasoline

  It appears to have been the common practice of antiquity to make provision, during peace, for the necessities of war, and to hoard up treasures beforehand as the instruments either of conquest or defence; without trusting to extraordinary impositions, much less to borrowing, in times of disorder and confusion ….1 We have always found, where a government has mortgaged all its revenues, that it necessarily sinks into a state of languor, inactivity, and impotence.

  —David Hume, “Of Public Credit” (1752)

  THE CHOIR OF DIRE DEBT ADMONITIONS HAS GONE SILENT FOR NOW. THIS is strange. Beginning in the 1980s and continuing through the Tea Party victory in 2010, no political debate was complete without one party or the other warning of damage to confidence in U.S. debt and the dollar itself due to profligate spending and increasing debt-to-GDP ratios. These warnings were bipartisan, albeit with varied timing and targeting depending on which party was on offense.

  In the 1980s, Democrats and some Republicans (David Stockman comes to mind) railed against the Reagan deficits. Reagan was a big spender who did run up deficits, yet one suspects the real objection was that new spending went to defense rather than entitlement programs favored by the Democrats. During the 1990s, the out-of-power party routinely complained about spending by the in-power party, while in truth both George H. W. Bush and Bill Clinton did a creditable job keeping the debt-to-GDP ratio under control. In the 2000s, Democrats complained about George W. Bush’s trillion-dollar war spending, and Republicans complained about Obama’s trillion-dollar stimulus that did nothing to stimulate a return to long-term trend growth. Yet now the damage was serious. Bush 43 doubled the national debt and Obama doubled it again from a higher level. When Trump was inaugurated in January 2017, the Bush-Obama team handed him a 105 percent debt-to-GDP ratio, worse than most of Europe and not far behind debt dandy Italy.

  Despite changing parties and changing fortunes, the critique of excessive spending never stopped. Until Trump. Now, both parties have gone silent. Trump has not attacked the favored Democrat entitlements so they have no cause for complaint. Trump has expanded military spending so Republicans are content. Removal of discretionary spending caps and the return of earmarks for pork-barrel projects has cheered both parties. Trump has revived the age of trillion-dollar deficits, last seen in the first Obama term. Entitlements and defense both get to gorge at the trough, so there’s no dissension in D.C.

  The only loser is the country. The slow growth of the debt-to-GDP ratio can be compared to a fatal tumor or a termite infestation. The initial stages may go unseen and unnoticed. Still, there comes a time when the damage is irreversible, complete, even fatal. The United States is near that point. Understanding the history of U.S. debt is a starting place for comprehending where we are today and why the present debt situation is not “business as usual,” but an entirely new state of affairs that threatens the centuries-old foundations of democracy and national security.

  A Brief History of U.S. Debt

  It’s wondrous that simple economic concepts are stretched by economists and pundits to the point of incomprehension by everyday Americans. So it is with deficits, debt, and the debt-to-GDP r
atio. No economic metrics are more certain to put citizens into a deep trance of indifference, yet none are more important to the perpetuation of liberty. In fact, these concepts are simple once stripped of jargon.

  The deficit is simply the excess of spending over revenue. The United States keeps its books on an annual basis, so if revenue for a given year is $3 trillion and spending is $4 trillion, the deficit that year is $1 trillion. Debt is the sum total of all prior deficits minus the occasional surplus. The United States has not had a surplus since the fiscal years 1999 and 2000, and before that, 1969. Today the U.S. national debt is $22 trillion. The debt-to-GDP ratio is merely national debt divided by national output calculated in the form of gross domestic product, or GDP. If the national debt is $22 trillion and GDP is $21 trillion, then the debt-to-GDP ratio is 105 percent ($22 trillion ÷ $21 trillion = 1.05). That’s it. With a grasp of these three concepts—deficits, debt, and debt-to-GDP—tendentious debates over fiscal policy, monetarism, Keynesianism, and central bank machinations come clearly into focus.

  A naïve view of U.S. national debt assumes the United States started with a clean slate in 1789, began accumulating a small amount of debt in the nineteenth century, and saw debt grow exponentially in the twentieth century, until reaching its current nonsustainable stage early in the twenty-first century. This view is incorrect.

  The history of the U.S. national debt is less linear and more nuanced than the naïve view suggests. The United States had national debt before it was even a nation. The subsequent history of that debt shows a pattern of alternating deficits and surpluses, depending on exigencies of the day. In general, the United States borrowed to finance wars and paid down debt during peacetime.2 As a result, the U.S. debt-to-GDP ratio rose and fell repeatedly, yet only moved to extremes on rare occasions. Consequently, it’s troubling that in the past ten years the U.S. debt-to-GDP ratio moved to extreme levels with no plausible plan to mitigate the trend. This debt crisis is the result of high baseline spending combined with the policy preferences of three presidents: Bush 43 (war spending), Obama (social spending), and Trump (tax cuts). Bush 43 added $5.85 trillion of debt, Obama added $8.59 trillion of debt, and Trump will add $8.28 trillion of debt through his first term, based on Treasury projections. That combined $22.72 trillion of debt in twenty years is a 300-percent increase in U.S. debt over the $5.8 trillion at the end of the Clinton administration. Simply put, after 230 years of prudent debt management, the U.S. national debt is now off the rails.