Worthy of Note

Notable news and views that shed light on changing dynamics this week

US/CHINA Heats Up Again

Even though most things will continue to revolve around COVID-19 in some fashion for quite a while, extant themes from before the pandemic are reemerging as global forces resume defense of respective interests.

The tension and war of words between China and the United States is a prime example. The pandemic finger-pointing has aggravated already prickly relations on nearly all fronts - economic, geopolitical, military.

Take a look at these headlines (and note my insights on this inevitability.)

Before the pandemic, pro-Democracy protests in Hong Kong against authoritarian Chinese controls, and the Chinese Communist Party’s response to them, was an international topic of debate and consequence. The protests were tolerated by China for a time, but then were squashed brutally right as the SARS-CoV2 epidemic took off, and despite calls for restraint from Western leaders.

Now China is planning to pass a law outlawing anti-government protests in Hong Kong, further eroding its special status and setting the stage for conflicts with liberal Western Democracies. The legislation also aims to oppose secession of the Chinese autonomous region and forbids foreign interference in Hong Kong.

One party rule, outlawed opposition, overwhelming brute force. Any special status for Hong Kong expired long ago in the eyes President Xi, despite any prior agreements to the contrary.

U.S. President Donald Trump promised a “very strong reaction” if the oppressive law is implemented, adding to the budding proposals of more sanctions against China as punishment for coronavirus mishandling. China’s response has been textbook CCP, arguing they never start trouble (stability), but won’t flinch if it comes their way.

This comes on the heels of Trump accurately accusing the Chinese Communist Party of leading a massive disinformation attack against the U.S.

The coronavirus schism has arguably eliminated the chance of further trade deals, and though Trump adviser Larry Kudlow has said the phase one deal is still intact, the tensions have increased the chance of existing agreements falling apart. Geopolitically, the Hong Kong situation will intensify, and more military chest-thumping will occur in the South China Sea. The pandemic may have paused our observance of this inevitable incongruity for a few weeks, but it has also served to accelerate the inevitable.

The war of words and tit-for-tat actions will become more acute over the summer, like last summer, but within the surreal context of 2020.

Major Bank Sees Currency Debasement Risk

I’ve written previously about the Fed’s policies maybe pushing on a string, with respect to massive money printing and asset purchases. One of the primary resulting distortions from these policies will be currency debasement according to JP Morgan.

Due to unprecedented monetary and fiscal measures unleashed by central banks around the world, the bank forecasts weaker long-term growth and currency debasement. The extraordinary efforts to save financial markets from locking up, ostensibly to inject growth, will end up hamstringing real growth just like prior iterations.

The analysts note inflation will hold off for a year or two because of the deflationary forces of economic disruptions and the cycles they trigger, but look at this chart.

Yardeni Research has tabulated the massive growth in central bank balance sheets in a series of charts here, and it’s hard to see how this doesn’t result in a Great Inflation at some point down the road.

In the mean time there will be even more balance sheet growth. While the Fed has pumped trillions into the system, the U.S. Congress has pulled the trigger on trillions more, and the U.S. Treasury is going to have to sell a boat load of treasuries to finance all the spending. It’s going to require a really big boat.

The Treasury announced last week that it would need to sell approximately $3 trillion in bonds in the third quarter alone to pay for the spending splurge on Capitol Hill.

Who’s going to buy all that debt? Treasury Secretary Steve Mnunchin is interested to know, and he needs ones with deep pockets. The Fed is really the only entity capable of picking up the slack. In doing so they will add another trillion (already $7 trillion+) or so to its balance sheet in the process.

JP Morgan Releases ‘Devastating’ Research Report

‘Devastating’ because it blows up the narrative that countries and states that end lockdown will lead to bigger outbreaks and a prolonged public health crisis.

A legendary researcher and forecaster for investment bank J.P. Morgan, referred to as ‘Gandalf’ on Wall Street, has released a research report showing rates of coronavirus infection actually going down in states that have ended the economically devastating lockdown policies.

Dr. Marko Kolanovic is the Global Head of Macro Quantitative and Derivatives Strategy team at J.P. Morgan. His team is responsible for developing macro, derivatives and quantitative equity strategies, as well as systematic cross-asset portfolios for clients. Put simply, he and his team are in the business of forecasting extremely complex issues with enough accuracy to put billions investment capital behind the conclusions — and he’s VERY good.

So when he shares something like this, it is quite notable:

Here we have evidence of two things: 1) reopening the economy may not lead to spikes in case at all (Great!), and 2) Such a report is described as ‘devastating’ by journalists covering it (What?).

The report says, “This means that the pandemic and COVID-19 likely have its own dynamics unrelated to often inconsistent lockdown measures that were being implemented. Adding, “millions of lives were being destroyed […] with little consideration that [lockdowns] might not only cause economic devastation but potentially more deaths than COVID-19 itself.

But this report is only ‘highly destructive or damaging’ to the political factions oriented against reopening that are using the fear of second wave outbreaks to win support for continued closures (and damage the political fortunes of Donald Trump). If data continues to reveal that ending lockdown has no meaningful deleterious effect on public health, then there remains no justification at all to keep enforcing the massive economic and sociological pain brought by shutdown policies.

Unless…partisan politics is at play. Which, of course, it is.

US to Exit ‘Open Skies’ Treaty

And Russia is crying foul, but that is par for the course. The 18 year old international surveillance treaty was essentially a ‘I’ll show you mine, if you show me yours’ agreement for unarmed surveillance flights over member countries’ territory. The idea was that if there was some transparency, accountability would come with it, but, despite their aghast reaction, Russia has been skirting rules for years.

President Donald Trump said this week that the US isn’t going to play this game if Russia is cheating. The U.S. contends that Russia has been violating the treaty by blocking it from conducting flights over the Baltic Sea city of Kaliningrad and Russia’s southern border near Georgia, both of which are permitted by the agreement. Both of which would also be the very nature of surveillance we’d want, where there are encroachment threats against NATO/Europe, and occupation activities festering in the Caucuses.

U.S. Defense Secretary Mark Esper told the Senate Armed Services Committee in March that Russia has been “cheating for many years.” 

While the signatories will protest, and the media will use the opportunity to depict Trump as reckless on the international stage, the real take away here is that it’s the opening move in Trump’s Art of the Deal.

The U.S. President has given the required six month notice of withdrawal, claimed the U.S. is being taken advantage of, and chaos ensues. Just, not for Donald Trump, who thrives on such dynamics and holds the advantage over everyone else clamoring to, please, keep the U.S. in this international agreement for peace!

In the end the U.S. will pull out (President Trump’s follow through is consistent) and the world will not immediately implode in war, but merely continue on without the pretense of playing fair. Or, Russia will view the costs of giving up their surveillance operations over the U.S. as too high a strategic price to pay, and they’ll attempt to reassure the U.S. of full future compliance.

Either way, what seems like a frenzy of uncertainty will actually be yet another example of Trump’s negotiating style in which he throws everyone else off balance at the offset, and uses the advantage to work towards [Insert MAGA Goal here].

More to come…

It’s our pleasure to ramp up ‘Worthy of Note’ for more consistent insights from DGI. It will be published at least twice a week, highlighting remarkable news and views and considering how they might shape dynamics in the fluid and and consequential worlds of finance, markets, politics, and geopolitical themes. Stay tuned and don’t forget to subscribe and share the letter with friends.