All along 2018, we argued that the Trade war launched by Donald Trump on China would take a severe toll on global growth and that the ultimate loser would end-up being America and American corporations.

In several posts  Trade wars are the wars of the 21st-century and America will lose that one,Trade wars, the trump method and liquidity, Sanctions as weapons of mass destruction, we highlighted the fact that America was not in a position to counter the rise of China as an economic and geo-political giant and that confronting its largest lender, its largest client and the largest consumer market of the world was not a successful strategy.

We also highlighted the fact that the Trade War would accelerate the rise of China to global dominance by forcing the Yuan to appreciate structurally and in a lasting manner, making China richer and even more powerful.

One year later and as we are getting extremely close to a signifiant deal between America and China, most of our predictions are proving right.

The US Trade Wars triggered a global economic slowdown that we are only starting to see the effects

In  OUR SEVEN INVESTMENT CALLS FOR 2019 we warned about a potential deflation scare sometimes in the second quarter or second half of the year and the recent economic data coming out of the world largest economies are all starting to point down.

Our analysis was based on the realization that in a globalized world where corporations operate across the globe, the Trade Wars have created an element of uncertainty that made CEO’s put most of their investment plans on hold. 

Building a factory or a distribution network in a foreign country requires visibility and predictability and what we have been witnessing across the world starting in the second quarter of 2018 has been a collapse in Investments and Fixed Capital Formation.

Uncertainty has also taken its toll on consumer confidence and therefore on consumption. When the financial markets tank, consumers refrain from buying big ticket items and eliminate unnecessary expenses.

In 2002, psychologist Daniel Kahneman was awarded the Nobel Memorial Prize in Economic Sciences for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.

In 2013, economist Robert J. Shiller received the Nobel Memorial Prize in Economic Sciences for his empirical analysis of asset prices where he demonstrated the impact of positive or negative psychology on asset prices.

In 2017, economist Richard Thaler was awarded the Nobel Memorial Prize in Economic Sciences for his contributions to behavioral economics and his pioneering work in establishing that people are predictably irrational in ways that defy traditional economic theory.

All this to say that psychology has a major effect on the economies and uncertainty induces a clear negative bias that ends up filtering through economic data over time. 

Uncertainty breeds paralysis on the investment side, lower investments affect CEO’s confidence in the future, lower CEO confidence have an impact on recruitments and employees’ job security, which in turn affects consumption, the stock market and real estate ultimately.

Commentators and Donald Trump blamed the FED for rising interest rates but the fact of the matter is that the normalization of monetary policy never even reached the stage of neutral in the sense that nominal rates remained at or below inflation rates.

Europe and Japan maintained interest rates at zero and trillions of long dated bonds with negative yield – a highly stimulative combination – while in the US the phenomenal increase in corporate debt over 2017 and 2018 shows that CEO’s always considered long term rates to be abnormally low and therefore an attractive opportunity to borrow.

Moreover, the current economic slowdown is global and the key question is what lies ahead.

USA

The US economy slowed down considerably in the last quarter of 2018 and the data published in the first two months of the year have not shown any improvement.

Real GDP slowed to 2.6% from 3.4% in the fourth quarter of 2018. As a result, the year-on-year rate of change was 3.1% was much lower than the figure expected at the beginning fo the year but still the strongest finish to any year dating back to 2005.

The moderation in growth was clear in retail sales, industrial production, durable goods
orders, home sales and construction but the most worrying part has been a massive and troubling inventory build in the second half of the year.

The inventory build was due to a confluence of two factors: One, producers stockpiling goods in nervous anticipation of an escalation of trade tensions; and two, the somewhat “mysterious” stall in economic activity toward the end of the fourth quarter — ranging from housing to holiday shopping — which was in our view clearly due to the negative wealth effect caused by the fall in the stock market resulted in a surplus of unsold goods.

Relative to history, the inventory accumulation in the second half of 2018 is large and threatens to overshadow production schedules (and manufacturing-related employment) in the first part of 2019. 

The threat of a significant inventory correction extracting a heavy toll on GDP in the first or second quarter is very much present. The massive inventory run-up – Inventories rose by $97.1 billion dollars in the fourth quarter following an increase of $89.8 billion in the third quarter- 
cannot be seen as anything but a ticking time bomb for economic growth ahead.

Ironically, the inventory build appears to have stemmed from stockpiling ahead of potential tariff escalations, so a somewhat perverse side effect of a trade war detente would be a massive
inventory liquidation clobbering GDP growth over the next couple of quarters.

Another area of weakness is real estate. Residential investment declined for a fourth straight
quarter (-3.5% vs. -3.6% prior) at the end of 2018, an occurrence not seen since the depths of the Great Recession in 1927. 

The four interest-rate hikes in 2018 clearly cooled the housing market, which also faces supply constraints and affordability pressures. History shows that when real estate starts weakening, it usually takes time – and a shift in investors’ psychology to turn the tide.

We see the US economy growing at 1.5 % or less in the first quarter of 2019 and maybe even less in the second quarter.

Canada

Canada’s economy practically came to a halt in the final three months of 2018, in a much deeper-than- expected slowdown that brings the underlying strength of the expansion into doubt.


The country’s economy grew by just 0.1 percent in the fourth quarter, for an annualized pace of 0.4 percent. That’s the worst quarterly performance in two and a half years, down from annualized 2 percent in the third quarter and well below economist expectations for a 1 percent annualized increase.

For all of 2018, the economy grew by 1.8 percent — below the Bank of Canada’s estimate for 2
percent. Monthly data show the economy ended the year contracting, with December gross domestic product down 0.1 percent.

While a slowdown was widely expected in the final months of the year due to falling oil prices, it’s a much bleaker picture than anyone anticipated with weakness extending well beyond the energy sector. 

Consumption spending grew at the slowest pace in almost four years, housing fell by the most in a decade, business investment dropped sharply for a second straight quarter, and domestic demand posted its largest decline since 2015.

The only thing that kept the nation’s economy from contracting was a build-up in inventories as companies stockpiled goods.

At the very least, the numbers suggest that heightened uncertainty — everything from the impact of higher interest rates to potential trade wars and oil-sector woes — has made a real impact on both consumer and business sentiment. 

The question now is what the weaker-than-expected data suggests about the economy’s ability to rebound back to more normal growth levels. Most economists had been expecting the soft patch would come to an end by spring and growth would accelerate closer to 2 percent for the rest of the year. No one, however, expected the economy would need to come back from such a low point. 

The Bank of Canada’s latest forecast, from January, is for annualized growth of 1.3 percent in the fourth quarter and 0.8 percent in the first quarter, before the expansion accelerates back to above 2 percent growth by next year.

Europe

Euro-area factories suffered their biggest drop in orders in almost six years in February amid mounting concern over trade tariffs and Brexit, dealing a blow to those anticipating a speedy rebound in momentum.

Led by Germany and Italy, manufacturing output in the 19- nation region contracted last month, with a Purchasing Managers’ Index falling to 49.3. 

Companies continued to report spare capacity and inflation pressures eased to levels last seen in
late 2016. Forward-looking indicators suggest that risks are tilted further to the downside as we move into the second quarter of 2019

So far, officials have argued the European economy will emerge from its current soft patch in the second half, but sluggish demand raises questions over the outlook. The ECB is currently updating
its projections for growth and inflation through 2021.

The Eurozone economy grew 0.2 percent in the final three months of 2018, matching the third quarter rate, which had been the lowest since the second quarter of 2014. The German economy stalled in the October-December period and Italy fell into recession for the first time since early 2013, while France and Spain continued to support the bloc’s growth.

The British economy grew by 0.2 percent only in the three months to December 2018, easing from a 0.6 percent expansion in the previous period. Private consumption and government consumption were the main driver of growth, while gross capital formation and net trade contributed negatively.

The Swiss economy advanced 0.2 percent in the three months to December 2018, rebounding from a 0.3 percent contraction in the previous period but missing market expectations of a 0.4 percent expansion. Household consumption increased at a stronger pace and net foreign demand contributed positively to the GDP growth while fixed investment contracted

India

 India’s economy slowed considerably last quarter, with little signs of a quick recovery amid rising
political tensions with neighboring Pakistan and weaker global demand.

Gross domestic product rose 6.6 percent in the three months to December from a year ago, lower than the 6.7 percent median estimate and down from a revised 7 percent in the previous quarter.

Waning consumer demand dampened momentum in the economy where domestic spending makes up about two-thirds of GDP. Growth in government consumption slowed last quarter, while exports and investments held up, data from the Central Statistics Office showed.

Simmering tensions between the nuclear-armed rivals India and Pakistan have the potential to hurt foreign investments and sour business sentiment in an economy that’s been one of the
fastest-growing in the world, but that’s now facing weaker domestic demand and a global slowdown. 

That may give the Reserve Bank of India, under new Governor Shaktikanta Das, reason to cut
interest rates again after February’s surprise easing. Inflation at a 19-month low and further weakness in growth definitely creates space for further cuts.

India heads into the general elections in April-May 2019.

More globally

The World economy softened in Q4 of 2018 and early evidence points to a marked slowdown in the first quarter of 2019.

World GDP growth was at 3.1% in Q4, well below the 4 % plus rates of 2017. 

Euro-zone GDP rose by just 0.2% in the 4th quarter, leaving the annualized rate at 0.8%, while a 0.3% quarterly rise in Japan (1.4% annualized) reversed only part of Q3’s 0.7% contraction. 
Even in the US, which had been holding up well, growth weakened from 3.4% to 2.6% annualized.

The picture for Q1 2019 is decidedly worse. In January, industrial production slumped by 3.7% m/m in Japan and by 0.6% in the US. 

Since data for other sectors have been disappointing too, we suspect that Japan’s GDP fell outright in Q1, the third quarterly contraction in five quarters. 

The US seems set for a slowdown to about 1.5% annualised. 

We do not have January industrial production data for the euro-zone yet, but the sharp 0.9% fall in December bodes ill and we judge that recession risks have increased.

Growth is slowing in emerging markets too, albeit not as sharply. 

There have been no new hard data for China because of the New Year but the Government just lowered its target growth rate for 2019 to 6 % while enacting additional stimulus in the form of signifiant tax cuts. China is probably the first economic zone to give signs of an economic improvement in 2019.

Premier Li Keqiang set a 2019 GDP growth target of 6 percent to 6.5 percent at the National People’s Congress last Tuesday, down from 6.5 percent”in 2017 and 2018. While Beijing’s targeted fiscal deficit of 2.8 percent is higher than last year’s 2.6 percent, billions will be going to cuts in personal-income and value-added taxes instead of on infrastructure projects.

China’s consumers are probably;y amongst the most taxed in the world and as America had a shot in the arm on 2018 with Donald Trump’s tax cuts, China is likely to get the same in 2019.

But Indian GDP growth slowed from 7% y/y in Q3 to 6.6% in Q4 and Brazilian growth edged down from 1.3% to 1.1%. One exception was Russia, where growth picked up somewhat in Q4. But even there a slowdown is to come in Q1.

The world economy is veering towards a sharp and synchronized slowdown in Q1 2019 that is almost entirely due to Donald Trump Trade Wars.

Indeed, in 2017, the world economy was finally pulling out of the deflationary pressures of the financial crisis and each and every economic zone of the world was accelerating. Monetary policies were strongly accommodative and inflation was coming back in a coordinated fashion.

The US Federal reserve, which was the most advanced Central Bank along the path of economic recovery, with employment at 50-years high and strong economic numbers, started to normalize monetary policy, ended Quantitative easing and increased interest rates.

In 2018, Donald Trump delivered a strong shot in the arm to the US economy through a counter-cyclical tax cut . It boosted economic growth to above 4 % for a few quarters and is having lasting effects on growth 

At the beginning fo 2018, there was NOTHING on the horizon that would have slowed the world economy’s momentum. Quite the opposite in fact !

Even the FED normalization barely brought interest rates to 2.25 % in America, barely in line with inflation, meaning that AT NO POINT IN 2018 did monetary policy become restrictive.


THE ONE THING THAT MADE THE WORLD ECONOMY SLOW DOWN IN 2018 WAS DONALD TRUMP’s TRADE WARS …

… AND THEIR IMPACT IS FAR FROM OVER.

The global economy is suffering more than expected from trade tensions and political uncertainty which are clouding prospects particularly in Europe, according to a gloomy report from the OECD published yesterday.

“The global expansion continues to lose momentum,’’ the Paris-based Organization for Economic Cooperation and Development said as it downgraded almost every Group of 20 nation’s economy. 

The OECD’s numbers are more downbeat than the IMF’s for many economies, particularly the euro region and the U.K., as the organization warns that things could get worse.

Central banks including the Federal Reserve have already responded to the changed circumstances, and the European Central Bank may soon follow. China already enacted wide tax cuts to stimulate consumption.

The OECD outlook goes against hopes that sources of weakness, including lower confidence, would prove temporary..

While central banks should stay in expansionary mode, the group called for structural reforms and fiscal stimulus in the European countries that could afford it, saying that “monetary policy alone cannot resolve the downturn in Europe or improve the modest medium-term growth prospects.”

The OECD cut its growth outlook for this year to 1 percent from 1.8 percent. ECB policy makers are meeting in Frankfurt this week, and the OECD said they should signal a delay to any rate hikes and possibly implement new measures to improve funding for banks. Both measures are expected to be discussed in Frankfurt on Thursday.

Deflation is back

With weaker economic numbers, weaker inflation numbers are likely and Central banks will find themselves in a position where they have to lower interest rates again.

As our readers know we have been predicting that a DEFLATION SCARE would take place in the second half of the year. ( See OUR SEVEN STRATEGIC CALLS FOR 2019 )

Oil prices and Commodities are bound to fall again and less strong labor markets will keep wage pressures at bay.

A quick look at the following inflation charts of the four largest economic zones of the world accounting for more than 50 % of the world GDP is telling.

US inflation

Eurozone Inflation

Japanese inflation

China’s inflation

In the second half of 2018, global inflation has almost halved in the major economies and is trending down solidly.

And the issue of deflation is not limited to the advanced economies. It is spreading to Emerging economies as well.

In Asia Headline inflation has dropped back sharply in recent months, with the biggest falls being recorded in Taiwan and the Philippines. Some of the decline has been driven by a pullback in food price inflation but a more important factor has been lower oil prices. Although oil prices have climbed higher in recent weeks, prices are still below the level they reached a year ago. 

Oil price inflation is likely to remain subdued over the coming months. We expect oil prices to fall again in 2019 and are just waiting for the SELL signal to short oil again. Supply and demand are not favorable and the big surprise ahead will be how weak demand numbers will be.

Energy price inflation would still be negative for most of this year. (See Chart 2.)

Food prices are driven to a greater extent by local factors, but our forecasts for agricultural commodities do at least suggest that prices are unlikely to face much upwards pressure from global factors.

Our forecasts for economic growth in most Asian countries are consistent with underlying price pressures falling. We expect growth to slow below or in line with potential in most countries in 2019, which should lead to spare capacity emerging in a number of places, most notably Taiwan and Malaysia.

We expect inflation to average below 1% this year in five countries: Korea, Taiwan, Thailand, Singapore and Malaysia. Inflation is also likely to be at or below the central bank-midpoint target in the Philippines, Indonesia and Vietnam.

With inflation set to fall further and economic growth likely to slow, we expect central banks to cut interest rates over the coming months.The Reserve Bank of India became the first central bank in the region to cut interest rates, when it lowered its policy rate by 25bp in February. 

We are also anticipating rate cuts in the Philippines, with the first cut likely to be in May. We also have cuts pencilled in for Malaysia and China. The consensus is for interest rates to remain unchanged in all three countries this year

We are not ruling out interest rate cuts elsewhere in the region, with the central banks of Korea and Thailand, most likely to loosen monetary policy this year. However, given the current emphasis in both countries on tackling risks in the financial sector and worries about rising property prices, we think rates will remain unchanged this year.

Europe and Japan cannot lower interest rates further and the joker in the room is the FED’s course of action in 2019.

No one today expects the FED to lower interest rates in 2019 or even to halt their unwinding of their bond holdings, but we would not be surprised if this debate were to re-surface in the latter part of the year.

So what will make the world economy grow again ????

The Trade War may be ending, but …

The eleven-month trade war looks like it’s finally nearing an end, but not necessarily because China is ready to bow to U.S. President Donald Trump’s demands.

Both sides have been working seriously to hammer out differences and are close to a deal that could lift most or all U.S. tariffs if Beijing follows through on pledges ranging from better protecting intellectual-property rights to buying a significant amount of American products.

The issue of the Currency undervaluation has been at the forefront and China seems to be ready to accommodate at least no depreciation of its currency and probably a gradual but substantial increase in its value against the US dollar.

Donald Trump and President Xi Jinping each have an incentive to avoid further tariff increases and a continuation of a war that has already hurt the global economy.

Xi doesn’t want to see job losses that could undermine the Communist Party’s legitimacy, while Trump has linked his success to the economy and stock-market gains.

The question now is whether Trump will lift penalties right away as China would like, or listen to trade hawks in his administration who want them in place until U.S. demands are met on structural reforms such as government support for state-run companies.

For Trump, any decision is a bet on his 2020 election campaign strategy. Recent reports indicate that Donald Trump really wants a deal with China to avoid another stock market slump.

But, the economic damage has already been done and it will be hard for the US economy to resume an upward path in 2019. Business confidence and consumer confidence have been hardly hit and the unpredictability fo the US President means that it will take time for Americans to believe in a serene world again.

Xi on the other hand will probably walk away relatively unscathed as it is becoming clearer and clearer by the day that China has the means to pursue stimulative policies and is already on the path of recovery. Moreover, China’s President has time on his hands way beyond the term of Donald Trump’s Presidency. 

The big loser of the Trade Wars will ultimately be America and American corporations.

The aggressive steps taken by US President Donald Trump against China in February 2018 had and will continue to have lasting effects on the psychology of the Chinese.  

The Chinese culture is non-confrontational by definition and the Chinese do not like to be attacked. They have a history where the West has been abusing China in the 19th and 20th century and that memory remains vivid.

America’s attacks on China, the Chinese system and some of its Iconic corporate leaders are creating a lasting sentiment of rejection in what is becoming the world’s largest consumer market and what will ultimately become the world’s largest economy.

Corporations like Apple, Starbucks or Harley Davidson are already feeling a decrease in sales and positive perception in China as Chinese consumers are turning towards Chinese-made products. This trend is far form over and people should certainly not make the mistake of thinking that this will pass easily. Once hurt and humiliated the Chinese will not forget.

Donald Trump will learn a lesson the hard way : never bully your largest client !!!!

And he is also playing with fire by bullying his largest lender…

But what worries us most is not the loss of market share that will certainly be a consequence of Donald Trump’s Trade war on China, 

it is the dire financial situation of America and American households.

The BIGGEST RISK WE SEE TODAY ON THE HORIZON IS THE EXCESS OF DEBT THAT AMERICA HAS ACCUMULATED ONCE AGAIN

For the second time in 20 years, America’s TOTAL DEBT has reached record highs and unsustainable levels.

America’s addiction to debt is leaving the country, its corporations and its citizens in a financial position that leaves to margin of error when the next economic downturn appears.

Since the 2008 financial crisis, the US total Government debt more than doubled from 10 Trillion to 22 Trillion in January 2019. And the strongest increase came precisely at a time where economic growth was strong and therefore debt should have been contained or even repaid.

Donald Trump’s tax cut of 2018 is a total anomaly in economic management.

Never in economic history has a tax cut been enacted at the top of an economic cycle.  

Tax cuts are usually used in recessions to boost economic activity and public finances are being restored when economic growth is strong.

This time round, America is increasing its public deficits at the top of the cycle, meaning that the next economic slowdown – recession will cause an unmanageable explosion in its public deficits.

America will then face the tough choice of raising taxes as the economy slows down – causing a depression – or allowing its debt to ballon to levels that will make America’s debt reach junk level.

America’s public debt to GDP is at the highest it has ever been in the past 60 years and the coming recession will make that ratio explode upwards as was the case with Japan in the lost decades of the 1990s and the 2000s.

Unfortunately, and contrary to Japan where savings ratios are high and public debt is financed by the Japanese themselves, American households are highly indebted and Household debt is still hovering at 80 % of GDP.

Add to that the fact that US corporate debt has swelled from nearly $4.9 trillion in 2007 to nearly $10 trillion at the end of 2018 according to Securities Industry and Financial Markets Association data.

At US$ 47 Trillion, America is by far the most indebted country of the planet and every 1 % increase in interest rates adds another 470 Billion of debt or financial liabilities every year.

When the next downturn comes, America will see its tax revenues decline, its budget deficit explode, interest rates rise and total debt shoot up.

The Trump years will probably be remembered as the years of the greatest economic mis-management of the modern history of America.

They will probably mark the end of America’s economic dominance of the world.

Credit Cover Photo. Hasan Almsi. Unsplash.com