• The Fed would do well to stick to its mandate and ignore the usual election cycle games.
  • Markets should join growing concerns about the toll trade deficits are taking on outlook for corporate sales and profits instead of clamoring for cheap money.
  • The White House claim that trade talks with China are now back on track is contradicted by a U.S. trade official who sees them in a “quiet period” — a euphemism for a total deadlock and perhaps no acceptable solution in sight during this administration’s current mandate.

Try as it may, the U.S. Federal Reserve always finds it impossible to keep monetary policy out of the election cycle maelstrom.

Politicians inevitably wade into interest rate discussions, and market punters take those “who-said-what” events as their daily betting fodder.

At the moment, markets and politicians share a consensus that the U.S. economy needs cheaper and more abundant liquidity. They are ignoring the Fed’s good policy record and an astounding $1.3 trillion of banks’ loanable funds while cobbling up implausible recession scenarios.

Unfairly, the Fed’s delivery of a fully-employed economy in an environment of price stability gets a short shrift, even though the U.S. economy is moving along a growth path of 3.1 percent. That is more than an entire percentage point above the economy’s physical limits to growth — also known as the noninflationary growth potential — with inflation indicators in the range of minus 0.8 percent and 2.1 percent measured, respectively, by unit labor costs and the core rate of consumer prices.

Still, markets continue to fret that the flattening yield curve foreshadows a bleak growth outlook, the economy, in their view, is headed for a recession and — music to politicians’ ears — the Fed has damaged the economy and is way overdue for a round of interest rate cuts.

Do a trade deal and leave the Fed alone

Hopefully, the Fed knows better, and will continue to discharge its difficult policy mandate regardless of market noise and political posturing.

High employment, growing real disposable household incomes and some of the lowest credit costs on record are directly driving more than 80 percent of the U.S. economy.

And this is the time for the Fed and the markets to sound alarm about problems created by needlessly disruptive trade policies and geopolitical tensions affecting supply chains, as well as the general business conditions.

Trade fights are continuing no end while colossal deficits keep pushing America’s net foreign debt to $10 trillion and counting. Those liabilities are funded by imports of foreign savings in exchange for a growing pile of U.S. debt instruments — $6.4 trillion at the end of last April.

China, a problem trade partner and a strategic competitor, held $1.1 trillion of all U.S. Treasury debt in non-resident private and official portfolios — a $78 billion decline from the most recent record observed in the middle of last year.

That means Beijing is no longer recycling some of its huge dollar incomes from surpluses on U.S. trade to help finance America’s large and growing public debt. According to Chinese official statistics, China’s trade surplus with the U.S. soared last month 11.2 percent from May to $29.92 billion. That put the Beijing’s trade surplus on American trades to $140.48 billion in the first half of this year, a 5 percent increase from the same period of 2018.

There usually is a discrepancy between U.S. and Chinese trade statistics, so we shall have to wait until the end of this month to see what the U.S. trade numbers are showing for the first half of this year.

The European Union is a tough love ally

One thing is certain, though: After two-and-a-half years in office, the Trump administration is failing to meaningfully narrow its half-a-trillion dollar trade deficit with China.

And it is just a matter of weeks or months until a resumption — if there is one — of trade talks with China hit a new impasse in the face of Beijing’s efforts to completely deconstruct Washington’s negotiation strategy.

That has been a danger all along that anybody could see: China would simply not allow the U.S. to interfere in its legislative process, or to change its economic and trade policies under a permanent threat of new sanctions.

Washington seems to have understood and accepted that its negotiating overreach must be abandoned without a face-saving retreat.

But that’s not all. Beijing apparently wants a total lifting of U.S. tariffs. China also threatened last week to impose sanctions of its own on American firms intending to sell $2.2 billion worth of arms to Taiwan.

This is a sad story of how one transforms an unassailable case against China’s rampant mercantilism into a humiliating retreat and acquiescence into a continuation of hundreds of billions dollars of American wealth and technology transfers to China.

A similar debacle is looming in trade negotiations with the European Union. In fact, that could be even worse than the trade problem with China. According to U.S. statistics, the trade deficit with the EU widened 7.2 percent in the first five months of this year, while over the same period, the deficit with China narrowed 10 percent.

The Europeans want to drive a hard bargain on automobile trade and have excluded farm products — a very important item for the U.S. — from their negotiating mandate with Washington.

To firm up their bargaining position, the Europeans have also leveraged a number of strategically important issues for Washington, such as the U.S. confrontation with Iran, and a review of the sanctions regime with Russia. There, too, is a prospect of broader trade and investment relations with China – an important process already under way in a number of major EU countries.

In the middle of all that, the U.S. is watching a serious deterioration of permanently strained ties between Japan and South Korea, its two key Asian allies, and an apparently radical shift toward closer Sino-Japanese ties — Tokyo’s old dream come true for a flourishing commerce and finance with its huge Asian neighbor.

Investment thoughts

The Fed would do well to stick to its mandate and ignore the usual election cycle games. A broadside about the ineffective trade policies and the damage that is doing to growth, employment and price stability would also be an appropriate response to the administration’s forays into Fed’s policies.

Markets should join the growing concerns about destructive trade disputes and the toll deficits are taking on outlook for corporate sales and profits. That would show their analytic sophistication instead of throwing tantrums and clamoring for cheap money.

The White House claim that trade talks with China are now back on track sounds like wishful thinking to a U.S. trade official who sees them in a “quiet period.” Things, in fact, look so negative, and in a total deadlock, that there may be no acceptable solution in sight during this administration’s current mandate.

Source: CNBC