Will Donald Trump Unravel the Global Ponzi Scheme? - Vivek Kaul's Diary
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Will Donald Trump Unravel the Global Ponzi Scheme?

Jan 31, 2017

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In the third volume of the Easy Money trilogy which was published in 2015, I discuss how global trade has degenerated into a Ponzi scheme.

As I write in the book: "The United States is the biggest economy in the world. It accounts for nearly one-fourth of the world's GDP. By virtue of this, it is also the world's biggest market, where China, Japan, and countries from South-East Asia could sell their goods and earn dollars in the process. It is also the world's biggest consumer of oil and consumes nearly a fourth of the global oil production. This meant that oil-rich states like Saudi Arabia could sell oil to it and thus earn dollars in the process.

So, the United States imported, and countries like China, Japan, Saudi Arabia, and other countries in Asia earned dollars in the process. These dollars were then invested in treasury bonds... as well as the private sector. With so much money chasing these American financial securities, the issuers of these securities could in turn offer low rates of interest on them.

This meant that the prevailing interest rate scenario in the United States remained low despite a high budget deficit. This allowed citizens to borrow money at low interest rates and buy homes. It also allowed them to encash the equity in their homes and spend it on consuming other goods. So, the Americans could buy cars from Japan, apparel and electronics from China and so on.

And so the cycle worked. The United States shopped, China earned, China invested back in the United States, the United States borrowed, the United States spent, China earned again and China lent money again. The same was true with Japan, though to a lesser extent.

The way this entire arrangement evolved had the structure of a Ponzi scheme. A Ponzi scheme is essentially a financial fraud wherein the money that is due to older investors is repaid by raising fresh money from newer investors. The scheme keeps running while the money brought in by the new investors is greater than the money that needs to be repaid to the older investors. The moment this reverses, the scheme collapses.

The entire US-China-Japan arrangement was like that. The Chinese invested money in various kinds of American financial securities, which helped keep interest rates low in the United States. This helped Americans to consume more. The money found its way back into China (like a return on a Ponzi scheme) and was invested again in various kinds of American financial securities, again helping keep interest rates low and the consumption going. Like in a Ponzi scheme, the dollars earned by China and other countries kept coming back to the United States. This arrangement... kept interest rates low."

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What the American President Donald Trump proposes to do threatens this global Ponzi scheme. Before we come to the specifics of this, let's take a look at Figure 1. It shows the trade deficit that the United States has run with China, over the last three decades.

The trade balance is essentially the difference between the imports and the exports of any country. If the trade balance of a country is in negative territory, it is said to run a trade deficit, which the United States does. Specifically, the United States runs a trade deficit with China i.e., it's imports from China are significantly greater than its exports to China. Also, over the last three decades the trade deficit that United States has run with China has exploded.

Figure 1:

Take a look at Figure 2. It shows the trade deficit that the United States has run with the world at large, over the last three decades.

Figure 2:

The Figure 2 shows that the trade deficit that the United States runs with the world at large has fallen in the aftermath of the financial crisis. This essentially means that the difference between what the United States is importing from the world and what it is exporting to the world, has come down.

Now take a look at Figure 3. It basically combines Figure 1 And Figure 2. What does it tell us?

Figure 3:

It tells us that the trade deficit that the United States runs with China, makes up for a greater proportion of the overall trade deficit, than it did before. In 2015, the trade deficit with China made up for 73.4 per cent of the overall trade deficit. In comparison, in 2000, the figure was just at 22.5 per cent.

Given that the United States runs a trade deficit with China as well as the world, countries earn dollars from it. These dollars then find their way back into the United States and get invested in financial securities and in the process help keep interest rates low in the United States.

The new American President Donald Trump, who took over earlier this month, wants to bring down this trade deficit that the United States runs with China in particular and the world in general. As I had discussed in the column dated January 23, 2017, this is one of the plans that Trump has, to make the United States of America great again.

As Peter Navarro, an economist known to be close to Trump, and who served as a policy advisor to the Trump campaign, puts it: "Trump proposes eliminating America's $500 billion trade deficit through a combination of increased exports and reduced imports." The trade deficit of the United States in 2015 stood at $500.4 billion.

So how does Trump plan to bring down imports? As his website puts it: "[He plans to direct] the Secretary of Commerce to identify every violation of trade agreements a foreign country is currently using to harm our workers, and also direct all appropriate agencies to use every tool under American and international law to end these abuses."

Trump also plans to: a) Instruct the Treasury Secretary to label China a currency manipulator. b) Instruct the U.S. Trade Representative to bring trade cases against China, both in this country and at the WTO. China's unfair subsidy behaviour is prohibited by the terms of its entrance to the WTO. c) Use every lawful presidential power to remedy trade disputes if China does not stop its illegal activities, including its theft of American trade secrets - including the application of tariffs consistent with Section 201 and 301 of the Trade Act of 1974 and Section 232 of the Trade Expansion Act of 1962. (Source: https://www.donaldjtrump.com/policies/trade)

Trump plans to impose import duties (i.e., tariffs) in order to ensure that the cheap Chinese imports into the United States, no longer remain cheap. CNN reported in late December 2016: "President-elect Donald Trump's transition team is discussing a proposal to impose tariffs as high as 10% on imports, according to multiple sources."

The question is why does Trump want to do this? I will just come to that.

On a recent visit to Baltimore I had the pleasure of listening to the famous economist Richard Duncan. Duncan's book The Dollar Crisis has had a tremendous impact on the way I looked at the international financial crisis, in my Easy Money books. As Duncan put it: "President-elect Trump [Duncan was talking before Trump took over as President] believes the US trade deficit has been responsible for the loss of manufacturing jobs in the United States and the downward pressure on US wages that has occurred over the last several decades."

The question is what will be the repercussions, if Trump and his associates do go about doing what they have proposed. My sense is it will lead to the unravelling of the global Ponzi scheme, which I talk about at the beginning of this piece. And in the process, nobody will be better off.

In fact, take a look at Figure 4, which maps America's imports and exports since 1990.

Figure 4:

One look at Figure 4 tells us that the import curve and the export curve closely map each other. What does that tell us? It tells us that the dollars earned by the countries which export goods and services to the United States (essentially imports for the United States), are used to buy goods and services being exported by the United States. As Duncan puts it: "Over the past 35 years, that deficit has become THE driver of global economic growth. In fact, the entire global economy has been constructed around unbalanced trade." So, what will happen if Trump makes it difficult for the United States to import stuff from China and other parts of the world, as he has promised to do? If the American imports come down, so will its exports primarily because other countries won't have the dollars required to import stuff from the United States. Also, with both imports as well as exports shrinking, the American trade deficit may not shrink.

Nevertheless, a fall in American imports would mean a fall in global demand and in the process the global economy will shrink. As Duncan puts it: "At this point, the attempt to eliminate the US trade deficit could very easily cause the global economy to collapse into a new Great Depression." Things could go particularly bad for China. In 2015, the United States ran a trade deficit of $367.2 billion with China. This meant a trade deficit of around a billion dollars per day.

As Duncan puts it: "If the US eliminates its $1 billion a day trade deficit with China, China's economy could collapse into a depression that would severely impact all of China's trading partners, and potentially lead to social instability within China and to military conflict between China, its neighbors and the US."

Further, eliminating imports from low-wage countries would mean that the consumer price inflation will rise in the United States. This will lead to higher interest rates.

We live in a world, where easy money available at low interest rates from the United States, has been invested in financial markets all over the world. And if interest rates start rising in the United States, it won't be good news for financial markets all over the world.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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8 Responses to "Will Donald Trump Unravel the Global Ponzi Scheme?"

Ashutosh Agrawal

Feb 5, 2017

Good analysis based on facts. You are right that cutting imports from China (and other countries) may not reduce trade deficit as exports will also go down. But, it is wrong to conclude that cutting imports will also lead to fall in global demand and shrinking of global economy. Unless the purchasing power of Americans declines drastically, their consumption pattern and volume will remain the same and hence will maintain its contribution to the global economy. Only, a major volume of Chinese products will be replaced by US made products. This is what Trump wants and this will definitely increase jobs for Americans and push up US economy.

So, rather than trying to reduce trade deficit, the focus should be on reducing imports. What is not available in a country or can not be manufactured there has to be imported, but it makes no financial sense to import things that are in abundance locally or can be manufactured in local industries using local manpower. Even if local manpower is more expensive, it makes sense to use them as the wages earned by them will contribute towards local demand and add to local economy. Not to mention that it will create a better society. Further, has anybody thought about how the large volume transportation of goods across the globe contributes negatively to the climate issues not only in terms of warming due to emissions from planes and ships but also by unnecessary exploitation of oil and other resources.

The need to keep weights of the products low has regrettably warranted increased use of plastics, a non biodegradable material causing havoc of refuse. These products last one fourth or one fifth the time their heavier but sturdier metal products used to last- which were also recyclable. If these are even half the price with cheap overseas labour, where is the economy for the consumers, who end up spending double over a period of 5-6 years? Think also about increased use of chemicals in producing plastics!

To conclude, a higher global trade volume is neither the answer to the overall global economy (it only helps some countries like China!) nor does it help the social issues or the environmental concerns. Within countries like China, it mostly helps only the rich class owning big industry and business and the government, which misuses this capacity as a political power tool.

Like (4)

Ronnie Jones

Jan 31, 2017

408062262- This is probably the best assessment I have read on this very real threat to the world - Yes it is the biggest Ponzi scheme ever devised and will have far reaching effects on world trade - Every Government and I mean every Government MUST be aware of the effect on THEIR position re trade - Keep up the good work Ronnie (Australia)

Like (4)

Srinivasan Ramachandran

Jan 31, 2017

Thanks for another insightful article. I love this space. I have a question on today's article though -

Quoting from the article ---- "So, the United States imported, and countries like China, Japan, Saudi Arabia, and other countries in Asia earned dollars in the process. These dollars were then invested in treasury bonds... "

My question is - What makes them invest back in treasury bonds? I understand, that by way of this investment, the banks in the US get more funds to lend again. But why would Chine invest back in US?

And as a followup to this question, does it mean then that if this reinvestment stops, that will also lead to a crack down in this ponzi scheme?

Would love to hear from you.

Thanks and keep these articles, that gives an inside picture than the normal rhetoric that we hear/read in other media, going.

Regards,
Srini

Like (4)

Nitin Mehta

Jan 31, 2017


I have been reading articles of Mr Vivek And Mr Bill. Definitely, the cruz of turmoil in financial market is easy printing of dollar money. Everybody knows it. Nobody is denying it.

Under Equitymaster umbrella, as an investor I am of the view that above 2 person are pessimistic and on the other hand Equitymaster team is optimistic on Equities and anticipate 70% run in the market.


The question - is the end of world happening today or tomorrow ... should I sell or rather do you suggest liquidate equities and sit on cash.

I mean there are contrarian and contradictory / extreme opinion and conclusion leading to confusion.
Well, an investor in equity market knows that once easy money disappears, market would fall like 2008 crash but can you predict when and how much.........you can take the accolades of buzzing the trumpets first but you should clearly specify should an EQUITYMASTER INVESTOR stay INVESTED at CURRENT levels or EXIT.
You cannot have both the head and tail as answer, after the coin is tossed.

























Like (1)

S K LIMAYE

Jan 31, 2017

Nice article. Everything explained in simple terms.

Like (1)

Sanjay

Jan 31, 2017

Excellent read. So long as global commodities (specially oil) are traded in USD, America effort to run trade deficits of this magnitude. They simply print dollars.

Like (1)

Atulark

Jan 31, 2017

It seems complete logical explanation. Disturbing this equation will hamper the world over trade and create multiple problems in economies which are only USD dependent. India already started facing heat in 150 billion USD IT industry trade. All this will put pressure on "easy money" and demand based industry (which always call Sustainable profits) will have breaks on its easy growth.
Actually this will have better effects on ecology as the "unnecessary" demand will reduce and all natural sources will have breathing period.
India should understand this and start looking back to its sustainable model, however it is very difficult to convince those who are mainly in to "have not" category.

Like (2)

Nebu

Jan 31, 2017

So in short wealth is neither created nor distroyed, it only changes hands!

Like (2)
  
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