Cry Tariff! And unleash the wolves of Chaos
This is my third blog on how the Tariff Strategy unveiled on Liberation Day by President Trump has only unleashed chaos not just for USA but has sent reverberations across the world — from the mighty China who account for a large part of US imports to the tiniest islands inhabited by penguins.
Unlike China and several countries within the EU, the Indian government’s response has been … well quite muted and perhaps imbued with opportunism, secretive pacts, and perhaps even cowardly expediency to Trump’s blusters — behaviors that have been publicly labelled by Trump — as “a stampede of grateful foreign powers kissing his arse — thankfully he declined to mention the name of the countries and the leaders”. It has been almost a week since liberation day and PM Modi and his colleagues are yet to make any public statement on his policy.
Treacherous Times thus far … the fall and the rise of Markets
Till the 9th of April, the share markets fell and how they fell — Dow Jones and S&P indices plummeted responding to what the media has termed — the self-induced economic meltdown. Trillions of dollars vanished into thin air, as the markets predictably collapsed. The jobs and retirement savings of US citizens were thrown into chaos as the 47th president stated that Tariffs are here to stay and that this is not a negotiation gambit. Trump’s spin doctors spoke of how this is a courageous leadership response to the decades of growing trade deficit where other countries had simply pillaged the wealth of USA and how this injustice and unfairness has to end — with the magic of “Tariffs”
And yet in the last few hours, there has been a reversal…
President Trump, as CNN puts it, ‘blinked’ and has put a pause to his capricious Tariff strategy — and this has been met with intense relief and a surge in the stock markets. The Republicans have been farcical in their attempts to make sense of this pause — for many of them had been defending the Tariff strategy vociferously so far. They have pointed out that the surge in rising markets is something that has never been seen before (blatantly denying the preceding fall in the past few days), or that President Trump is a fantastic negotiator (swearing on The Art of the Deal) and knows how to create leverage, and of course that he is a masterful strategist.
While I refuse to comment on the dexterity of politicians to turn defeat into victory, this blog builds on the previous one where I had talked about the ‘Dollar’ and the seeming paradox of how the dollar has strengthened over the decades while the American economy has experienced a growing and massive trade deficit. How is this possible? For any other country, such as India, the trade deficit leads to the currency going through the throes of devaluation.
The Dollar — In God we Trust, as Trade Deficits pile up over decades …
In the Christmas classic — ‘Miracle on 34th street’, a young girl wanting to believe in Santa Claus, gives the Judge a $1 bill where on the backside of the note, she circles the phrase — “In God We Trust”. In this poignant scene, where the Judge is sitting on his judgment that Chris Kringle is a lunatic, the dollar bill makes the judge realize he would be a hypocrite if he doesn’t let a man believed to be Santa Claus free, when his own government system operates under the belief in God.
In the original black and white Christmas classic, a film by Frank Capra and starring the lugubrious James Stewart — ‘It’s a Wonderful Life’, that my kids would not have heard of — “In God We Trust” becomes the central phrase — it is a visual element that is observed in many scenes.
These wonderful poignant themes and scenes are not exaggerations but only endorse what the markets have talked about for many decades. The strength of the Dollar and the underlying sentiment of “In God We Trust’ is best exhibited by the Dollar Smile.
The Dollar Smile
The Dollar has been the most trusted currency in the past hundred plus years. There is a term that describes its hold on world economies — known as the Dollar Smile Theory. Postulated by Stephen Jen, a former economist at the International Monetary Fund and Morgan Stanley, who now runs a hedge fund and advisory firm Eurizon SLJ Capital in London, came up with a theory and named it the “Dollar Smile Theory.”
“The Dollar Smile Theory says the U.S. dollar tends to strengthen against other currencies when the U.S. economy is extremely strong OR weak”
1. When the U.S. economy significantly outperforms the rest of the world, the U.S. dollar tends to be strong and increase in value relative to other currencies. This is the ‘domestic’ US dollar that behaves like any other currency — say the Indian Rupee.
2. When the global financial markets are disorderly or crashing, and sentiment switches to “risk-off“, since the U.S. dollar is perceived as the ultimate safe-haven currency, everyone rushes to safety and starts buying USD causing it to rally. This is the international US dollar that is the primary currency used for global trade, and is sourced through US GOVERNMENT BONDS.
Will this theory hold true? Well Donald J Trump seems to really test this theory and push it to its extremes. The past few days have not been very encouraging. President Trump has had to renege on his earlier stance of “Tariffs” — he and his party have tried their best to deem their stance as a part of his ‘stable genius’ strategies. However, it is important to also go beyond this and look at some numbers — in the Bond Market.
Tariffs and the Bond Markets
On 9th April, President Trump had to confront and swallow the bitter truth that there was an increasing sell-off of US Government Bonds in the past 48 hours. As CNN puts it — “In a metaphorical sense, investors were selling the idea that the United States, long a bedrock of the global economy, was a rock of safety. Their ebbing confidence encapsulated how Trump’s volatile style has turned the United States from a bastion of the world’s stability to one of its most destabilizing influences.”
In God We Trust — was fast becoming an empty cliché
The 10-year Treasury yield briefly spiked above 4.5%, sending a wave of confusion through markets that are already jittery about a possible recession. Normally, bonds are seen as a safe place to hide when the economy turns uncertain — but this time, that old rule isn’t playing out. If this trend were to continue, the pressure on both the economy and markets could intensify. Higher yields make it more expensive for businesses and consumers to borrow money. That, in turn, could slow down growth — the very thing the Fed is trying to avoid.
But the central bank is in a tough spot. With tariffs pushing up prices globally, inflation is becoming harder to ignore. If the Fed acts too soon, it could lose credibility. If it waits too long, a downturn might arrive faster than expect ..
The Economist says that — “One possible explanation is that foreign holders of U.S. debt — especially China, Japan, and the U.K. — are quietly selling off their Treasuries. These are the same countries hit hardest by Trump’s trade moves.”
As David Zervos, chief market strategist at Jefferies, pointed out on CNBC’s Worldwide Exchange, this could be a form of economic retaliation. “If countries can use their stock of U.S. financial assets that they’ve accumulated… then they can create some problems,” he said.
For the first time perhaps — the Dollar Smile Theory was being challenged as global markets were losing faith in US Assets.
What lies Ahead?
Well I don’t really know… Trump still, as on date, wishes to raise tariffs to Chinese exports while making his deals with other countries. Many countries are more pragmatic and would remain opportunistic as they make ‘deals’ with Trump and Company.
However the US political ambiance does not promise stability and certainty under his governance — was tempted to write ‘his rule’. There appears to be signs of how the world is slowly as well as radically shifting.
But I would not be exaggerating if I were to say that ‘Trust’ and “Faith’ has been significantly corroded in the past week and perhaps the Dollar may not be the preferred currency as defined by its past.
President Trump would be remembered by historians and economists for his Cry Wolf / Cry Tariff stances and the sheer volatility and chaos that has ensued such stances…
