China and the Global Economy With Richard Duncan #641

Richard Duncan blog

Bruce Norris is joined again this week by Richard Duncan.  Richard is the author of three books on the global economic crisis, including the international bestseller The Dollar Crisis: Causes, Consequences, and Cures, which forecasts the global economic crisis of 2008 with extraordinary accuracy. Since beginning his career as an equities analyst in Hong Kong in 1986, Richard has served as Global Head of Investment Strategy at ABN AMRO Asset Management in London worked, as a financial sector specialist for the World Bank in Washington D.C., and headed equity research departments for James Capital Securities and Solomon Brothers in Bangkok. He also worked as a consultant for the IMF in Thailand during the Asian crisis. He is now the publisher of the video newsletter Macro Watch, which can be found on his Web site

Episode Highlights

  • What does unemployment and the ten-year T-Bill say about the U.S. economy?
  • How serious is the event involving the yield curve inversion?
  • What is happening with the global economy, especially in places like China?
  • What are these so-called ghost cities we are seeing in China?
  • What could cause the next recession, and would it be less or more severe than the Great Recession?
  • What should we expect to see if we have more quantitative easing?
  • What is the current monetary policy, and what are Richard’s thoughts on how the money should be spent?

Episode Notes

Bruce follows a lot of charts, and he’s never found a chart that had unemployment of the U.S. at 3.7% or having an inability to pass a ten year T bill rate of 2 1/2%. Bruce wondered what that says about the state of the U.S. economy that we can’t raise rates when we have this unemployment. Richard said the state of the U.S. economy is that it is dependent on asset prices continuing to rise. We need asset price inflation to drive the economy. The reason interest rates are so low is because if they start to go higher, as we saw in the sharp correction in the Stock Market in December the interest, if monetary policy tightened interest and rates moved higher, then the stock market moves lower. If the stock market moves lower, then suddenly job growth stops and then starts to contract. The economy would go into a steep recession.

So the economy has been driven by lower and lower interest rates, beginning with a 10-year bond yield peak in the early 1980s at about 15 percent. It’s come down now to two and a half percent since there’s been a decline in interest rates that have driven the U.S. economy. The U.S. economy has been completely restructured around those low interest rates in the U.S.  The U.S. economy could not withstand significantly higher interest rates without falling into a very severe recession.

Bruce asked Richard how seriously he takes the event involving the inversion of the yield curve. He said there has been quite an accurate signal for a very long time. However, it typically inverts at nine months at least in a recession. One thing that it indicates is with the longer term bond yield, the 10-year government bond yield. If it is low, then that suggests that there are not a lot of borrowing opportunities in the economy or a lot of profitable investment opportunities. If there were profitable investment opportunities, then people would borrow more money instead of buying government bonds. They would borrow, and they would invest in new industries. This, in turn, would push up interest rates and 10-year bond yields would move higher. The fact that they are so low is telling us that the opportunities within the economy are limited in the US economy.

Bruce asked about if you have a 10-year T-Bill at about two and a half and a 10-year bond rate at basically 0, is that spread significant and does it indicate something like a reversion to a mean of some point in the future where the ten-year would actually get closer to zero? He asked if it would likely lower or maintain that spread or even bigger. Richard said it’s certainly possible that the ten-year bond yield could move lower. A few years ago, it was as low as 1.6%. Yet, these foreign interest rates are very relevant for U.S. interest rates.

In Europe, the European Central Bank continued with their own quantitative easing, which was very aggressive at the peak. They gradually tapered it off, and they only ended that in December. It’s already over, and there are zero interest rates. In Japan, their quantitative easing is still going full steam ahead, and their 10-year bond yield is zero over the last week. The 10-year bond yield in both Japan and Germany were below zero. They were negative. Anyone who bought a new bond last week in those countries was guaranteed to lose money if they held it to maturity.

Bruce wondered if they don’t sell many bonds, although Ricarhd said they do. Japan, in particular, has a very large budget deficit. What’s going on is that the Bank of Japan is essentially printing as many Yen as necessary to hold the 10-year government bond yield at zero. The central bank has the ability to create as much money as it chooses. If it chooses to print them out, they can buy as many bonds as necessary to push up the bond prices until the bond yields are at any level it chooses. The Bank of Japan decided to keep the Japanese 10-year bond yield somewhere between zero and 10 basis points, although it’s been less than that over the last few weeks. Those low interest rates abroad contribute to the lower interest rates on U.S. government bond yields as well.

What we’ve seen over the last several months is that the global economy has been slowing, in large part because China’s economy is weakening. China’s economy is probably the greatest economic bubble in history, and it would have slowed down regardless. But, now that President Trump has initiated this trade war with China and started cutting tariffs on Chinese goods, that’s just made things considerably worse in China. So China’s slowing quite sharply. They’re importing less from countries like Germany. Germany barely avoided falling into a recession in the most recent quarter. The global economy in general is just slowing largely because of the big slowdown in China.

Bruce asked about the ghost city building for China and if it is still ongoing or if they have as many go cities as they intend to have. Richard said there is an enormous amount of investment of all types going on in China. A great deal of that investment is in the projects that are entirely unnecessary. This includes the ghost cities where no one lived. They built cities where there are no people and built bridges across rivers that don’t exist. They built the bridges where they don’t even have a river. The rivers are just in the planning stage.

If you could have 50,000 people, you can’t be the first person that shows up. You literally would have to have a government capable of saying that a lot of people are showing up in the next week and are going to need a doughnut shop and other things all simultaneously. You’d have to have a communist country able to pull that off. Bruce wondered if this was their intent. Richard answered by saying 50,000 people in China not a city, it’s neighborhood. These ghost cities are somewhere around 300,000 to 500,000 people, and that’s just to start. China has dozens and dozens of cities with more than a million people.

China has a saying “One Belt, One Road, or “Belt Road Initiative,” where they are essentially building infrastructure to recreate the Silk Road. Essentially, they’re building infrastructure not only all across the Asian continent, but into Europe, the Middle East, South Asia, Pakistan, and even Africa and South America. This makes a lot of sense for them because they can use all of the extraordinary excess industrial capacity that they have in things like cement and steel. In just three years, 2010, 2011, and 2012, China produced as much cement as the United States did during the entire 20th century. They had to keep doing this, or their economy would implode. It makes more sense to pave Mongolia with cement rather than just pouring the cement in the China Sea.

That’s what this initiative is about. They extend loans to these countries, and then those loans finance infrastructure, and Chinese workers and material build the infrastructure. Their influence around the world is increasing at an extraordinary rate. Finally, the United States government and military establishment have become concerned that if this continues, China will be the global economic dominant superpower, both economically and technologically. This could lead to militarily in the not too distant future. That’s really the true reason behind this trade war that President Trump has initiated. It’s not always to force China into fair trade and to stop China’s extraordinary trade surplus with the U.S. from growing any larger. He thinks it’s really to stop China’s growth altogether.

Bruce next asked Richard what he thinks would cause the next recession and if it would be less or more severe than the Great Recession. Richard said first of all, part of the reason the economy grew as much as it did last year was because of the tax cuts and the increased spending that Congress passed at the beginning of last year. This resulted in the budget deficit becoming significantly higher. It was good, old-fashioned Keynesian stimulus that drove a considerable amount of the economic growth last year. Now, that stimulus package is fading, although budget deficit will remain high and continue expanding. So the fiscal stimulus is weakening, and that’s going to be a drag on the economy. The global economy is also weakening in part because of the slowdown in China.

The financial markets were becoming very alarmed at the prospect of 25% trade tariffs going up on Chinese goods as they were scheduled to do on March 1st. They were so alarmed that President Trump announced that he was going to delay that and started sending out signals that the trade talks with China were going much better. They expected some favorable conclusion. More or less, he had to back off from putting up higher trade tariffs because that would have really been such a severe blow to China. The slowdown in China would have been a severe blow to the global economy, and that could have tipped the U.S. into a recession by itself.

Economies eventually all go into a recession in the normal course of events. This expansion has been going on for almost the longest on record. In terms of the next recession, there’s no reason that it needs to be severe. It may be prevented altogether for many more years. Richard thinks what will occur is once we start seeing signs of a definite slowdown and the real risk of a recession., the Fed will be very quick to cut interest rates. The federal funds rate is now between 2 1/4 and 2 1/2%. They will start slashing that very quickly, and they will move back to zero if necessary. If that’s not enough to do the trick, then there’ll be another round of quantitative easing. They will start printing money again and buying government bonds, and that could potentially inject $3 1/2 trillion into the financial markets. They could inject another $3 1/2 trillion or $7 trillion or $10 trillion, whatever it takes to make the asset prices go up and make the economy keep growing. This could happen as long as globalization doesn’t break down and as long as we don’t have high rates of inflation.

Bruce said historically when a recession starts or an inversion of the yields happens, you’re at 5 1/2 or 6% or more, and this is probably going to occur at less than half of that. The Fed usually lowers somewhere between four and a half and five percentage points on the short term rate. Bruce asked if we are at 2 1/2, could we likely go negative or would they get aggressive with QE4? Richard does not think they would purposely go negative on the federal funds rate. They would launch QE4. The central bankers around the world have made it clear and repeatedly signaled in public at press conferences that quantitative easing is now a permanent part of the central bank toolkit. So we should expect more of this in the future.

For that reason, as a society, we should think about how that newly created money should be used. Of course, there have been negative side effects from the quantitative easing. On the one hand, the quantitative easing stopped the Great Recession in its tracks and brought about the recovery that’s been going on for 10 years. On the other hand, the negative side effect was that it pushed up asset prices so much that it has greatly increased income inequality in the country. The people who own assets have benefited the most. Richard read that the three wealthiest Americans own as much wealth as the bottom 50%.

If we’re going to have more quantitative easing, we have to ask ourselves if we want it only to continue to push up asset prices or if there is some better way that we can use this money that is going to be created. He believes there is a better way to use it rather than just allowing it to push up Manhattan penthouse prices from $100 million to $200 million each. He said we should use the newly printed money much more wisely. If we’re going to print this money, we should print it and use it for investment purposes. If we’re going to print $3 trillion over the next five years, we should put a half a trillion dollars into genetic research and another half a trillion into biotech research, nanotech research, Neurosciences, artificial intelligence, and robotics. This way we can actually induce a technological revolution in the United States that restores our technological superiority and locks in another American century.

Bruce asked him what he thought the likelihood of that occurring is, to which Richard said it’s growing. Once it becomes clear that there will be more quantitative easing, then the question that is going to arise is how we should use this money. Recently, President Trump has started calling for more quantitative easing. Not only did he say the Fed should cut interest rates, but they should stop quantitative tightening and start printing again. Recently, the government has started investing more and allocated $2 billion to DARPA, which is the Defense Department agency charged with technological development.

Two billion dollars was allocated for developing artificial intelligence. That’s just a relatively small amount compared with what he was describing, but if it makes sense to invest two billion dollars, then why not $200 billion since we’re going to print the money anyway and the money will come at essentially no cost to anyone. We would build some kind of infrastructure that’s the future I.

Bruce ended by asking about modern monetary policy. This has to do with unlimited debt, and he doesn’t know if the intention is to use it wisely. Richard said a modern monetary theory seems to be a theory in the making. He does not think there is anyone very clear definition of what it is. However, he does not come at this as someone from the Modern Monetary Theory school, but he’s come at this from a different angle. Essentially what they are saying is that it is possible for the US government to borrow much more money than it had, and if necessary, at least some of these people believe it is possible to finance that money with paper money creation. If they do this, that gives the U.S. government much more scope to spend money on various schemes.

Different people have different ideas about how the money should be spent. Some people believe it should be spent on a Green New Deal. Other people believe it should be spent on a guaranteed basic income. Richard’s view is that it should be spent investing in new industries and technologies, at least a very significant part of it. This would ensure that the United States maintains its global, technological, and by extension, military dominance for the future since that’s security. It would also result in technological miracles and medical models.

With money on this scale, we could go for a cancer moonshot. Invest this kind of money into genetic engineering and biotech, and we can cure many if not all of the disease over the next 15 to 20 years. That sounds a lot better than doing the new Green Deal.

They ended the segment by talking about Richard’s website and business. His business is called Macro Watch, which is a video newsletter. He uploads a new video every couple of weeks to his Web site. These videos describe important developments in the global economy and how they’re likely to affect the stock market, bond market, property prices, commodities, and currencies. His website is If they would like to subscribe, he’s offering a 50 percent subscription discount to Macro Watch. If they hit the subscribe button and use the coupon code River, like Mississippi River, but just river, they can subscribe at a 50% discount. At the very least, he hopes you will sign up for his free blog. Bruce and his son have signed up for both, and it’s money well spent.

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