Recommended Weekend Reads

May 10 - 12, 2024

Here are our recommended reads from reports and articles we read in the last week. We hope you find these useful and that you have a relaxing weekend.   And let us know if you or someone you know wants to be added to our distribution list. 

Americas

• Mexico and the United States Need to Talk About China Now  Foreign Policy

  Mexican President Andrés Manuel López Obrador is rarely shy about criticizing foreign governments—usually that of the United States or other Latin American nations. Yet in January, López Obrador published a video touting his “very good” relationship with the people and government of China during a meeting with Beijing’s ambassador to Mexico. This was no accident. The video came just one day after an explosive report by ProPublica on alleged narco money in López Obrador’s various presidential campaigns, a story that the Mexican president said was part of a media campaign against him by the U.S. government. His meeting with the Chinese ambassador was intended to send a message, but it was also part of a broader trend. During López Obrador’s sexenio, China’s political and economic activity in Mexico has grown significantly. With his successor taking office on Oct. 1, Mexico’s approach to relations with China could shift or continue on a path that is likely to increase tensions with Washington.

• The Wrath of Khan: How Antitrust Policy Can Undermine U.S. National Security  Center for Strategic & International Studies

  To give credit where it is due, today’s title comes from my colleague Jim Lewis, who is coauthor of a report CSIS released on May 3: “Beyond Economics: How U.S. Policies Can Undermine National Security Goals” This white paper describes a range of U.S. policies that appear to be at odds with our national security goals and makes six recommendations for reconciling the differences. The paper begins with an explanation of why technology, particularly critical and emerging technologies (CET), is essential to national security. Space does not permit repeating all of that here, but just think semiconductors, and you’ll get the picture. Our defense infrastructure depends on information and communications technology, and that is only going to become truer in the future.

• Colombia’s Uncertainty Is Sinking Investment and More   Americas Quarterly

  Rising interest rates and a corporate tax rate among the world’s highest help explain the massive drop in Colombia’s fixed investment—a 9% decline in real terms to represent only 17.8% of the nation’s GDP—but they are only part of the story. Increased economic and political uncertainty has also played a significant role as President Gustavo Petro faces a pivotal moment in his four-year term to get at least some of his key reforms approved by Congress.   To the increasing doubts stemming from the lengthy discussions of the structural reforms, the government has fanned more uncertainties by announcing controversial measures in strategic economic sectors while floating the idea of a new Constitution. All are having a compounded effect on both investment and Colombia’s growth prospects. On May 2, the OECD urged authorities to apply policies to revive investment while forecasting a meager GDP expansion of 1.2% for 2024.

• Investment in US factories has soared since the end of 2022  Peterson Institute for International Economics

  Real business investment in manufacturing structures in the United States has risen sharply since the end of 2022. The amount of investment in this category in the first quarter of 2024 was about 80 percent higher than the amount at the end of 2022. “Industrial policy” legislation enacted in recent years likely helped fuel this sharp increase. For example, the Inflation Reduction Act and the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act, both enacted in 2022, provided large subsidies for the renewable energy and semiconductor industries. Although investment in manufacturing structures represents a relatively small part of overall US economic activity, the recent increases in this category have boosted annualized GDP growth by about ¼ percentage point since the end of 2022. Notwithstanding high interest rates, other types of US business investment have also increased. Altogether, private business fixed investment has contributed about ½ percentage point to annualized real GDP growth since the end of 2022.

• The Dollar versus the Euro as International Reserve Currencies  National Bureau of Economic Research

  This study begin by examining determinants of aggregate foreign exchange reserve holdings by central banks (size of issuing country’s economy and financial markets, ability of the currency to hold value, and inertia). But understanding the determination of reserve holdings probably requires going beyond the aggregate numbers, instead observing individual central bank behavior, including characteristics of the holding country (bilateral trade with the issuing country, bilateral currency peg, and proxies for bilateral exposure to sanctions), in addition to the characteristics of the reserve currency issuer. On a currency-by-currency basis, US dollar holdings are somewhat well explained by several issuer characteristics; but the other currencies are less successfully explained. It may be that the results from currency-by-currency estimation are impaired by insufficient sample size. This consideration offers a motivation for pooling the data across the major currencies and imposing the constraints that reserve holdings are determined in the same way for each currency. In this setting, most economic determinants enter with significance: economic size as measured by GDP, size of financial markets as measured by foreign exchange turnover, bilateral currency peg, and bilateral trade share. However, geopolitical variables (bilateral alliance, bilateral sanctions) usually do not enter with significance.

• Will the Dollar Ever Weaken?   Christopher Smart/OMFIF

  It goes up when things are good and it goes up when things are bad, so it’s a fair question to ask under what circumstances the US currency ever actually goes down. When everyone seems to accept that the Federal Funds rate will stay higher for longer, just what will it take to reverse an appreciation trend that is beginning to look more secular than cyclical? The short answer is that there are lots of things that could reverse the current trend. It’s just that very few of them seem likely anytime soon.

• Government Debt, Limited Foresight, and Longer-term Interest Rates  Federal Reserve Board

  With the issuance of U.S. Treasury debt having risen substantially in recent years, the effect of government debt issuance on longer-term interest rates has come under renewed attention.  While government debt can affect economic outcomes in a variety of ways, its effect on interest rates is an important determinant of the consumption and savings decisions of households as well as the investment decisions of firms and hence of macroeconomic activity.  In this note, we study the role of expectations formation in influencing the relationship between government debt and longer-term interest rates.  While it is common to analyze the effects of government debt on interest rates in a dynamic setting under the assumption of full information, rational expectations, the realism of this assumption is questionable.  In particular, this assumption implies that economic decision makers know all possible future situations that will arise and can use that knowledge to formulate complete state-contingent plans into the distant future.  A key contribution that we make in this paper is to depart from this assumption and study the effects of government debt on interest rates when economic decision makers are ‘boundedly rational’ and only have limited foresight about future events.2  In particular, we adopt the approach of Woodford (2018) in which agents can only engage in sophisticated forecasting and planning out to a finite horizon.3  We embed this approach into the model of Li and Wei (2013), as it provides a simple relationship linking the future path of government debt to longer-term yields and is an empirically relevant model for the effects of the supply of government debt on longer-term interest rates.4  We illustrate how limited foresight attenuates the effect of the supply of government debt on longer-term interest rates.  Calibrating the model to recent empirical evidence implies that limited foresight diminishes the effects of government debt substantially relative to the benchmark of rational expectations. 

Indo-Pacific

• East Asia’s Coming Population Collapse: And How It Will Reshape World Politics  Foreign Affairs

  In the decades immediately ahead, East Asia will experience perhaps the modern world’s most dramatic demographic shift. All of the region’s main states—China, Japan, South Korea, and Taiwan—are about to enter into an era of depopulation, in which they will age dramatically and lose millions of people. According to projections from the Population Division of the UN Department of Economic Social Affairs, China’s and Japan’s populations are set to fall by eight percent and 18 percent, respectively, between 2020 and 2050. South Korea’s population is poised to shrink by 12 percent. And Taiwan’s will go down by an estimated eight percent. The U.S. population, by contrast, is on track to increase by 12 percent.

• Expanding the Tool Kit to Counter China's Economic Coercion Center for Strategic & International Studies

  China’s 40-year economic development has transformed it into one of the world’s largest economies and most powerful countries. Over the past 12 years, China has been increasingly willing to leverage its economic might to pressure countries to act in its interest. The United States and its allies and partners are not prepared to counter China’s economic coercion. This report identifies coercive sanctions the United States and allied policymakers can use to effectively compete with China in the economic domain and deter future economic aggression from Beijing.

• India’s Battleground State  Foreign Policy

  The biggest question about India’s ongoing national election is not if Prime Minister Narendra Modi and his Bhartiya Janata Party (BJP) will win but rather by how much they will win. Modi’s deep popularity makes a third consecutive term very likely. But a few factors, including inflation and opposition to the BJP’s Hindu nationalism, could deprive the party of the supermajority that it seeks. The southern state of Karnataka is a battleground between the BJP and the Indian National Congress party, its main political opposition. Congress won big in Karnataka’s state election last year, picking up nearly 43 percent of votes. This underscores the challenges the BJP alliance faces to winning 400 seats of the 543 in the Lok Sabha, India’s lower house of Parliament—which would be a nearly 50-seat increase from its 2019 result.

Geoeconomics

• What’s Driving the Global Gold Rush?  Harold James/Project Syndicate

  A recent surge in the gold price is symptomatic of a changing world order and the onset of a new age of conflict and uncertainty. Governments and central banks have long viewed the precious metal as a potential source of monetary stability and economic security, and this time is no exception. Gold has returned to the international monetary system. Over 50 years ago, US President Richard Nixon “closed the gold window” (ended the dollar’s fixed-rate convertibility into gold), and the world moved on from its obsession with precious metals. A new era of fiat currency had begun. But now, fiat money is being challenged by fiscal worries and new technology (blockchains/distributed ledgers), and the price of gold has reached all-time highs above $2,400 per ounce.

A Superb Panel in Palm Beach

Pitcairn’s Outstanding Lunch Discussion Global Events and Investing

I was recently delighted to join my friends at Pitcairn for a client luncheon and superb panel discussion In Palm Beach, Florida.

Our discussion was wide-ranging, wonderfully challenging, and thought-provoking. Held in the elegant Brazil Court Hotel, I was thrilled to sit with Chief Global Strategist Rick Pitcairn, Managing Director for Wealth Strategy Jen Proper, and Chief Investment Officer Nathan Sonneberg (who also masterfully moderated).

The upcoming battle over revising the 2017 tax bill is clearly going to be challenging for investors and corporations as Congress and the next Presidential Administration are going to be forced to grapple with the exploding national debt. All this comes in the face of intense pressure to bolster U.S. military spending and sustain and grow industrial policy, luring technology, pharma, and other critical industries back to the U.S. Massive contradictory pressures with enormous market implications.

Thank you, Jay and the entire Pitcairn team for having me!

Left to right: Pitcairn CIO Nathan Sonneberg, Chief Global Strategist Rick Pitcairn, Head of Wealth Strategy Jen Proper, and yours truly.

Our super-star host, Managing Director and Head of Pitcairn’s Florida Office, Jay Goetschius, who masterfully put this great event together.