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December 13, 2018

"Backfire Economics" is a series of posts by Mark Perry that focuses on the unintended, yet often predictable consequences of the tariffs that President Trump has imposed since launching his trade war strategy earlier this year. By our unofficial count, there are at least 24 entries in the series, the most recent one at this writing here, where each focuses on some aspect of how the President's tariffs on foreign-produced goods have negatively impacted U.S. businesses and people.

Until now, we don't think that anyone has applied the "backfire economics" concept to the tariffs that other nations have imposed upon American goods as part of their trade war strategies with the U.S. And we may have a doozy with China's retaliatory 25% tariff on U.S.-grown soybeans, which were clearly intended to inflict economic harm upon American soybean producers and exporters.

But before we can talk about that, we have to talk about a story that we were surprised to see in the news last week, which had the headline "China Is So Desperate for Pork That It's Buying American Again".

It's definitely a clickbait headline, and it worked, because we clicked it and learned that China is experiencing a shortage of pork because of a highly infectious disease called African Swine Fever, which doesn't affect humans but is very deadly for hogs, all the more so because it has neither a vaccine nor an antidote. The first case was reported on 1 August 2018, and since then, it has spread as an epidemic among China's pig farms.

A nightmare is unfolding for animal health experts: African swine fever (ASF), a highly contagious, often fatal disease of domestic pigs and wild boars, has appeared in China, the world’s largest pork producer. As of today, ASF has been reported at sites in four provinces in China’s northeast, thousands of kilometers apart. Containing the disease in a population of more than 430 million hogs, many raised in smallholder farmyards with minimal biosecurity, could be a monumental challenge....

East Asia’s first confirmed outbreak occurred on 1 August in Shenyang, a city in Liaoning province, China’s Ministry of Agriculture says. Investigators have traced the disease back through sales of pigs and concluded the virus has been circulating in the area since at least March, says Wantanee Kalpravidh, a veterinarian at the Food and Agriculture Organization’s (FAO’s) Emergency Centre for Transboundary Animal Disease in Bangkok.

A genetic analysis suggests the virus is closely related to the strain circulating in Russia, scientists from the Institute of Military Veterinary Medicine in Changchun, and other Chinese institutions reported on 13 August in Transboundary and Emerging Diseases. “The increasing demand for pork has resulted in a great increase in the volume of live pigs and pork products imported to China,” heightening the risk of introduction, they wrote. The virus probably arrived in imported pork products, Kalpravidh says, which then infected pigs that were fed contaminated table and kitchen scraps.

Since August, the epidemic of African Swine Fever among China's pig farms, which account for half of the world's population of pigs, has prompted the culling of more than a half-million pigs since it was first detected, where it now "has spread rapidly to more than half of China's provinces despite measures to contain it", with new outbreaks still occurring four months later.

Map of China Provinces, red-shaded provinces indicate African Swine Fever has been detected in 2018

Part of what makes African Swine Fever so contagious is that the virus behind it is very resilient: "African swine fever virus can survive heat, putrefaction, smoking, partial cooking, and dryness and lives up to six months in chilled carcasses. The incubation period is from 5 to 15 days."

That characteristic has prompted Chinese authorities to clamp down on the practices of transporting pigs out of regions impacted by the epidemic and feeding pigs table and kitchen scraps as they seek to gain ground on the epidemic.

China has already banned the transport of live hogs from infected provinces and neighboring regions to prevent the spread of ASF and requires trucks carrying live animals to be registered and to use location-tracking systems.

China has also banned the practice of feeding food scraps and swill to swine.

Note that we keep coming back to the topic of feeding scrap human food, which often features pork as the leading protein in China, to swine. This is where China's retaliatory tariffs aimed at U.S. soybeans may now come into play.

Since imposing a 25% tariff on U.S.-grown soybeans that has led Chinese buyers to shun the crop, China's primary soybean consumers, the nation's swine farms, have had to turn to substitutes for them. Earlier in the year, they were able to substitute Brazilian and Argentinian-grown soybean crops, but that doesn't appear to have been sufficient to meet the nation's demand for the protein-rich animal feed in the latter half of the year. Chinese authorities have responded by both lowering their standards for soybeans and also substituting other crops, where the available replacements likely do not share the the same high protein content that makes soybeans desirable to use as feed in raising hogs.

So what do thousands of Chinese hog farmers, and especially the ones with very small operations, do to fill the protein gap? If you answered "increase the amount of leftover meat scraps they feed to their hogs", you have identified a potentially very serious contributing factor to the rapid spread of African Swine Fever in China, and also a deadly, if unintended consequence of backfire economics in action.

Stopping an epidemic after it has gotten started is a lot like dealing with a cascade failure - it often requires an active intervention to significantly slow the rate of infection. In this case, the ideal intervention would be targeted at breaking the cycle where contaminated meat scraps are fed to healthy pigs, which would mean substituting protein-rich non-contaminated feed for this disease vector.

The ideal substitute would involve buying and distributing large quantities of soybeans, where there is only one source China can turn at this time of year that has a large, harvested crop ready to export to meet its increasingly urgent need: the United States. So that's what China has done, where we now have a new clickbait headline to feature, ripped straight out of 12 December 2018's news: "Exclusive: China makes first big U.S. soybean purchase since Trump-Xi truce. As deals go, China's soybean buyers would appear to be getting a very good one as it is paying about $9.07 per bushel in spending $500 million for 1.5 million metric tons of U.S.-grown soybeans, where they've paid higher prices on average in recent years.

The question now is whether it will be enough in time to arrest the "nightmarish" spread of African Swine Fever among China's hog farms?

Mark Perry has 24 examples of where backfire economics from U.S. trade war tariffs are hurting Americans. We have one example where backfire economics from China's retaliatory tariffs has hurt China's population. How many more examples are out there?

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December 12, 2018

It's not much to write home about, but the number of U.S. firms whose stocks are publicly traded on stock exchanges in the U.S. increased for the first time in years in 2018.

Admittedly, the increase of 2 firms from 3,484 in 2017 to 3,486 in 2018 doesn't really qualify as a dramatic reversal for the nation's stock exchanges, which once counted no fewer than 7,322 firms among their actively traded listings back in 1996. But it is the first real reversal that we've seen in these numbers in more than 22 years that isn't attributable to a change we made in the data sources we track, where the data from 2013 onward is taken from the number of firms that are included in the Wilshire 5000 total market index.

Number of Listed Firms in U.S. Stock Market, 1975-2018 (Excluding Investment Funds and Trusts)

Who knew that 2018 was the year that the U.S. stock market stopped shrinking? And will that reversal of trend continue next year?

Data Sources

Craig Doidge & G. Andrew Karolyi & René M. Stulz, 2017. "The U.S. listing gap," Journal of Financial Economics, vol 123(3), pages 464-487. DOI: 10.1016/j.jfineco.2016.12.002. (NBER Working Paper No. 21181).

Wilshire Associates. Wilshire Broad Market Indexes, Wilshire 5000 Total Market Index Fundamental Characteristics. [2013, 2014, 2015 (for month ending 06/30/2015), 2016 (for month ending 06/30/2016), 2017 (for month ending 03/31/2017)].

Wilshire Associates. Wilshire Broad Market Indexes, Wilshire 5000 Total Market Index Fundamental Characteristics. [PDF Document]. 29 June 2018.

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December 11, 2018

In recent years, U.S. exports have typically peaked in the months of October through December because these months coincide with the harvesting of the U.S. soybean crop, which has become the nation's single largest export product to China.

But not in 2018, because of the retaliatory tariffs that China's government has placed upon U.S.-grown soybeans as part of its trade war strategy with the U.S., which have led China's soybean buyers to effectively boycott the 2018 crop. The following chart shows the dramatic plunge in the year-over-year rate of growth in the value of U.S. exports to China that is a direct consequence of China's trade war strategy.

Year Over Year Growth Rate of Exchange Rate Adjusted U.S.-China Trade in Goods and Services, January 1986 - October 2018

In the absence of the trade war, such a plunge into negative growth territory would be a clear indication that China's economy is experiencing deep recessionary conditions. China's economy is indeed decelerating and appears to be facing a growing threat of deflation that would be consistent with some degree of contraction occurring within the country's economy, but we believe the negative impact indicated in the chart is being exaggerated by the impact of China's tariffs on U.S. goods.

Perhaps a better question to ask is why don't we see a similar phenomenon develop in response to the tariffs imposed by the U.S. on the goods that China exports to the United States? The chart above confirms that the rate of growth of value of goods that the U.S. is importing from China is positive, which suggests that U.S. tariffs are having very little impact on U.S. demand for goods produced in China.

The answer to that question has a great deal to do with the strategy the U.S. has pursued in selectively imposing tariffs on Chinese goods. Benedikt Zoller-Rydzek and Gabriel Felbermayr of the European Netork for Economic and Fiscal Policy Research (econPOL) have analyzed the U.S. government's tariff strategy and found a strong explanation for the apparent lack of impact (emphasis ours):

On September 24th 2018, the United States introduced import tariffs on a wide range of Chinese products. The tariffs will affect US imports from China with a value that exceeds USD 250 billion - around 50% of all imports. In this analysis we show that, contrary to public opinion, the greatest share of the tariff burden falls not on American consumers or firms, but on Chinese exporters. We calibrate a simple economic model and find that a 25 percentage point increase in tariffs raises US consumer prices on all affected Chinese products by only 4.5% on average, while the producer price of Chinese firms declines by 20.5%. The US government has strategically levied import duties on goods with high import elasticities, which transfers a great share of the tariff burden on to Chinese exporters.

Altogether, these estimates suggest that Chinese firms are paying for about 75% of the additional cost that the U.S. government's tariffs have added on top of the cost of Chinese produced goods, insulating U.S. consumers from paying the full cost of the U.S.-imposed tariffs. That additional cost is then contributing to the increased level of economic distress that has gained ground in China's economy throughout much of 2018.

That is why the 90-day truce on new tariffs negotiated between China Premier Xi and U.S. President Trump, shaky though it may be, is still a big deal. Since the deal, China's government has indicated it would allow the following steps to be taken:

We'll have more to say on that last story in the very near future, where we think that the story is being driven in part by the backfiring of one aspect of the Chinese government's trade war strategy.

We'll close with an update to our chart showing the overall impact of the U.S.-China trade war to date to the overall level of goods and services traded between the two nations.

Combined Value of U.S. Exports to China and Imports from China, January 2008 - October 2018

Through October 2018, the gap between the pre-trade war trend and the trailing twelve month average of the value of goods exchanged between the U.S. and China has widened to $1.6 billion, which has primarily been driven by China's effective boycott of U.S.-grown soybeans.

References

Board of Governors of the Federal Reserve System. China / U.S. Foreign Exchange Rate. G.5 Foreign Exchange Rates. Accessed 7 December 2018.

U.S. Census Bureau. Trade in Goods with China. Accessed 7 December 2018.

U.S. Census Bureau. U.S. Trade Online. Accessed 7 December 2018.  

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December 10, 2018

There was one major economic event that occurred last week and it shifted the forward-looking focus of investors, sending stock prices sharply downward as a result.

That event was the partial inversion of the U.S. Treasury yield curve that took place on Tuesday, 4 December 2018. A yield curve inversion occurs whenever the yield, or interest rate, of a longer term bond or note issued by the U.S. Treasury Department falls below the level of a shorter term bond or note. This kind of event is often associated with an increased likelihood of an economic recession in the future, when businesses can expect to experience falling levels of earnings and cash flow, which is why stock prices would fall in the current day even though any economic distress is only in the potential outlook for the future and is not as yet guaranteed.

For a quick recent history of the Treasury yield curve, check out TheFirsh's two-minute long animated chart of the curve's history since 1990. Recessions followed within 1-2 years of significant yield curve inversions that occurred in 1989-90, 2000 and 2006-07 (the animation ends at the end of November 2018, so it doesn't capture the latest inversion).

Yield Curve's 28 years in 2 minutes [OC] from r/dataisbeautiful

On Tuesday, 4 December 2018, the yield of the 5-year Treasury dropped to be lower than the yields of the 2-year and 3-year notes. Although the amount by which the 5-year note dropped below the 2 and 3 year notes is small, the negative implications of the event were amplified thanks to the highly influential New York Fed branch president John Williams, whose unfortunately timed and tone-deaf hawkish comments promising additional short-term interest rate hikes well into 2019 prompted investors to shift a significant portion of their attention beyond 2019-Q1 to the more distant future quarters of 2019-Q3 and 2019-Q4, where the expectation is already well established that these quarters will experience a significant deceleration in the growth rate of dividends.

At a time when investors are sensitive to the potential for economic distress ahead, a Fed branch president announcing that they think the Fed should keep hiking interest rates well into 2019 is the equivalent of pouring gasoline onto a small campfire in a dried-out, under-maintained, underbrush-thick section of California's state forests. It's a stupid own-goal, on par with one of former Fed Chair Ben Bernanke's bigger mistakes.

That was all it took to send stock prices sharply lower through the end of the first week of December 2018. The S&P 500 broke out of the final portion of our red-zone forecast, where we had assumed that investors would largely remain focused on 2019-Q1 through 7 December 2018, where we find that investors have instead shifted a little over 50% of their forward-looking focus toward 2019-Q3 or 2019-Q4 (there's not much difference in where the level of the S&P 500 would be for investors focusing on either future quarter). It's early, but it's looking like we're seeing the fifth Lévy flight event of 2018.

Alternative Futures - S&P 500 - 2018Q4 - Standard Model with Redzone forecast assuming investors focusing on 2019Q1 from 7 November 2018 through 7 December 2018 - Snapshot on 8 Dec 2018

That explains how and why the level of the S&P 500 got to where it is as of the end of Week 1 of December 2018. We've also come to the end of our redzone forecast period, where out of 20 days where the market was open (markets were closed on Wednesday, 5 December 2018 to mark the passing of former U.S. President George H.W. Bush), the S&P 500 closed within our forecast range on 10 of those days.

While our redzone forecast turned out to be wrong for 50% of the actual observations, the lowest level of accuracy we've ever achieved over a forecast period, it proved to be very useful in detecting when investors shifted their forward-looking attention away from 2019-Q1 toward other more distant future quarters during the past month. We can also confirm that stock prices are not following the echo of October 2018's market volatility.

While the Treasury yield curve inversion was the most significant, market-moving event of the first week of December 2018, other stuff happened too, where the stuff we think is worth noting is listed below....

Monday, 3 December 2018
Tuesday, 4 December 2018
Thursday, 6 December 2018
Friday, 7 December 2018

Meanwhile, Barry Ritholtz reviewed the week's major economy and market-related news and divided it up into its positives and negatives. Unfortunately, he missed the developing yield curve inversion as the week's biggest market-driving negative, but he picked up on other factors that we didn't cover. This week is a good example of why it's beneficial to take in a range of analytical viewpoints!

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December 7, 2018

Biomimicry is an approach to developing new inventions and technologies that is inspired by the natural "solutions" to practical problems that plants and animals have evolved over eons, where human designers seek to replicate those solutions.

Via Core77, we learned of a Kickstarter project by London-based design studio Animaro to develop a kinetic clock concept that is directly inspired by how some flowers open and close each day as part of their daily circadian rhythms. The following video shows Animaro's Solstice kinetic clock in action:

At this writing, the project has five days left to go, but it has already cleared its minimum funding threshold and will be made, with deliveries estimated to begin in June 2019.

We'll close with Loren Lewis' A day in the life of a Morning Glory, which shows off some of the natural inspiration for the Solstice kinetic clock.

Previously on Political Calculations

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