By John W. Whitehead

“All governments suffer a recurring problem: Power attracts pathological personalities. It is not that power corrupts but that it is magnetic to the corruptible.”― Frank Herbert

Power corrupts.

Worse, as 19th-century historian Lord Acton concluded, absolute power corrupts absolutely.

It doesn’t matter whether you’re talking about a politician, an entertainment mogul, a corporate CEO or a police officer: give any one person (or government agency) too much power and allow him or her or it to believe that they are entitled, untouchable and will not be held accountable for their actions, and those powers will eventually be abused.

We’re seeing this dynamic play out every day in communities across America.

A cop shoots an unarmed citizen for no credible reason and gets away with it. A president employs executive orders to sidestep the Constitution and gets away with it. A government agency spies on its citizens’ communications and gets away with it. An entertainment mogul sexually harasses aspiring actresses and gets away with it. The U.S. military bombs a civilian hospital and a school and gets away with it.

Abuse of power—and the ambition-fueled hypocrisy and deliberate disregard for misconduct that make those abuses possible—works the same whether you’re talking about sexual harassment, government corruption, or the rule of law.

For instance, 20 years ago, I took up a sexual harassment lawsuit on behalf of a young woman—a state employee—who claimed that her boss, a politically powerful man, had arranged for her to meet him in a hotel room, where he then allegedly dropped his pants, propositioned her and invited her to perform oral sex on him.

Despite the fact that this man had a well-known reputation for womanizing and this woman was merely one in a long line of women who had accused the man of groping, propositioning, and pressuring them for sexual favors in the workplace, she was denounced as white trash and subjected to a massive smear campaign by the man’s wife, friends and colleagues (including the leading women’s rights organizations of the day), while he was given lucrative book deals and paid lavish sums for speaking engagements.

William Jefferson Clinton eventually agreed to settle the case and pay Paula Jones $850,000.

Here we are 20 years later and not much has changed.

We’re still shocked by sexual harassment in the workplace, the victims of these sexual predators are still being harassed and smeared, and those who stand to gain the most by overlooking wrongdoing (all across the political spectrum) are still turning a blind eye to misconduct when it’s politically expedient to do so.

This time, it’s Hollywood producer Harvey Weinstein—longtime Clinton associate and a powerhouse when it comes to raising money for Democrats—who is being accused of decades of sexual assaults, aggressively sexual overtures and harassment.

I won’t go into the nauseating details here. You can read them for yourself at the New York Times and the New Yorker.

Suffice it to say that it’s the same old story all over again: man rises to power, man abuses power abominably, man intimidates and threatens anyone who challenges him with retaliation or worse, and man gets away with it because of a culture of compliance in which no one speaks up because they don’t want to lose their job or their money or their place among the elite.

From what I’ve read, this was Hollywood’s worst-kept secret.

In other words, everyone who was anyone knew about it. They were either complicit in allowing the abuses to take place, turning a blind eye to them, or helping to cover them up.

It’s not just happening in Hollywood, however.

And it’s not just sexual predators that we have to worry about.

For every Harvey Weinstein (or Roger Ailes or Bill Cosby or Donald Trump) who eventually gets called out for his sexual misbehavior, there are hundreds—thousands—of others in the American police state who are getting away with murder—in many cases, literally—simply because they can.

The cop who shoots the unarmed citizen first and asks questions later might get put on paid leave for a while or take a job with another police department, but that’s just a slap on the wrist. The shootings and SWAT team raids and excessive use of force will continue, because the police unions and the politicians and the courts won’t do a thing to stop it. Case in point: The Justice Department will no longer attempt to police the police when it comes to official misconduct. Instead, it plans to give police agencies more money and authority to “fight” crime.

The war hawks who are making a profit by waging endless wars abroad, killing innocent civilians in hospitals and schools, and turning the American homeland into a domestic battlefield will continue to do so because neither the president nor the politicians will dare to challenge the military industrial complex. Case in point: Rather than scaling back on America’s endless wars, President Trump—like his predecessors—has continued to expand America’s military empire and its attempts to police the globe.

The National Security Agency that carries out warrantless surveillance on Americans’ internet and phone communications will continue to do so, because the government doesn’t want to relinquish any of its ill-gotten powers. Case in point: The USA Liberty Act, proposed as a way to “fix” all that’s wrong with domestic surveillance, will instead legitimize the government’s snooping powers.

Unless something changes in the way we deal with these ongoing, egregious abuses of power, the predators of the police state will continue to wreak havoc on our freedoms, our communities, and our lives.

Police officers will continue to shoot and kill unarmed citizens. Government agents—including local police—will continue to dress and act like soldiers on a battlefield.

Bloated government agencies will continue to fleece taxpayers while eroding our liberties. Government technicians will continue to spy on our emails and phone calls. Government contractors will continue to make a killing by waging endless wars abroad.

And powerful men (and women) will continue to abuse the powers of their office by treating those around them as underlings and second-class citizens who are unworthy of dignity and respect and undeserving of the legal rights and protections that should be afforded to all Americans.

As Dacher Keltner, professor of psychology at the at the University of California, Berkeley, observed in the Harvard Business Review, “While people usually gain power through traits and actions that advance the interests of others, such as empathy, collaboration, openness, fairness, and sharing; when they start to feel powerful or enjoy a position of privilege, those qualities begin to fade. The powerful are more likely than other people to engage in rude, selfish, and unethical behavior.”

After conducting a series of experiments into the phenomenon of how power corrupts, Keltner concluded: “Just the random assignment of power, and all kinds of mischief ensues, and people will become impulsive. They eat more resources than is their fair share. They take more money. People become more unethical. They think unethical behavior is okay if they engage in it. People are more likely to stereotype. They’re more likely to stop attending to other people carefully.”

Power corrupts. And absolute power corrupts absolutely.

However, it takes a culture of entitlement and a nation of compliant, willfully ignorant, politically divided citizens to provide the foundations of tyranny.

As researchers Joris Lammers and Adam Galinsky found, those in power not only tend to abuse that power but they also feel entitled to abuse it: “People with power that they think is justified break rules not only because they can get away with it, but also because they feel at some intuitive level that they are entitled to take what they want.”

That sense of entitlement and immunity from charges of wrongdoing dovetails with Richard Nixon’s belief that “when the President does it, that means that it is not illegal.”

For too long now, America has played politics with its principles and allowed the president and his colleagues to act in violation of the rule of law.

“We the people” are paying the price for it now.

Americans have allowed Congress, the White House and the Judiciary to wreak havoc with our freedoms. They have tolerated an oligarchy in which a powerful, elite group of wealthy donors is calling the shots. They have paid homage to patriotism while allowing the military industrial complex to spread death and destruction abroad. And they have turned a blind eye to all manner of wrongdoing when it was politically expedient.

This culture of compliance must stop.

The empowerment of petty tyrants and political gods must end.

For starters, let’s go back to the basics: the Declaration of Independence, the U.S. Constitution and the Bill of Rights.

Let’s recommit to abiding by the rule of law.

Here’s what the rule of law means in a nutshell: it means that everyone is treated the same under the law, everyone is held equally accountable to abiding by the law, and no one is given a free pass based on their politics, their connections, their wealth, their status or any other bright line test used to confer special treatment on the elite.

Let’s demand scrutiny and transparency at all levels of government, which in turn will lead to accountability.

We need to stop being victimized by these predators.

As I point out in my book Battlefield America: The War on the American People, I’m not just talking about the political predators in office, but the ones who are running the show behind the scenes—the shadow government—comprised of unelected government bureaucrats whose powers are unaffected by elections, unaltered by populist movements, and beyond the reach of the law.

There is no way to erase the scars left by the government’s greed for money and power, its disregard for human life, its corruption and graft, its pollution of the environment, its reliance on excessive force in order to ensure compliance, its covert activities, its illegal surveillance, and its blatant disdain for the rule of law.

“We the people”—men and women alike— have been victims of the police state for so long that not many Americans even remember what it is to be truly free anymore. Worse, few want to shoulder the responsibility that goes along with maintaining freedom.

Still, we must try.

 

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In order to understand the disaster that is unfolding in Venezuela, we need to journey through the most recent century of our history and look at how our institutions have changed over time.

What we will find is that Venezuela once enjoyed relatively high levels of economic freedom, although this occurred under dictatorial regimes.

But, when Venezuela finally embraced democracy, we began to kill economic freedom. This was not all at once, of course. It was a gradual process. But it happened at the expense of the welfare of millions of people.

And, ultimately, the lesson we learned is that socialism never, ever works, no matter what Paul Krugman, or Joseph Stiglitz, or guys in Spain like Pablo Iglesias say.

It was very common during the years we suffered under Hugo Chávez to hear these pundits and economists on TV saying that this time, socialism is being done right. This time, the Venezuelans figured it out.

They were, and are wrong.

On the other hand, there was a time when this country was quite prosperous and wealthy, and for a time Venezuela was even referred to as an “economic miracle” in many books and articles.

However, during those years, out of the five presidents we had, four were dictators and generals of the army. Our civil and political rights were restricted. We didn’t have freedom of the press, for example; we didn’t have universal suffrage. But, while we lived under a dictatorship, we could at least enjoy high levels of economic freedom.

A Brief Economic History of Venezuela

The economic miracle began a century ago, when from 1914 to 1922, Venezuela entered the international oil race. In 1914, Venezuela opened its first oil well. Fortunately, the government did not make the mistake of attempting to manage the oil business, or own the wells. The oil wells were privately owned, and in many cases were owned by private international companies that operated in Venezuela. It wasn’t totally laissez-faire, of course. There were tax incentives and other so-called concessions employed to promote exploration and exploitation of oil. But most industries — including the oil industry — remained privatized.

Moreover, during this period, tax rates in the country were relatively low.

In 1957, the marginal tax rate for individuals was 12 percent. There was certainly a state presence, and the public sector absorbed 20 percent of GDP. But, government spending was used mainly to build the country’s basic infrastructure.

The area of international trade was relatively free as well — and very free compared to today. There were tariffs that were relatively high, but there were no other major barriers to trade such as quotas, anti-dumping laws, or safeguards.

Other economic controls were few as well. There were just a few state-owned companies and virtually no price controls, no rent controls, no interest-rate controls, and no exchange-rate controls.

Of course, we weren’t free from the problems of a central bank, either. In 1939, Venezuela created its own central bank. But, the bank was largely inactive and functioned primarily defending a fixed exchange rate with the US dollar.

Moving Toward More Interventionism

Despite the high levels of economic freedom that existed during those years, government legislation started to chip away at that freedom. Changes included the nationalization of the telephone company, the creation of numerous state-owned companies, and state-owned banks. That happened in 1950. The Venezuelan government thus began sowing the seeds of destruction, and you can see the continued deterioration in the level of economic freedom in the decade of the 1950s.

In 1958, Venezuela became a democracy when the dictatorship was overthrown. With that came all the usual benefits of democracy such as freedom of the press, universal suffrage, and other civil rights. Unfortunately, these reforms came along with continued destruction of our economic freedom.

The first democratically elected president was Rómulo Betancourt. He was a communist-turned-social democrat. In fact, while he was in exile, he founded the Communist Party in Costa Rica and helped found the Communist Party in Colombia as well. Not surprisingly, as president, he started destroying the economic institutions we had by implementing price controls, rent controls, and other regulations we hadn’t had before. On top of that, he and his allies created a new constitution that was hostile to private property.

In spite of this — or perhaps because of it — Betancourt is almost universally revered in Venezuela as “the father of our democracy.” This remains true even today as Venezuela collapses.

Of course, compared to today, we had far greater economic freedom under Betancourt than we do in today’s Venezuela. But, all of the presidents — with one exception — who came after Betancourt took similar positions and continued to chip away at economic freedom. The only exception was Carlos Andrés Pérez who in his second term attempted some free market reforms. But, he executed these later reforms so badly and haphazardly that markets ended up being blamed for the resulting crises.

The Rise of Hugo Chávez

Over time, the destruction of economic freedom led to more and more impoverishment and crisis. This in turn set the stage for the rise of a political outsider with a populist message. This, of course, was Hugo Chávez. He was elected in 1998 and promised to replace our light socialism with more radical socialism. This only accelerated the problems we had been facing for decades. Nevertheless, he was able to pass through an even more anti-private-property constitution. Since Chávez’s death in 2013, the attacks on private property have continued, and Chávez’s successor, Nicolás Maduro, promises only more of the same. Except now, the government is turning toward outright authoritarian socialism, and Maduro is seeking a new constitution in which private property is almost totally abolished, and Maduro will be allowed to remain in power for life.

A Legacy of Poverty

So, what are the results of socialism in Venezuela? Well, we have experienced hyperinflation. We have people eating garbage, schools that do not teach, hospitals that do not heal, long and humiliating lines to buy flour, bread, and basic medicines. We endure the militarization of practically every aspect of life.

The cost of living has skyrocketed in recent years.

Let’s look at the cost of goods in services in terms of a salary earned by a full college professor. In the 1980s, our “full professor” needed to pay almost 15 minutes of his salary to buy one kilogram of beef. Today, in July 2017, our full professor needs to pay the equivalent of 18 hours to buy the same amount of beef. During the 1980s, our full professor needed to pay almost one year’s salary for a new sedan. Today, he must pay the equivalent of 25 years of his salary. In the 1980s, a full professor with his monthly salary could buy 17 basic baskets of essential goods. Today, he can buy just one-quarter of a basic
basket.

And what about the value of our money? Well, in March 2007, the largest denomination of paper money in Venezuela was the 100 bolivar bill. With it, you could buy 28 US dollars, 288 eggs, or 56 kilograms of rice. Today, you can buy .01 dollars, 0.2 eggs, and 0.08 kilograms of rice. In July 2017, you need five 100-bolivar bills to buy just one egg.

So, socialism is the cause of the Venezuelan misery. Venezuelans are starving, eating garbage, losing weight. Children are malnourished. Anyone in Venezuela would be happy to eat out of America’s trashcans. It would be considered gourmet.

So, what’s the response of our society? Well, it’s the young people who are leading the fight for freedom in Venezuela in spite of what the current political leaders tell them to do. They don’t want to be called “the opposition.” They are the resistance, in Spanish, “la resistencia.” They are the real heroes of freedom in our country, but the world needs to know that they have often been killed by a tyrannical government, and all members of the resistance are persecuted daily.

Nevertheless, a new pro-market leadership must emerge before we can expect many major changes. Our current political opposition parties also hate free markets. They don’t like Maduro, but they still want their version of socialism.

This is not surprising. As Venezuelans, our poor understanding of the importance of freedom and free markets has created our current disaster. We Venezuelans never really understood freedom in its broader dimension because when we enjoyed high levels of economic freedom, we allowed the destruction of political and civil rights, and when we finally established a democracy, we allowed the destruction of economic freedom.

But there is reason for hope. Along with the Mises Institute we do believe that a revolution in ideas can really bring a new era to Venezuela. On behalf of the resistance and millions of people in our country, we thank the Mises Institute for this opportunity to briefly tell the full history of Venezuela. Thank you very much.

The petrodollar system is being undermined by exponential growth in technology and shifting geopolitics. What comes next is a paradigm shift…

 

In the summer of 1974, Treasury Secretary William Simon traveled to Saudi Arabia and secretly struck a momentous deal with the kingdom. The U.S. agreed to purchase oil from Saudi Arabia, provide weapons, and in essence guarantee the preservation of Saudi oil wells, the monarchy, and the sovereignty of the kingdom. In return, the kingdom agreed to invest the dollar proceeds of its oil sales in U.S. Treasuries, basically financing America’s future federal expenditures.

Soon, other members of the Organization of Petroleum Exporting Countries followed suit, and the U.S. dollar became the standard by which oil was to be traded internationally. For Saudi Arabia, the deal made perfect sense, not only by protecting the regime but also by providing a safe, liquid market in which to invest its enormous oil-sale proceeds, known as petrodollars. The U.S. benefited, as well, by neutralizing oil as an economic weapon. The agreement enabled the U.S. to print dollars with little adverse effect on interest rates, thereby facilitating consistent U.S. economic growth over the subsequent decades.

An important consequence was that oil-importing nations would be required to hold large amounts of U.S. dollars in reserve in order to purchase oil, underpinning dollar demand. This essentially guaranteed a strong dollar and low U.S. interest rates for a generation.

[ZH: Still, the underlying concept of how Petrodollar recycling, or as some call it, petrocurrency mercantilism works, leaves some confusion. So in order to alleviate that, here courtesy of Cult State, is a quick and simple primer that should hopefully answer all questions. From CultState:

So what is petrocurrency mercantilism?

It’s when a national bank and an energy producer collude to generate artificial demand for a currency at the expense of the purchasing power of other currencies.

The flowchart below shows how it all works.

Given this backdrop, one can better understand many subsequent U.S. foreign-policy moves involving the Middle East and other oil-producing regions.

Recent developments in technology and geopolitics, however, have already ignited a process to bring an end to the financial system predicated on petrodollars, which will have a profound impact on global financial markets. The 40-year equilibrium of this system is being dismantled by the exponential growth of technology, which will have a bearish impact on both supply and demand of petroleum. Moreover, the system no longer is in the best interest of key participants in the global oil trade. These developments have begun to exert influence on financial markets and will only grow over time. The upheaval of the petrodollar recycling system will trigger a resurgence of volatility and new price trends, which will lead to a renaissance in macro investing.

Let’s examine these developments in more detail.

First, TECHNOLOGY is affecting the energy markets dramatically, and this impact is growing exponentially. The pattern-seeking human mind is built for an observable linear universe, but has cognitive difficulty recognizing and understanding the impact of exponential growth.

Paralleling Moore’s Law, the current growth rate of new technologies roughly doubles every two years. In the transportation sector, the global penetration rate of electric vehicles, or EVs, was 1% at the end of 2016 and is now probably about 1.5%. However, a doubling every two years of this level of usage should lead to an automobile market that primarily consists of EVs in approximately 12 years, reducing gasoline demand and international oil revenue to a degree that today would seem unfathomable to the linear-thinking mind. Yes, the world is changing—rapidly.

Alternative energy sources (solar power, wind, and such) also are well into their exponential growth curves, and are even ahead of EVs in this regard. Based on growth curves of other recent technologies, and due to similar growth rates in battery technology and pricing, it is likely that solar power will supplant petroleum in a vast portion of nontransportation sectors in about a decade. Albert Einstein is rumored to have described compound interest (another form of exponential growth) as the most powerful force in the universe. This is real change.

The growth of U.S. oil production due to new technologies such as hydraulic fracturing and horizontal drilling has both reduced the U.S. need for foreign sources of oil and led to lower global oil prices. With the U.S. economy more self-reliant for its oil consumption, reduced purchases of foreign oil have led to a drop in the revenues of oil-producing nations and by extension, lower international demand for Treasuries and U.S. dollars.

China has agreed with Russia to purchase Russian oil and natural gas in yuan.
◦As an example of China’s newfound power to influence oil exporters, China has persuaded Angola (the world’s second-largest oil exporter to China) to accept the yuan as legal tender, evidence of efforts made by Beijing to speed up internationalization of the yuan. The incredible growth rates of the Chinese economy and its thirst for oil have endowed it with tremendous negotiating strength that has led, and will lead, other countries to cater to China’s needs at the expense of their historical client, the U.S.
◦China is set to launch an oil exchange by the end of the year that is to be settled in yuan. Note that in conjunction with the existing Shanghai Gold Exchange, also denominated in yuan, any country will now be able to trade and hedge oil, circumventing U.S. dollar transactions, with the flexibility to take payment in yuan or gold, or exchange gold into any global currency.
◦As China further forges relationships through its One Belt, One Road initiative, it will surely pull other exporters into its orbit to secure a reliable flow of supplies from multiple sources, while pressuring the terms of the trade to exclude the U.S. dollar.

The world’s second-largest oil exporter, Russia, is currently under sanctions imposed by the U.S. and European Union, and has made clear moves toward circumventing the dollar in oil and international trade. In addition to agreeing to sell oil and natural gas to China in exchange for yuan, Russia recently announced that all financial transactions conducted in Russian seaports will now be made in rubles, replacing dollars, according to Russian state news outlet RT. Clearly, there is a concerted effort from the East to reset the economic world order.

ALL OF THESE DEVELOPMENTS leave global financial markets vulnerable to a paradigm shift that has recently begun. In meetings with fund managers, asset allocators, and analysts, I have found a virtually universal view that macro investing—investing based on global macroeconomic and political, not security-specific trends—is dead, fueled by investor money exiting the space due to poor returns and historically high fees in relation to performance. This is what traders refer to as capitulation. It occurs when most market participants can’t take advantage of a promising opportunity due to losses, lack of dry powder, or a psychological inability to proceed because of recency bias.

A current generational low in volatility across a wide spectrum of asset classes is another indicator that the market doesn’t see a paradigm shift coming. This suggests that current volatility is expressing a full discounting of stale fundamental inputs and not adequately pricing in the potential of likely disruptive events.

THE FEDERAL RESERVE is now in the beginning stages of a shift toward “normalization,” which will lead to diminished support for the U.S. Treasury market. The Fed’s total assets stand at approximately $4.5 trillion, or five times what they were prior to the financial crisis of 2008-09. The goal of the Fed is to “unwind” this enormous balance sheet with minimal market disruption. This is a high-wire act a thousand feet in the air without a safety net or prior practice. Additionally, at some not-so-distant future date, the U.S. will need to finance enormous and growing entitlement programs, and our historical international sources for that financing will no longer be willing to support us in that endeavor.

The market participants with whom I met theoretically could have the ability to accept cognitively the points made in this article. But the accumulation of many small losses in a low-volatility and generally trendless market has robbed them of confidence and the psychological balance to embrace any new paradigm proactively. They are frozen with fear that the lower- return profile of recent years is permanent—ironic in an industry that is paid to capture price changes in a cyclical world.

One market legend with whom I spoke suggested he wouldn’t have had the success he enjoyed in his career had he begun in the past decade. Whether or not this might be true, it doesn’t mean that recent lower returns are to be extrapolated into the future, especially when these subpar returns occurred during the quantitative-easing era, a period that is an anomaly.

I have been fortunate to ride substantial bets on big trends, earning high risk-adjusted returns using time-tested techniques for exploiting these trends. Additionally, I have had the luxury of not participating actively full-time in macro investing during this difficult period. Both factors might give me perspective. I regard this as an extraordinarily opportune moment for those able to shed timeworn, archaic assumptions of market behavior and boldly return to the roots of macro investing.

The opportunity is reminiscent of the story told by Stanley Druckenmiller, who was promoted early in his investment career to head equity research at a time when his co-workers had vastly more experience than he did. His director of investments informed him that his promotion owed to the same reason they send 18-year-olds to war; they are too dumb to know not to charge. The “winners” under the paradigm now unfolding will be market participants able to disregard stale, anomalous concepts, and charge.

RELATEDLY, THERE IS a running debate as to whether trend-following is a dying strategy. There is plenty of anecdotal evidence that short-term and mean-reversion trading is more in vogue in today’s markets (think quant funds and “prop” shops). Additionally, the popularity of passive investing signals an unwillingness to invest in “idea generation,” or alpha. These developments represent a full capitulation of trend following and macro trading.

Ironically, many market players who wrongly anticipated a turn in recent years to a more positive environment for macro and trend-following are throwing in the towel. The key difference is that now there is a clear catalyst to trigger the start of the pendulum swinging back to a fertile macro/trend-following trading environment.

As my mentor, Bruce Kovner [the founder of Caxton Associates] used to say, “Nobody rings a bell at key turning points.” The ability to properly anticipate change is predicated upon detached analysis of fundamental information, applying that information to imagine a plausible world different from today’s, understanding how new data points fit (or don’t fit) into that world, and adjusting accordingly. Ideally, this process leads to an “aha!” moment, and the idea crystallizes into a clear vision. The thesis proposed here is one such vision.

Chris Anthony’s analysis of the parallels of Seneca’s excerpt on materialism. The Dangerous and overall outcome ignoring the past is its sheer ability to repeat itself.

 

The United States is the undisputed capital of the unicorn – private companies worth more than $1 billion. This title though, is becoming more and more under threat, primarily from China.

You will find more statistics at Statista

As Statista’s Martin Armstrong notes, according to CB Insights, there are currently 215 unicorns in the world, of which 108 are from the U.S.

When it comes to the ‘birth’ of new unicorns however, America’s strength is clearly being diluted.

In 2013, 75 percent of new unicorns were born in the United States, fast forward to 2017 though, and this share has fallen to just 41 percent.

The number of new unicorns from around the world has remained reasonably stable over this time, but it is the rapid increase in activity in China – from 0 percent in 2013 to 36 percent this year – that is putting the most pressure on U.S. dominance.

Authored by James Rickards

 

China is a relatively open economy; therefore it is subject to the impossible trinity.

China has also been attempting to do the impossible in recent years with predictable results.

Beginning in 2008 China pegged its exchange rate to the U.S. dollar. China also had an open capital account to allow the free exchange of yuan for dollars, and China preferred an independent monetary policy.

The problem is that the Impossible Trinity says you can’t have all three. This model has been validated several times since 2008 as China has stumbled through a series of currency and monetary reversals.

For example, China’s attempted the impossible beginning in 2008 with a peg to the dollar around 6.80. This ended abruptly in June 2010 when China broke the currency peg and allowed it to rise from 6.82 to 6.05 by January 2014 — a 10% appreciation.

This exchange rate revaluation was partly in response to bitter complaints by U.S. Treasury Secretary Geithner about China’s “currency manipulation” through an artificially low peg to the dollar in the 2008 – 2010 period.

After 2013, China reversed course and pursued a steady devaluation of the yuan from 6.05 in January 2014 to 6.95 by December 2016. At the end of 2016, the Chinese yuan was back where it was when the U.S. was screaming “currency manipulation.”

Only now there was a new figure to point the finger at China. The new American critic was no longer the quiet Tim Geithner, but the bombastic Donald Trump.

Trump had threatened to label China a currency manipulator throughout his campaign from June 2015 to Election Day on November 8, 2016. Once Trump was elected, China engaged in a policy of currency war appeasement.

China actually propped up its currency with a soft peg. The trading range was especially tight in the first half of 2017, right around 6.85.

In contrast to the 2008 – 2010 peg, China avoided the impossible trinity this time by partially closing the capital account and by raising rates alongside the Fed, thereby abandoning its independent monetary policy.

This was also in contrast to China’s behavior when it first faced the failure of its efforts to beat impossible trinity. In 2015, China dodged the impossible trinity not by closing the capital account, but by breaking the currency peg.

In August 2015, China engineered a sudden shock devaluation of the yuan. The dollar gained 3% against the yuan in two days as China devalued.

The results were disastrous.

U.S. stocks fell 11% in a few weeks. There was a real threat of global financial contagion and a full-blown liquidity crisis. A crisis was averted by Fed jawboning, and a decision to put off the “liftoff” in U.S. interest rates from September 2015 to the following December.

China conducted another devaluation from November to December 2015. This time China did not execute a sneak attack, but did the devaluation in baby steps. This was stealth devaluation.

The results were just as disastrous as the prior August. U.S. stocks fell 11% from January 1, 2016 to February 10. 2016. Again, a greater crisis was averted only by a Fed decision to delay planned U.S. interest rate hikes in March and June 2016.

The impact these two prior devaluations had on the exchange rate is shown in the chart below.

Major moves in the dollar/yuan cross exchange rate (USD/CNY) have had powerful impacts on global markets. The August 2015 surprise yuan devaluation sent U.S. stocks reeling. Another slower devaluation did the same in early 2016. A stronger yuan in 2017 coincided with the Trump stock rally. A new devaluation is now underway and U.S. stocks may suffer again.

 

China cannot keep the capital account closed without damaging badly needed capital inflows. Who will invest in China if you can’t get your money out?

China also cannot maintain high interest rates because the interest costs will bankrupt insolvent state owned enterprises and lead to an increase in unemployment, which is socially destabilizing.

China cannot maintain a strong yuan because that damages exports, hurts export-related jobs, and causes deflation to be imported through lower import prices. An artificially inflated currency also drains the foreign exchange reserves needed to maintain the peg.

Since the impossible trinity really is impossible in the long-run, and since China’s current solutions are non-sustainable, what can China do to solve its policy trilemma?

The most obvious course, and the one likely to be implemented, is a maxi-devaluation of the yuan to around the 7.95 level or lower.

This would stop capital outflows because those outflows are driven by devaluation fears. Once the devaluation happens, there is no longer any urgency about getting money out of China. In fact, new money should start to flow in to take advantage of much lower local currency prices.

There are early signs that this policy of devaluation is already being put into place. The yuan has dropped sharply in the past month from 6.45 to 6.62. This resembles the stealth devaluation of late 2015, but is somewhat more aggressive.

The geopolitical situation is also ripe for a Chinese devaluation policy. Once the National Party Congress is over in late October, President Xi will have secured his political ambitions and will no longer find it necessary to avoid rocking the boat.

 

China’s President Xi Jinping awaits appointment to a second term at the 19th National Congress of the Communist Party of China, starting October 18. His reappointment is a foregone conclusion.

China has clearly failed to have much impact on North Korea’s nuclear weapons ambitions. As war between North Korea and the U.S. draws closer, neither China nor the U.S. will have as much incentive to cooperate with each other on bilateral trade and currency issues.

Both Trump and Xi are readying a “gloves off” approach to a trade war and renewed currency war. A maxi-devaluation of the yuan is Xi’s most potent weapon.

Finally, China’s internal contradictions are catching up with it. China has to confront an insolvent banking system, a real estate bubble, and a $1 trillion wealth management product Ponzi scheme that is starting to fall apart.

A much weaker yuan would give China some policy space in terms of using its reserves to paper over some of these problems.

Less dramatic devaluations of the yuan led to U.S. stock market crashes. What does a new maxi-devaluation portend for U.S. stocks?

We might have an answer soon enough.

Chris Anthony interviews New Orleans own Sen Moise Hoodoo.