Trump’s Tariff Gambit: A Political Win, an Economic Minefield for the Philippines

 

What the circus ringmaster really wants is an iron-clad mechanism – already being developed by his team – that unilaterally imposes whatever level of tariffs Trump may come up with on whatever excuse: could be to circumvent “current manipulation”, to counter a value-added tax, on “security grounds”, whatever. And to hell with international law. For all practical purposes, Trump is burying the WTO—Pepe Escobar  

In this issue

Trump’s Tariff Gambit: A Political Win, an Economic Minefield for the Philippines

I. Introduction: A Tariff with Two Faces

II. Trump’s Sweeping Tariffs: A Policy of Chaos: The Rise of Regime Uncertainty

III. U.S. Stock Market Meltdown Echoes the Smoot-Hawley Era and the Great Depression

IV. The Tariff’s Double-Edged Sword: For the Philippines, Relative Tariffs Represent a Political Win, But a Formidable Economic Challenge

V. Fallout from Tariffs: An Uncertain Future: Tariffs May Deter Investment in the Philippines

VI. Shaky Foundations: Why the Consumer Economy Isn’t Immune

VII. Financial Fragility: Historic Savings-Investment Gap, Record Debt, and Dollar Dependence

VIII. Intertemporal Impact or Short-to-Longer Term Impact on the Philippine Economy

IX. The US Dollar’s ‘Triffin Dilemma’: Global Risks and Philippine Challenges

X. Conclusion: Winnowing the Political Chaff from the Economic Wheat 

Trump’s Tariff Gambit: A Political Win, an Economic Minefield for the Philippines 

Will the Philippines benefit from Trump's sweeping tariff reforms? The realities of the existing economic and political structure suggest otherwise. 

I. Introduction: A Tariff with Two Faces

Figure 1

On April 9, 2025, the United States imposed a 17% tariff on Philippine goods—a lighter burden compared to Vietnam’s 46% or Cambodia’s 49%. The Philippines was listed among the 'worst' tariff offenders against the US. (Figure 1, upper table) 

At first glance, this appears to be a political victory, offering the Philippines a chance to attract investment and outshine its ASEAN neighbors in a global trade war. 

Some experts even argue that because the Philippines is a consumption-driven economy, it would be less affected by the ongoing trade war, potentially insulating it from the worst of the fallout.

However, a closer examination reveals a far more challenging reality.

The Philippines faces deep-seated vulnerabilities: a heavy reliance on trade (42% of its 2024 GDP), a chronic savings shortage that hampers investment, and global risks that could destabilize the U.S.’s dollar dominance.

As the Philippines navigates this turbulent landscape, its ability to transform this political advantage into economic gains hinges on addressing these structural weaknesses amidst an uncertain global economic horizon.

II. Trump’s Sweeping Tariffs: A Policy of Chaos: The Rise of Regime Uncertainty 

On April 3, 2025, President Trump declared a national emergency, citing the U.S.’s $1.2 trillion goods trade deficit in 2024 as a threat to national and economic security. This declaration, invoking the International Emergency Economic Powers Act (IEEPA), allowed the administration to impose reciprocal tariffs without Congressional approval, including a baseline 10% tariff on all countries. 

The Trump administration’s formula for these reciprocal tariffs—(trade deficit ÷ imports) ÷ 2—serves as a proxy for what they deem “unfair” trade practices.

This approach, however, oversimplifies the intricate politics of global merchandise trade. The U.S. trade deficit is not merely a result of unfair practices but a symptom of deeper structural dynamics, including the U.S. dollar’s role in the Triffin Dilemma, global easy money policies, various mercantilist practices by numerous nations and more.

The absurdity of using a one-size-fits-all metric like the trade deficit to define “unfair practices” is starkly illustrated by the Trump administration’s decision to impose tariffs on the remote Antarctic outpost of Heard and McDonald Islands. Inhabited primarily by penguins and seals, and unvisited by humans for nearly a decade, this territory faces tariffs despite a complete absence of economic activity.

Ironically, nations like Cuba, North Korea, Belarus, and Russia were exempted from these tariffs due to the absence of bilateral trade with the U.S., a result of existing sanctions. 

The Trump administration’s aggressive tariff regime has pushed U.S. effective tariff rates beyond those of the Smoot-Hawley era, a period infamous for exacerbating the Great Depression. (Figure 1, lower chart) 

As Cato’s Grabow, Lincicome and Handley recently wrote, "The result appears to be the highest US tariffs since 1909, already ten times the size of those in place before Trump took office and at an average rate exceeding even that imposed by the infamous Smoot-Hawley Act, which is widely blamed for prolonging the Great Depression."  (Cato, 2025) [bold added]        

This drastic policy shift—a potential abrupt reversal of globalization—introduces significant Regime Uncertainty (Higgs 1997), defined as the perceived lack of protection for property rights due to the unpredictability of government policies and institutional frameworks.

Regime uncertainty distorts economic calculations, obscuring the ‘hurdle rate’—the minimum return required to justify investment in viable projects.

Or it discourages investment by creating an opaque economic horizon where businesses cannot reliably predict future costs, revenues, or risks.

Figure 2

Measured as a trade policy uncertainty metric, regime uncertainty has rocketed to an all-time high, signaling a profound shift in the global economic landscape that could have far-reaching consequences for countries like the Philippines. (Figure 2) 

III. U.S. Stock Market Meltdown Echoes the Smoot-Hawley Era and the Great Depression 

It is hardly surprising that last week’s U.S. stock market meltdown—the largest two-day wipeout in history—serves as a stark symptom of these policy-induced uncertainties.

The regime uncertainty plaguing the economic horizon heightens the risk of profound economic weakness, disrupting supply chains, amplifying hurdles for capital flows and Foreign Direct Investment (FDI), magnifying credit delinquencies, and prompting path-dependent responses from central banks—involving "policy easing" to counteract economic slowdowns, which could also fuel inflation risks.

In combination, these factors raise the specter of a global recession or even a financial crisis.

Given the historic highs in global debt and leverage—amounting to $323 trillion as of Q3 2024, or 326% of global GDP, according to the Institute of International Finance—a stagflation-induced financial crisis could render the 2008 Global Financial Crisis a proverbial ‘walk in the park.’ 

Is history rhyming? 

David R. Breuhan offers a historical parallel: "The stock market collapse began on Oct. 28, 1929, as news spread that the Smoot Hawley Tariff Bill would become law. The front-page New York Times article read: ‘Leaders Insist Tariff Will Pass.’ Although the tariff bill didn’t become law until June 1930, its effects were felt eight months prior. Markets reacted immediately, as they discount future earnings. Most economists blame the gold standard for the crash, but this analysis misses the forward-looking nature of the human mind, which is the market itself. Markets need not wait for earnings to decrease due to imminent policies that will result in future losses. Hence the rapid nature of the crash. The use of leverage in the 1920s exacerbated the crash. Margin calls were made, further cascading the markets." (Breuhan, 2024) [bold added]

The parallels are striking. Today’s markets, burdened by high leverage and global debt, are reacting to the uncertainty of Trump’s tariff regime, much like they did to Smoot-Hawley nearly a century ago.

For the Philippines, this global financial instability could exacerbate the economic challenges posed by the tariff, as investors may grow wary of emerging markets amid a potential global downturn. 

IV. The Tariff’s Double-Edged Sword: For the Philippines, Relative Tariffs Represent a Political Win, But a Formidable Economic Challenge

Figure 3

A chart of U.S.-Philippines trade from 1985 to 2024 reveals a persistent trade deficit, peaking at $7 billion in 2022, underscoring the high stakes of this trade war for the Philippines. (Figure 3, upper window)

Trump’s reciprocal tariff exposes the country’s vulnerabilities: a heavy reliance on trade (42% of 2024 GDP), a savings shortage that stifles investment, and global risks that could upend the U.S.’s dollar dominance.

The 17% tariff on Philippine goods, part of President Trump’s strategy to shrink the $1.2 trillion U.S. trade deficit, appears to be a political win at first glance.

Compared to Vietnam’s 46% or Cambodia’s 49%, the Philippines seems to have dodged the worst of this trade war. Mainstream analysts have spun this as an opportunity: with a lower tariff, the Philippines could attract investors looking to shift supply chains away from pricier neighbors. 

Philippine Trade Secretary Cristina Roque even called it a chance to negotiate a sectoral free trade agreement with the U.S., potentially boosting market access. For a country eager to stand out in ASEAN, this lighter tariff feels like a rare edge.

But the economic reality paints a far more daunting picture. 

The Philippines faces formidable structural hurdles that could blunt this political advantage.  Here are some examples. 

1. Energy costs, for instance, are among the highest in the region at $0.20 per kWh—double Vietnam’s $0.10—making manufacturing less competitive (International Energy Agency, 2024). 

2. Regulatory complexity adds another layer of difficulty: the Philippines ranks 95th globally in the World Bank’s Ease of Doing Business Index, trailing Vietnam (70th) and Indonesia (73rd), with bureaucratic red tape often delaying investments. 

3. Human capital represents another significant hurdle. While the tariff matches Israel’s 17%, the Philippines lacks Israel’s robust R&D ecosystem to export high-tech goods like medical equipment, leaving it reliant on lower-value sectors such as electronics assembly and agriculture. 

Israel invests 6.3% of its 2023 GDP in R&D, one of the highest rates globally, compared to the Philippines’ meager 0.324%, limiting its ability to compete in advanced industries. 

These constraints mean that even a “favorable” tariff doesn’t automatically translate into economic gains—investors may still look elsewhere if the cost of doing business remains prohibitively high. 

The tariff’s silver lining hinges on the Philippines overcoming these challenges, but deeper vulnerabilities lurk beneath the surface. 

High trade exposure and financial-fiscal constraints threaten to turn this political win into an economic missed opportunity, as the country grapples with the fallout of a global trade war. 

V. Fallout from Tariffs: An Uncertain Future: Tariffs May Deter Investment in the Philippines 

The regime uncertainty introduced by Trump’s tariff policy creates an opaque economic horizon, deterring investments even in a country like the Philippines, which some argue is insulated due to its consumption-driven economy (72.5% of its 2024 real GDP). 

However, this narrative overlooks the fundamental economic principle encapsulated in Say’s Law: "supply enables demand" (Newman 2025) or "production precedes consumption." (Shostak 2022) 

The 17% tariff directly threatens this dynamic by reducing demand for Philippine exports, which totaled $12.14 billion to the U.S. in 2024, accounting for 16.6% of total exports. (Figure 3, lower graph) 

Analysts estimate a direct annual loss of $1.6–1.89 billion, cutting income for workers in export sectors like electronics and agriculture, and thus curbing their spending power. 

Nota Bene: These estimates reflect only the direct impact, ignoring the epiphenomenon from complex feedback loops, such as secondary and the nth effects on supply chains, employment, and consumer confidence, which could amplify the economic toll. 

Government data further disproves the notion of immunity.

Figure 4

The share of goods exports and imports in 2024 GDP was 42% (13.8% exports, 28.1% imports), a significant exposure for a supposedly consumer-driven economy. This means trade disruptions hit hard, affecting both production (exports) and consumption (imports of goods like electronics and food). (Figure 4, topmost image) 

Excluded from this discussion are exports and imports of services. If included, exports and imports in real GDP would account for 64.2% of the 2024 GDP! (Figure 4, middle graph) 

AP Lerner (1936) highlighted the mutual dependence of exports and imports in trade economics. A decline in exports limits foreign exchange earnings, which in turn reduces the ability to finance imports. This creates a ripple effect, showcasing the interconnected nature of international trade. 

Even the service sector, a key income source through business process outsourcing (BPO, contributing 8.5% of 2024 GDP), isn’t safe. 

U.S. firms, facing their own tariff costs (e.g., 46% on Vietnam), might cut back on outsourcing to the Philippines, further denting income. 

The opaque economic horizon—marked by unclear earnings projections and obscured hurdle rates—adds to the reluctance to deploy investments. 

Businesses, unable to accurately forecast returns amidst this uncertainty, are likely to delay or cancel projects, from factory expansions to new market entries, exacerbating the Philippines’ economic challenges. 

VI. Shaky Foundations: Why the Consumer Economy Isn’t Immune 

The consumer economy narrative also ignores the role of debt. 

Household debt has skyrocketed to Php 2.15 trillion in 2024, up 24.26% from 2023, with credit card debt alone rising 29.65% year-on-year. But this borrowing isn’t free—high interest rates strain budgets, which comes on top of the loss of purchasing power from inflation. 

Consumer loans as a percentage of NGDP soared to a record 11.7%, while consumer loans relative to consumer NGDP also reached a historic high of 15.32% in 2024. 

In contrast to other developed economies, the Philippine banking sector’s low penetration levels have concentrated household debt growth within higher-income segments. This phenomenon heightens concentration risk, as financial stability becomes increasingly reliant on a limited, affluent demographic. 

Despite this debt-fueled spending, GDP growth slackened to 5.2% in the second half of 2024, down from 6.1% in the first half, while annual core CPI (excluding food and energy) fell from 6.6% in 2023 to 3% in 2024, signaling weak demand. 

Clearly, “free money” hasn’t spruced up the economy. 

Add to this the uncertainty facing export and import firms, which could lead to job losses, and a looming U.S. migration crackdown that threatens remittances—$38.34 billion in 2024, or 8.3% of 2024 GDP, with 40.6% from the U.S. (Figure 4, lowest pie chart) 

If Filipino workers in the U.S. face deportations, remittances could slash household spending, especially in rural areas. 

This could add to hunger rates—which according to SWS estimates—in Q1 2025 have nearly reached the 2020 pandemic historic highs. 

Far from immune, the Philippines’ consumer economy is on shaky ground, vulnerable to both domestic and global pressures. 

VII. Financial Fragility: Historic Savings-Investment Gap, Record Debt, and Dollar Dependence 

The Philippines’ economic challenges are compounded by a chronic savings-investment gap that severely limits its ability to adapt to the tariff. 

Domestic savings are a mere 9.3% of 2024 GDP, while investments stand at 23.7%, creating a staggering 14% gap that forces reliance on volatile foreign capital, such as remittances ($38 billion) and FDI ($8.9 billion in 2024). 

These inflows, however, are increasingly uncertain amid rising global trade tensions. 

This savings scarcity is primarily driven by fiscal pressures. Government spending has soared to 14.5% of GDP, fueled by post-COVID recovery efforts and infrastructure projects, pushing national debt to Php 16.05 trillion (60.72% of GDP) in 2024.

Figure 5

External debt grew 9.8% to USD 137.63 billion, surpassing the country’s gross international reserves (GIR) of USD 106.3 billion—a figure that includes external public sector borrowings deposited with the Bangko Sentral ng Pilipinas (BSP). (Figure 5, topmost diagram) 

The external debt service burden surged 15.6% year-on-year to a record USD 17.2 billion in 2024, pushing its ratio to GDP to the highest level since 2009.  (Figure 5, middle window) 

To finance this ballooning debt, the government borrows heavily, crowding out private investment. 

Banks, holding Php 5.54 trillion in government securities in 2024 (net claims on the central government), prioritize lending to the government while directing credit to riskier private sectors—consumers, real estate, and elite firms—rather than promoting finance to manufacturing or SMEs, which are crucial for adapting to the tariff through innovation or market diversification. 

Not only through deposits, banks have been net borrowers of public savings via the capital markets. In 2024, the banking system’s bills and bonds payable swelled 30.9%, from Php 1.28 trillion in 2023 to Php 1.671 trillion. 

Meanwhile, non-bank sectors, competing for the same scarce savings, also face high interest rates, creating a significant roadblock to investment. 

High fiscal spending also fuels inflation. The Philippine CPI posted 6% in 2023, above the central bank’s 2–4% target. This acts as an inflation tax, eroding household savings as rising costs (e.g., food prices up 20%) force families to spend rather than save. 

Though the CPI dropped to 3.2% in 2024, the fiscal deficit remains near pandemic highs, exacerbating financial pressures.

With banks, the government, and businesses all vying for limited funds, the Philippines struggles to finance the reforms needed to turn the tariff’s political edge into economic gains, such as the CREATE MORE Act’s incentives to lower energy costs and attract investors.

Moreover, uncertainties from the tariffs put at risk the rising systemic leverage (total bank lending + public debt), which rose 11.13% year-on-year in 2024 to Php 29.960 trillion—accounting for 113% of 2024 NGDP! (Figure 5, lowest graph) 

Worse, potential weakness (or a recession) in GDP could spike the fiscal deficit, necessitating more debt, including external financing, which further strains the demand for foreign exchange. 

The Philippines’ dependence on dollars for its external debt and imports makes it particularly vulnerable to global shifts in dollar availability, a risk amplified by the tariff’s broader implications. 

VIII. Intertemporal Impact or Short-to-Longer Term Impact on the Philippine Economy 

The tariff’s impact on the Philippines unfolds over time, with distinct short-term and long-term effects. 

In the short term (0–2 years), the estimated $1.6–1.89 billion export loss, combined with a potential remittance drop, should add pressure on the peso (already at 57.845 in 2024), translating to higher inflation and squeezing consumers. 

Job losses in export sectors like electronics and agriculture, coupled with credit constraints from the savings gap, limit the government’s ability to cushion the blow. GDP growth, already down to 5.2% in the second half of 2024, could dip further, missing the government’s 6–8% target for 2025. 

Over the longer term (3–10+ years), there’s potential for growth if the Philippines leverages reforms like the CREATE MORE Act, which offers power cost deductions and tax breaks to attract investment. 

However, all these take time, effort, and funding, which—unless there is clarity in the economic horizon—could offset whatever gains might occur.

Figure 6 

Philippine trade balance has struggled even in anticipation of the passage of the CREATE Act. (Figure 6, topmost image)

The BSP’s USDPHP implicit cap or ‘soft peg regime’—which subsidizes the USD—has played a significant role, contributing to surging imports and external debt (previously discussed here). This policy, while stabilizing the peso in the short term, exacerbates the trade deficit and increases reliance on foreign capital, making long-term growth more challenging. 

The savings gap and fiscal pressures make this a steep climb. Without domestic capital, the Philippines remains vulnerable to global capital flow disruptions, which could derail its long-term economic prospects. 

The interplay of these factors underscores the need for a strategic, holistic, and sustained approach to economic reform—one that tackles both immediate challenges and structural weaknesses. 

However, given the tendency of popular politics to prioritize the short term, this vision may seem far-fetched. 

IX. The US Dollar’s ‘Triffin Dilemma’: Global Risks and Philippine Challenges 

These disruptions tie into broader global risks, starting with the Triffin Dilemma. 

The Triffin Dilemma, named after economist Robert Triffin, highlights a fundamental conflict in the U.S.’s role as the issuer of the world’s reserve currency. To supply the world with enough dollars to meet global demand, the U.S. must run current account deficits. 

The Triffin Dilemma arises because running persistent deficits to supply dollars undermines confidence in the dollar’s value over time. If deficits grow too large, foreign holders may doubt the U.S.’s ability to manage its debt (U.S. national debt was $34.4 trillion in 2024, or 121.85% of GDP), potentially leading to a shift away from the dollar as the reserve currency. (Figure 6, middle graph)

Conversely, if the U.S. reduces its deficits (e.g., through tariffs), it restricts the global supply of dollars, which can disrupt trade and financial markets, also eroding the dollar’s dominance. 

The U.S. dollar’s role as the world’s reserve currency (58% of global reserves) relies on constant U.S. trade deficits to supply dollars globally. (Figure 6, lowest chart)

The U.S.’s $1.2 trillion deficit in 2024 does just that, supporting its “exorbitant privilege” to borrow cheaply and fund military power. 

But tariffs, by aiming to shrink this deficit, reduce the dollar supply, risking the dollar’s dominance. If countries shift to alternatives like the Chinese yuan (2.2% of reserves) or euro (20%), the U.S. faces higher borrowing costs, potentially curbing military spending ($842 billion in 2024), while the Philippines struggles to access dollars for its USD 191.994 billion external debt and trade deficit in 2024. This could weaken the peso further, raising costs and inflation. 

Meanwhile, if other nations like China or the EU liberalize trade in response, alternative markets could emerge. 

The Philippines might redirect exports to China (which posted a $992 billion surplus in 2024) or leverage the EU-Philippines FTA, but this risks geopolitical tensions with the U.S., its key ally, especially amid West Philippine Sea disputes. 

An “iron curtain” in trade, investments, and capital flows looms as a worst-case scenario, further isolating the Philippines from the global capital needed to bridge its savings gap. The potential erosion of the U.S.’s military presence in the Indo-Pacific, due to financial constraints, could also embolden China, complicating the Philippines’ strategic position. 

X. Conclusion: Winnowing the Political Chaff from the Economic Wheat

While the 17% U.S. tariff on Philippine goods seems to offer a political edge, the economic reality tells a different story.

The regime uncertainty from Trump’s bold tariff regime exposes internal fragility brought about by high trade exposure, a savings-investment gap, and fiscal-financial constraints.

The consumer economy isn’t immune, as export losses, rising debt, and remittance risks threaten investments and spending power.

Global risks, like the erosion of the U.S.’s dollar privilege through the Triffin Dilemma, could further limit the Philippines’ adaptability.

Over the long term, reforms like the CREATE MORE Act could unlock growth, but only if the Philippine government acts swiftly to boost savings by further liberalizing the economy, reforming exchange rate policies, and supporting these efforts with a material reduction in fiscal spending.

Trump’s tariff is a wake-up call: though the drastically shifting tides of geopolitics translate to the need for flexible policymaking ideally, the sunk cost of the incumbent economic structure operating under existing policies hinders this process.

‘Resistance to change’ that works against vested interest groups—such as entrenched political and business elites who benefit from the status quo—will likely pose a significant obstacle too.

As such, drastic changes in the economic and financial climate raise the risk of a recession or a crisis, particularly given the Philippines’ high systemic leverage and dependence on foreign capital.

The next step may be to throw a prayer that Trump eases his hardline stance, offering a reprieve that could buy the Philippines time to adapt to this new global reality. 

___

References 

Colin Grabow, Scott Lincicome, and Kyle Handley, More About Trump’s Sham “Reciprocal” Tariffs, April 3, 2025 Cato Institute 

Robert Higgs, Regime Uncertainty, 1997 Independent.org 

David R. Breuhan A Brief History of Tariffs and Stock Market Crises November 4, 2024, Mises.org 

Frank Shostak, Government “Stimulus” Schemes Fail Because Demand Does Not Create Supply, July 26, 2022, Mises.org 

Jonathan Newman, Opposing the Keynesian Illusion: Spending Does Not Drive the Economy, January 21, 2025 

A. P. Lerner, The Symmetry between Import and Export Taxes, 1936 Wiley jstor.org 

The Transitioning Political Phase: Shadows of Smoot Hawley and Financial Crisis Claims First Government-Belgium

We are now entering into the political phase of the current global crisis.

To begin with, the modern day version of the Smoot-Hawley Act seems to be in the process of resurrection.

This from Washington Post (bold highlights mine),

``Only a few weeks after world leaders vowed at a Washington summit to reject trade protectionism and adhere to free-market principles as they combat the global financial crisis, a host of nations are already breaking that promise.

``Moving to shield battered domestic manufacturers from foreign imports, Indonesia is slapping restrictions on at least 500 products this month, demanding special licenses and new fees on imports. Russia is hiking tariffs on imported cars, poultry and pork. France is launching a state fund to protect French companies from foreign takeovers. Officials in Argentina and Brazil are seeking to raise tariffs on products from imported wine and textiles to leather goods and peaches, according to the World Trade Organization.

``The list of countries making access to their markets harder potentially includes the United States, where critics are calling the White House's $17.4 billion bailout of the U.S. auto industry an unfair government subsidy that would put foreign competitors at a disadvantage.

``Though still relatively narrow in scope, the moves, observers warn, in the coming months may grow into a broader wave of protectionism. That could worsen the global financial crisis by further choking world trade, which is already facing its first decline since 1982 as the world economy sharply slows and demand dries up.

``In hard times, analysts say, nations are more inclined to take steps that inhibit trade, often with dire consequences. Trade restrictions imposed by countries trying to protect domestic industries in the 1930s, for instance, escalated into a global trade war that deepened and prolonged the Great Depression.

``Exporting firms tend to be innovative, dynamic and capable of generating good job growth," said Eswar S. Prasad, a professor of trade policy at Cornell University and senior fellow at the Brookings Institution in Washington. "If trade restrictions caused by trade wars shut them down, their suppliers shut down, job losses get worse, and you can quickly have a spiraling downward effect on the entire economy."

``To be sure, most of the measures taken to date appear to be within the limits of current international trade treaties, which grant countries some room to raise tariffs and contain loopholes that can be exploited to protect domestic industries.

``But the general trend toward protectionism could undermine what has been the steady march of free trade during the era of globalization, with export-dependent countries such as China standing to lose the most."

So the unintended consequences of bailouts are partially contributing to such movement.

Next, we have national governments falling under the weight of the financial crisis.

Belgium is reportedly the first of the victim.

This according to the Financial Times, ``The Belgian government last night became the first national administration to fall as a direct result of events linked to the global financial crisis.

``Belgium's King Albert II formally accepted the resignation of the coalition government led by Yves Leterme, prime minister - but ordered it to stay on in a caretaker capacity to deal with "day-to-day" business.

The political ramifications of the crisis carries a big weight to trade, migration and capital flows dynamics, hence requires to be monitored.

For us, protectionism is one major threat or risk that can bring about the modern day version of the Great Depression.

How Political Tea Leaves Will Shape The Investment Landscape

``One key attribute that gives money value is scarcity. If something that is used as money becomes too plentiful, it loses value. That is how inflation and hyperinflation happens. Giving a central bank the power to create fiat money out of thin air creates the tremendous risk of eventual hyperinflation. Most of the founding fathers did not want a central bank. Having just experienced the hyperinflation of the Continental dollar, they understood the power and the temptations inherent in that type of system. It gives one entity far too much power to control and destabilize the economy.” Dr. Ron Paul, The Neo-Alchemy of the Federal Reserve

Never has ascertaining the probabilities of the rapidly evolving highly fluid macro environment been as critical today in shaping one’s portfolio or even in anticipation of the how to allocate resources in the coming business environment.

Why? Because future revenue streams, productivity levels, earnings and all other micro metrics, aside from market or business cycles, will all depend on the outcome from the present set of policy choices.

While the investment field shudders at the thought mentioning such ominous phrase; ``it’s different this time”, well, it hard to say it but it does seem different this time.

As we noted in last week’s Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?,

``Even as global governments have been rapidly anteing up on claims to taxpayers’ future income stream by a concoction of “inflationary” actions such as lender of last resort, market maker of last resort, guarantor of last resort, investor of last resort, spender of last resort and ultimately buyer of last resort, a credit driven US economic recovery isn’t likely to happen; not when governments are tightening supervision or regulatory framework, not when banks are hoarding money to recapitalize, not when borrowers are tightening belts and suffering from capital losses on declining assets and certainly not when income is shrinking as unemployment and business bankruptcies rise on falling profits, and most importantly not when the collective psychology has been transitioning from one of overconfidence to one of morbid risk aversion.

``Thus the best case scenario for the credit driven “economic growth” will be a back to basics template-the traditional mechanisms of collateralized backed lending based on borrower’s capacity to pay. But these won’t be enough to reignite the Moneyness of credit. Not even under the US government’s directive.”

We found our assertions pleasantly echoed by the world’s Bond King in his latest outlook; from PIMCO’s Mr. William Gross (who confirms our cognitive biases-emphasis ours)

``My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to – that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner.”

So as global governments take up the shoes from the private sector, the outcomes as reflected by market conditions and on the economic landscape will obviously be different, see Figure 1.

Figure 1 Gavekal: Portfolio Distribution In Different Environments

From Gavekal’s Brave New World is a simplified template where we see basically four economic environments; from which a long term theme, at the moment, has been struggling to emerge, albeit under a current, possibly temporary, dominant theme which are being battled out by government forces.

But nonetheless, we can identify whence our recent past, posit on the present environment and identify possible outcomes.

From the privilege of hindsight the most obvious is the inflationary boom, which was characterized by a credit inspired boom in almost every asset classes across the world, but in contrast to the template, this includes a boom in government bonds!

Today we are seeing the opposite- a market driven deflationary bust, where the unwinding debt burden has prompted for a reversal of the former order or an across the board selling except for US treasuries and the US dollar. Thus the characteristics as described in the template are presently still being perfected.

Yet, given the observable actions of governments, one may infer that the current deflationary bust phase is being engaged in with a tremendous surge of inflationary forces (bailouts, guarantees, lending, capital provision, etc.) in the hope to restore the former order.

And this has been the source of the fierce debates encapsulating the investment industry; will today’s deflationary bust outrun inflationary forces and transit into a modern day global depression? Will the unintended consequences of the concerted inflationary injections by global central banks result to a US dollar crisis or inflationary bust or hyperinflationary depression? Or will Goldilocks be resurrected with government stilts?

Deflation and Endowment Effects

The basic problem is the house of cards built upon by an unsustainable credit structure from which the world’s economy has been anchored upon, see figure 2.

Figure 2: courtesy of contraryinvestor.com: Unsustainable Credit Market

As we previously noted there are basically two ways to preside over such predicament. One is to allow market forces to reduce debt to levels where the afflicted economy could pay these off. Two, is to reduce the real value of debt via inflation. Of course, there is always the third way: the default option.

But since we believe that the US government and the other debt laden economies are likely to avoid the third option, as their taxpayers have been aggressively absorbing the losses, these relegate us to the first two options.

Deflation proponents (mostly Keynesians) argue that the central bank measures are proving to be impotent when dealing with the tsunami of debt because losses have simply been staggering to drain “capital” than can be replaced and which has similarly devastated the credit system beyond immediate repair. Hence, the global central bank actions are unlikely to rekindle a credit driven (inflationary boom) economic recovery.

In addition, they argue that because of the credit prompted seizure in the banking system its spillover effects to the real economy will lead to a much further decline in aggregate demand which accentuates the overcapacity in the global trade network which will further transmit deflationary forces worldwide.

Moreover, they’ve boisterously indulged in a public blame game in the context of trade balances. They accuse the current account surplus economies, who still seem reluctant to abide by their behest of absorbing declining world aggregate demand via their prescribed policies of increasing domestic consumption, of being ‘beggar thy neighbor’. Some of them have even implied that the continued thrust towards mercantilism in today’s recessionary as “Protectionism In Disguise” (PID).

This of course, according to our self-righteous omnipotent camp will lead to further deflation as excess capacity will forcibly be dumped into the markets and may result to countervailing protectionist actions.

Grim indeed.

The bizarre thing is that Keynesians have been fighting among themselves: the insiders or policymakers believe that eventually their actions will triumph, while the outsiders believe that their sanctimonious wisdoms represent as the much needed elixir to the present predicament.

Yet all of these exhibits nothing more than the cognitive bias of the “endowment effect” or placing a higher value on opinions they own than opinions that they do not.

The rest is speculation.

End Justifies The Means: The Gathering Inflation Storm?

There are two ways one can categorize all these competing analysis.

One, means to an end- (free dictionary) something that you are not interested in but that you do because it will help you to achieve something else; or applied to the recent events, the analysis that “my way has to be followed” regardless of the outcome.

Yes, the US and many European governments have practically followed nearly all Keynesian prescriptions short of outright nationalizations of the affected industries, yet NO definitive progress.

In short, we see many analysis based on the strict adherence to ideological methodologies than the actual pursuit of economic goals.

Of course, this will have to be wrapped with technical gobbledygook, such as liquidity trap, debt trap, and assorted claptraps (possibly even crab traps), to entertain and wow their audience, especially catered to those seeking easy answers or explanations to the performance of today’s market as the trajectory for the future.

Two, end justifies the means- (free dictionary) in order to achieve an important aim, it as acceptable to do something bad or the end result determines the course of action.

As we have earlier said the major alternative recourse to deal with an unsustainable debt structure is to ultimately inflate the real value of debt, which essentially shifts the burden from the debtor to the creditor.

And there have been rising incidences of voices expressing such direction:

This from Atlanta Federal Reserve President Dennis Lockhart (Wall Street Journal) ``A direct path to recovery is unlikely, as we have seen, events arise that knock us off the path to a stable credit environment…the Fed retains a number of options to help the economy.” (highlight ours)

This from former IMF Chief Economist Kenneth Rogoff whom we earlier quoted in Kenneth Rogoff: Inflate Our Debts Away!

``Modern finance has succeeded in creating a default dynamic of such stupefying complexity that it defies standard approaches to debt workouts. Securitisation, structured finance and other innovations have so interwoven the financial system's various players that it is essentially impossible to restructure one financial institution at a time. System-wide solutions are needed….

``Fortunately, creating inflation is not rocket science. All central banks need to do is to keep printing money to buy up government debt. The main risk is that inflation could overshoot, landing at 20% or 30% instead of 5-6%. Indeed, fear of overshooting paralysed the Bank of Japan for a decade. But this problem is easily negotiated. With good communication policy, inflation expectations can be contained, and inflation can be brought down as quickly as necessary.

This from a commentary entitled “Central banks need a helicopter” by Eric Lonergan a macro hedge fund manager at the Financial Times (highlight mine),

``What is lacking is a legal and institutional framework to do this. The helicopter model is right, but we don’t have any helicopters…Central banks, and not the fiscal authorities, are best placed to make these cash transfers. The government should determine a rule for the transfer. It is the government’s remit to decide if transfers should be equal, or skewed to lower income groups….The reasons for granting this authority to the central bank are clear: it requires use of the monetary base. Granting government such powers would be vulnerable to political manipulation and misuse. These are the same reasons for giving central banks independent authority over interest rates.”

Let’s go back to basics, the reason governments are inflating the system away (albeit in rapid phases) is because of the perceived risks of destabilizing debt deflation. Yet you can’t have market driven deflation process without preceding government stimulated inflation. Thereby deflation is a consequence of prior inflation. It is a function of action-reaction, cause and effect and a feedback loop- where government tries to manipulate the market and market eventually unwinds the unsustainable structure.

Our point is simple; if authorities today see the continuing defenselessness of the present economic and market conditions against deflationary forces, ultimately the only way to reduce the monstrous debt levels would be to activate the nuclear option or the Zimbabwe model.

And as repeatedly argued, the Zimbabwe model doesn’t need a functioning credit system because it can bypass the commercial system and print away its liabilities by expanding government bureaucracy explicitly designed to attain such political goal.

As Steve Hanke in the Forbes magazine wrote, ``The cause of the hyperinflation is a government that forces the Reserve Bank of Zimbabwe to print money. The government finances its spending by issuing debt that the RBZ must purchase with new Zimbabwe dollars. The bank also produces jobs, at the expense of every Zimbabwean who uses money. Between 2001 and 2007 its staff grew by 120%, from 618 to 1,360 employees, the largest increase in any central bank in the world. Still, the bank doesn't produce accurate, timely data.”

In other words, the Rogoff solution simply qualifies the ‘end justifying the means’ approach, where the ultimate goal is political -to reduce debt in order for the economy to recover eventually or over the long term for political survival, than an outright economic end. Yet because of the vagueness of such measures, there will likely be huge risks of unintended painful consequences. But nonetheless, if present measures continue to be proven futile, then path of the policy directives could likely to lead to such endgame measures-our Mises moment.

Yet, the Rogoff solution simply cuts through the long chase of the farcical rigmarole advanced by deflation proponents who use their repertoire of technical vernaculars of assorted “traps” to convey a deflation scenario. When worst comes to worst all these technical gibberish will simply evaporate.

Moreover, deflation proponents seem to forget that the Japan’s lost decade or the Great Depression from which Keynesians have modeled their paradigms had one common denominator: “isolationism”.

Japan’s debacle looks significantly political and culturally (pathological savers) induced, while the Smoot Hawley Act in the 1930s erected a firewall among nations which essentially choked off trade and capital flows and deepened the crisis into a Depression.

This clearly hasn’t been the case today, YET, see Figure 3.

Figure 3: US global: Global Central Banks Concertedly Cutting Rates

There had been nearly coordinated massive interest rate cuts this week by several key central banks; the Swedish Riksbank slashed its rates by nearly half, cutting 175 bp to 2%, followed by the Bank of England, which slashed rates by 100bp (last month it cut by 150 bp), while the ECB was the most conservative and cut of 75bp. Indonesia followed with 25 bp while New Zealand cut a record 150bp to 5% (guardian.co.uk).

And as we quoted Arthur Middleton Hughes in our Global Market Crash: Accelerating The Mises Moment!, ``the market rate of interest means different things to different segments of the structure of production.”

If the all important tie that binds the world has been forcible selling out of the debt deflation process, then as these phenomenon subsides we can expect these interest rate policies to eventually gain traction.

And it is not merely interest rates, but a panoply of distinct national fiscal and monetary policies targeted at cushioning such transmission.

Remember, even in today’s globalization framework, the integration of economies hasn’t been perfect and that is why we can see select bourses as Tunisia, Ghana, Iraq or Ecuador defying global trends, perhaps due to such leakages.

The point is there is no 100% correlation among markets and economies. And when the forcible selling (capital flow) fades, the transmission linkages will focus on other aspects as trade or remittances which have varying degrees of external connections relative to their national GDP.

Thus, considering the compounded effects of individual economies and their respective national policy actions, market or economic performances should vary significantly.

The idea that global deflation will engulf every nation seems likely a fallacy of composition if not a chimera.

Reviving Smoot-Hawley Version 2008?

Next, there is this camp agitating for a revised form of protectionism.

They accuse nations with huge current account surplus, particularly China, for nurturing trade frictions amidst a recessionary environment-by obstinately opting to sustain the present trade configuration which is heavily modeled after an export led capital intensive investment growth.

The recent surge of the US dollar against the Chinese Yuan and China’s recent policies of providing for higher rebate and removal of bank credit caps have been interpreted to as being implicitly protectionist.

The alleged risks is that given the slackening of aggregate demand, China’s export oriented growth model could pose as furthering the deflationary environment by dumping excess capacity to the world.

Echoing former accusations of currency manipulation, but in a variant form, the adamant refusal by China to reduce its export subsidies (via Currency controls etc.) at the expense of domestic consumption, is seen by critics as tantamount to fostering protectionism and thus, should require equivalent punitive sanctions.

Recessions are, as seen from the mainstream, defined as a broad based decline in economic activity, which covers falling industrial production, payroll employment, real disposable income excluding transfer payments and real business sales.

But recessions or bubble bust cycles are mainly ``a process whereby business errors brought about by past easy monetary policies are revealed and liquidated once the central bank tightens its monetary stance,” as noted by Frank Shostak.

In other words, when China gets implicitly or explicitly blamed for “currency manipulation” or for failing to adopt policies that “OUGHT TO” balance the world trade, it assumes that the US, doesn’t carry the same burden.

But what seems thoroughly missed by such critics is that the extreme ends of the current account or trade imbalances reflect the ramifications of the Paper-US dollar standard system. You can’t have sustained and or even extreme junctures of imbalances under a pure gold standard!

Besides, since the supply or issuance of currencies is solely under the jurisdiction of the monopolistic central banks, which equally manages short term interest rate policies or the amount of bank reserves required, then the entire currency market operating under the Paper money platform accounts for as pseudo-market or a manipulated market.

To quote Mises.org’s Stefan Karlsson, ``Any currency created by a central bank is bound to be manipulated. In fact, manipulating the currency is the task for which central banks were created for. If they didn't manipulate the currency, there would be no reason to have a central bank.” (underscore mine)

In addition, the fact that the US functions as the world’s reserve currency makes it the premier manipulator- for having the unmatched privilege to extend paper IOUs as payment or settlement or in exchange for goods and services.

We don’t absolve the Chinese for their policies, but perhaps, by learning from the harsh experience of its neighbors during the Asian crisis, the Chinese have opted to adopt similar mercantilist nature to protect its interest but on a declining intensity as it globalizes.

The point that Chinese authorities are considering full convertibility of the yuan, as per Finance Asia (emphasis mine), ``The Chinese authorities should raise the profile of the renminbi during the global financial turmoil and get ready for the currency’s full convertibility, according to Wu Xiaoling, deputy director with the finance and economic committee of the National People’s Congress”, or this ``Wu, who was a deputy governor of the People’s Bank of China (PBOC) until earlier this year, told a seminar in Beijing in November that the renminbi should become an international reserve currency in tandem with its full convertibility, reflecting a renewed interest in loosening control of the currency as the country becomes more deeply integrated in the world financial system. She said it was difficult to find an alternative reserve currency but added that the renminbi was ready to become an international currency to replace the dollar,” equally demonstrates the political thrust to gain superiority by becoming more integrated with the world via reducing mercantilist policies and adopting international currency standards.

But, unlike the expectations of our magic wand wielding experts, you don’t expect them to do this overnight.

Figure 4 Gavekal: China Reserves Outgrow China’s Trade Surplus & FDI

Also during the past years, China’s currency reserves didn’t account for only trade surpluses or FDI flows, but as figure 4 courtesy of Gavekal Capital shows, a significant part of these reserves could have emanated from portfolio or speculative flows even in a heavily regulated environment.

Thus, the recent surge of US dollar relative to the Yuan may not entirely be a policy choice but also representative of these outflows given the current conditions. The fact that China’s real estate has been decelerating and may have absorbed most of these speculative flows could reflect such dynamics.

Nonetheless Keynesians always focus on the aggregate demand when recessions or a busting cycle also means a contraction of aggregate supply.

Malinvestments as seen in jobs, industries or companies or likewise seen in supply or demand created by the illusory capital or “money from thin air” which would need to be cleared. Or when the excesses in demand and in supply are sufficiently reduced or eliminated, and losses are taken over by new investors funded by fresh capital, then the economy will start to recover.

Again Frank Shostak (highlight mine), ``Contrary to the Keynesian framework, recessions are not about insufficient demand. In fact Austrians maintain that people's demand is unlimited. The key in Austrian thinking is how to fund the demand. We argue that every unit of money must be earned. This in turn means that before a demand could be exercised, something must be produced. Every increase in the demand must be preceded by an increase in the production of real wealth, i.e. goods and services that are on the highest priority list of consumers (we don't believe in indifference curves).”

The point is whatever decline in aggregate demand also translates to a decline in capacity as losses squeezes these excesses out. Today’s falling prices may already reflect such oversupply-declining demand adjustments.

Said differently the calls to maintain or support “demand” by means of more government intervention aimed at propping up of institutions, which are not viable and can’t survive the market process on its own, isn’t a convincing answer. The pain from the adjustments in debt laden Western economies is also felt but to a lesser degree in Asian economies.

Likewise, imposing undue protectionist sanctions to suit the whims of such pious and all knowing experts, will likely have more unintended consequences, foster even more imbalances and or risks further deterioration of the present conditions.

Forcing China to radically reform, without dealing with the structural asymmetries from today’s fractional reserve banking US dollar standard, won’t resolve the recurring boom-bust cycles. This simply deals with the symptoms and not the cause.