Party Like It's 1929

The U.S. government took square aim at its own foot Friday by putting sanctions on Chinese paper imports.
The move threatens to hurt an already slowing U.S. economy, to boost an inflation rate running too high for the Federal Reserve's comfort, to exacerbate the dollar's downtrend and to thwart capital inflows in the bond market, where yields are edging higher.

In a replay of tariffs slapped on steel imports in 2002, the Commerce Department said it would impose tariffs of 10.9% to 20.4% on Chinese coated papers in retaliation for subsidies Beijing provides. The dollar reacted negatively to the protectionist measure, which recalls the currency's drop in the wake of the steel tariffs. Although later reversed by the World Trade Organization, those levies helped set off a 35% decline in the dollar against the euro in the following year, writes Ashraf Laidi, CMC Markets' chief foreign-exchange analyst.
Whether or not these new tariffs also are reversed by the WTO, the U.S. actions could trigger retaliation by China, notably further diversification of its currency reserves, the vast majority of which are held in dollars in the form of U.S. bonds. As noted here several weeks ago, one academic study estimated that foreign-capital inflows have lowered long-term U.S. interest rates by 90 basis points (0.9%.) All else being equal, less buying of U.S. assets would tend to boost yields.
These higher rates would pile onto the already staggering housing market.
Higher inflation resulting from the tariffs and the weaker dollar would add to pressure on the Federal Reserve not to lower rates to offset the effect of a housing slide on the economy, according to T.J. Marta, fixed-income strategist for RBC Capital Markets.

"Higher yields would put more pressure on besieged, overlevered homeowners, whether they are trying to [refinance] into [adjustable-rate mortgages] or 30-year fixed rates," he writes. "Just when we believe the markets can really mess things up (subprime-underwriting negligence), the government steps in a shows us how it's really done."
Even before Friday's invocation of Smoot-Hawley, there were hints of a slippage of foreign demand for U.S. Treasuries as their purchases at last week's auctions of two- and five-year notes fell well short of their recent totals.
The benchmark 10-year yield moved up to 4.65% Friday from 4.605% a week earlier, while the two-year note inched up a basis point, to 4.591%. That returned the Treasury yield curve (at least the two-to-10-year portion closely watched by traders) to a positive slope. Last November, two-year notes yielded as much as 20 basis points more than 10-year maturities.

Smoot and Hawley were co-sponsors of the disastrous tariff that was moving toward passage in Congress in 1929, and which, according to some analyses, helped to trigger the stock market crash of that year and to make the Great Depression an international disaster as world trade collapsed. But, it should also be noted that the U.S. economy already was in the early stages of a recession by the time the market crashed in October 1929. In 2007, signs of slowing economic growth are mounting, as corporate capital spending is slumping at the same time housing activity is sliding. New orders of durable goods rose 2.5% in February, a "pathetic" rebound from the downwardly revised 9.3% plunge in January, as Paul Kasriel, chief economist of Northern Trust, characterized the data. "Core" durable goods orders (non-defense goods excluding aircraft) are down at a 13.5% annual rate in the past three months.

Core durable-goods shipments are declining at a 9.8% annual rate so far this quarter, according to Credit Suisse economists Neal Soss and Jay Feldman, putting them "on track for the worst performance since the quarter leading up to the Iraq War" -- the first quarter of 2003.

The Fed's forecast is for capital spending to rebound and pick up the baton from slumping housing. And given strong corporate cash flows and still-easy credit conditions, that might be expected, although corporate profits are set to slow in coming quarters (see "Less Gain, More Pain" on page 49.)
But other things might be at work, suggests Charles Dumas of Lombard Street Research. Just as U.S. corporations are paring inventories, which was evident in fourth-quarter gross-domestic-product data, they are curbing capital spending.
"Stock options encourage top management to manage for shareholder value." That attitude no doubt extends to private equity, which has been more inclined to pay itself huge dividends rather than plow earnings back into the business.
"This is the major difference between this century and the last," observes Robert Kessler, head of the eponymous Denver asset-management company. "In the latter part of the 20th century, at least we got the productivity advancement in technology. This century has given us the greatest debt creation ever seen," with little to show for it but massive bonuses for deal makers and their enablers on Wall Street.

No wonder that the concentration of wealth at the top, according to the New York Times, is the greatest since 1929. That year just keeps popping up for some reason. ---