Forget the deteriorating US economy, rates are going to be cut

Donald Trump no doubt would claim it as a win.

When Jerome Powell let slip on Friday that US monetary policy was restricting the economy, he unleashed a wave of buying on both stock and debt markets and, no doubt, jubilation in the White House.

The message, at least superficially, was that interest rates were about to be cut.

But Powell’s restrained delivery underscored a more tentative mood. This was no time for celebration.

From Powell’s point of view, the upcoming cuts were not because inflation had been tamed. It was because the economy was weakening, and its impact was feeding through to jobs.

“The labour market appears to be in balance,” he told attendees at the annual US Fed gabfest in Wyoming.

Ever since the new president was installed in January, the US Fed chief has endured a barrage of insults and slurs, none of them professional.

Donald Trump wants interest rates lower for two reasons, and two reasons alone.

First and foremost, he believes lower interest rates will make him more popular. And secondly, they will help reduce the $US1 trillion annual interest bill on America’s massive and growing federal budget deficit.

Powell, however, made it clear that, rather than succumbing to presidential pressure, his decision was based upon the enormous obstacles Trump had placed ahead of the US economy.

“This year, the economy has faced new challenges,” he said.

“Significantly higher tariffs across our trading partners, a remaking of the global trading system, tighter immigration policy has led to an abrupt slowdown in labour force growth.”

US consumer confidence, meanwhile, has plunged while retail sales barely grew in July. About the only indicator that is on the rise is inflation, which is gradually shifting north as tariffs begin to bite.

That’s a devilish combination for whoever ends up taking Powell’s chair next year.

The tariff trap

Largely a man for the moment, the US president is likely to leave a lasting legacy.

His dismantling of the global trade structure, which has stood in place since the end of World War II, will likely remain for decades.

Protection and trade barriers are easy to establish. Dismantling them is politically fraught.

So far, the impact of Trump’s tariffs has been relatively muted. Instead of an all-out trade war, almost every country bar China appears to have meekly accepted Washington’s demands.

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Even countries like Australia that had trade deficits with the US bizarrely have incurred a 10 per cent hit.

Longer term, the tariffs are likely to cause the US an enormous amount of damage as US consumers are stripped of choice and as the protection barriers whittle away American producers’ need to innovate their way to global dominance.

The shifts are enormous. At the start of the year, US tariffs were sitting at a touch above 2 per cent. They’re now eight times higher at 18 per cent. And there is still no concrete arrangement with China.

If the official inflation numbers have yet to reflect that, it’s because big businesses have yet to pass on the full price slug.

General Motors and Ford both claim they forked out about $US1 billion each in tariffs in the second quarter alone.

The US corporate tax rate may have been slashed, but any windfall has been gobbled up by an enormous tariff impost now in place on American business and consumers.

China’s metallic defence

When he moved back into the White House, it was clear the new president would rattle the trade chains again.

Most anticipated that, once again, the primary target would be China, an assumption backed up by the fiery rhetoric emanating from Washington.

And yet, after a global flurry of hastily negotiated trade arrangements, China so far has remained beyond his reach.

A fortnight ago, the US president extended the trade truce with China for another 90 days.

Perhaps, unlike the rest of the world, it is because China refused to capitulate. President Xi enthusiastically engaged in a series of tit for tat retaliatory tariffs with Trump until they reached levels that essentially ruled out trade.

The pair then watched as the flow of goods out of China all but evaporated in May and June, both refusing to blink.

Beijing, meanwhile, pulled out its Trump card. It cut off the supply of heavy rare earths and hard magnets to the US, which are vital in defence and advanced manufacturing.

It was a strategy that had the potential to cripple much of American manufacturing in everything from automobiles and communications to advanced technology.

China now has either a stranglehold or a dominant position on metal processing and refining across a vast swathe of commodities, including lithium, cobalt, nickel and graphite. It is also the world’s biggest steel producer and, as such, is the price setter.

It has also developed advanced manufacturing industries for each of those refined metals, making high-end components upon which end users in Europe and the US rely.

Instead of refusing to buy things from other countries, China now simply refuses to sell vital components, giving it a much stronger hand in any negotiations.

He who hurts the least

Trade embargoes hurt. But not forever.

The more they’re employed, the less reliable the supplier is perceived and the more incentive a buyer has to look elsewhere.

Once the dominant force in global banking and the financial markets arena, America’s influence has begun to wane.

In part, that is due to the restrictions and sanctions on financial assets it has imposed over the years on wayward nations and its enemies.

Seizing Russian foreign exchange assets after the invasion of Ukraine may have been widely approved by many in the West. But it sounded a warning to other unfriendly nations that the US dollar no longer was safe and that alternatives were needed.

While there is no viable alternative to the US dollar just yet, Beijing has toyed with the idea of yuan-backed stablecoin to facilitate global transactions.

But China’s economy is in a world of pain and with its opaque regulatory framework remains and authoritarian political system, its attractions are limited.

The Middle Kingdom has also discovered the backlash to the misuse of muscle.

Banning sales of refined metal and components, even unofficially, has forced end-users to look elsewhere for supplies.

The global rush for alternative rare earths and critical minerals sources has been on in earnest for the past three years and Australia has emerged as a likely winner, given its ample supplies of these commodities.

But China’s domination of refined metal will be difficult to replace.

They’re often dirty industries involving harmful chemicals and loads of emissions, creating major environmental hurdles for would-be processors. And they take years to build, even in areas that don’t have stringent environmental rules.

The great unwinding of the free trade era has only just begun. Winners will be thin on the ground.

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