Taking on China in this Cold War: An 11 Step Plan

With President Trump recognizing the 75th anniversary of D-Day in Europe this week, I found myself wondering how the historic giant of that era, Winston Churchill, would view the present day, particularly the West’s relationship with China. Churchill not once, but twice, was early to see the threats oppressive, domination-seeking regimes posed to freedom loving people everywhere. While the political intelligentsia called for appeasement toward Hitler’s Nazi Germany, Churchill called for strength and resolve, nearly destroying his political career. Similarly, as World War II was nearing its conclusion, he saw the threat posed by Stalin’s Soviet Union, minimized by President Roosevelt and others. Indeed, the Soviets wouldn’t cede any of the Eastern European territory they had taken back from the Nazis, descending an “Iron Curtain” across Europe. Churchill was right both times; the establishment wrong.

As we engage with an increasingly powerful, emboldened, and repressive China, we should remember the painful lessons of history. I suspect Churchill would applaud Trump’s trade actions, lock arms with him, and call for more aggressive global action until China agrees to follow international law and join the ranks of civilized nations. Let’s make no mistake: China is an extraordinarily repressive regime. Political dissent is not tolerated, the government uses technology to track its citizenry’s every move, Taiwan lives under the threat of invasion if not for American support, Chinese Christians face constant persecution, and at least one million Muslims have been locked away in literal concentration camps for “re-education.”

Rather than confront China for these horrendous abuses, the Western elites have gone the route of appeasement, this time economically, to disastrous results. The Clinton and Bush Administrations bet that economic prosperity would lead to political liberalization. As such, they let China into the WTO, let it keep preferential developing nation status, let it depress its currency and subsidize its manufacturers, thereby stealing our industrial base, functionally raping and pillaging the Rust Belt, and costing at least one million manufacturing jobs. To this day, China continues to take Western technology and steal IP, and if a Western company complains, it loses any access to their market. When China hacked into Anthem or OPM, amassing data on millions of Americans, there wasn’t any outcry from our elites who instead remain obsessed with Russia.

This strategy of economic appeasement has instead been one of economic surrender with disastrous consequences. We have succeeded in making China incredibly wealthy, rebuilding its country and military, while giving them over $3 trillion in foreign currency reserves. Yet, the Chinese Communist Party has used this track record of economic success to further entrench itself, growing ever more oppressive and totalitarian. Economic appeasement toward China has only succeeded in making a dangerous, totalitarian regime more powerful with greater economic resources with which to challenge the West. Abject failure.

Fortunately, this soft on China approach, an unmitigated disaster, has come to an end with President Trump working to defend America’s industrial base. This is a generational opportunity to fix the US-China relationship. Postponing the inevitable battle only helps China, which has grown stronger every year. Often, it is only clear you’ve entered a “Cold War” well after it has begun. Well, it has begun; China’s been waging economic war on America for years, but our leaders are only now waking up to it. China is hell-bent on supplanting America as the world’s most powerful nation, leveraging its export-driven economy to move further up the value chain, entangle itself permanently in world supply chains, and build out its military might. Its imperial island building in the South China Sea leaves no doubt as to its ultimate intentions. After all, it is only natural for authoritarian leaders who oppress people inside their borders to seek to oppress those outside their borders as well.

Just ask yourself: how would the Cuban Missile Crisis have gone if the Soviet Union supplied America with most of its consumer goods, or rare earth metals, or medical ingredients, or worse all of the above? I suspect it would not have gone as well as quickly. We must be clear-eyed; relying on China economically poses a clear national security threat. We must disentangle our supply chain today so that China cannot use economics to leverage better military or geopolitical outcomes. Ultimately, economic security is national security.

Thus far, Trump has levied 25% tariffs on $250 billion of Chinese imports. Unsurprisingly in trade deal negotiations, China has backtracked, in keeping with their history of never living up to promises. Fortunately, rather than accept a bad deal, Trump had his team say “no,” raise the tariff rate to 25%, and contemplate further tariffs. However, this is not enough. Until and unless China faces real economic pain, they will never agree to follow the international rules and make real concessions. Recognizing that this trade conflict is but one front in an ongoing economic Cold War, we must enhance the pressure. The President must publicly and forcefully, perhaps with a detailed address to the nation prior to the G-20 summit, explain the threat China poses and call for a national, coordinated response.

Currently, China is coordinating policy, imposing tariffs, but also cutting taxes, and easing monetary policy to support growth. Ultimately, America has far more leverage and tools if our government’s institutions can unite and coordinate behind a central mission: to grow the economy, repair our industrial base, and enhance domestic economic security and sufficiency. Wars are when a nation is united and policy is coordinated. Now is the time for such a national effort. To do so, I would humbly suggest the President announce the following action plan as he prepares for the G-20.

 

  1. Trump should announce we will not re-open negotiations with China. Ultimately, these talks have increased business uncertainty, and consequently, some businesses have been slow to readjust supply chains or launch new investments domestically in case talks lead to a deal. Make it clear to executives they should assume the tariffs are the permanent “new-normal,” and uncertainty will diminish, and growth will pick-up as they invest in boosting domestic capacity.
  2. For America to re-engage with China on trade talks, China will have to, as the only pre-condition, actually stop the flow of fentanyl into America. While recently they have increased regulations on fentanyl, they must enforce these laws. Chinese fentanyl, which President Xi lets come to America, has poisoned our streets and killed at least 45,000 Americans. Xi and the Chinese government is at the least complicit in this mass murder of our citizens. They should be held to account for this. They must commit to paying the US government $45 billion ($1 million per American dead due to China) as a show of good faith to merit a reopening of the trade dialogue. Until they publicly commit to the $45 billion, which we can use to end the opioid epidemic, there will be no trade discussions. I suspect this means no trade talks for some time.
  3. Trump should announce tariffs on the remaining $300 billion of Chinese imports by July 1. As these are more consumer facing (ie iPhones), the tariff rate should begin at 10% on September 1, rising to 25% on January 1, 2020. By staggering the tariffs as such, corporations will have ample time to begin moving supply chains and reshoring jobs to minimize product disruptions and price changes. An orderly implementation of tariffs will calm consumers and markets, ultimately making them more productive
  4. Trump should, effective no later than year end, ban and embargo Huawei, ZTE, and any other Chinese-linked entity from core technology infrastructure susceptible to espionage. Any foreign network using Chinese equipment would also be banned from having secure communications with the US.
  5. As seen by China’s threats on rare earth metals, they cannot be relied on as a stable supplier, yet we rely on them for most of our medical ingredients, which is unacceptable. Any product where China accounts for more than 33% of the supply would be protected by additional national security tariffs to take effect January 1 to promote more domestic production and self-sufficiency.
  6. Chinese state-owned entities would be barred from issuing either stock or borrowing money in US dollars to limit China’s ability to finance its economic war upon us.
  7. No Chinese individuals planning to return to China can receive student visas. We will no longer educate the global competition. Our schools will educate Americans first and foremost.
  8. America works best when it works together, so recognizing this, and to ensure calm in financial markets, the Federal Reserve should announce it will coordinate monetary policy with fiscal policy. It’s time for the Fed to stand with Trump and not with China, which needs to see our economy slow. Namely, in conjunction with these actions on trade, the Fed should announce an immediate 1% interest rate cut to 1.38% and end to balance sheet normalization. Moreover, the Fed should pledge to increase the supply of dollars with an unlimited QE program whenever the trade-weighted dollar passes $125 (it is nearing a record of $130) to defend against foreign currency manipulations and protect American exporters. These policies will boost growth and minimize any disruptions to markets.
  9. Until and unless Democrats agree to immediately use the tariff revenue (at least $90 billion in year 1) to fund new infrastructure projects via a new “China Rebuilds America Fund,” which would make the tariff policy clearly pro-growth, Trump should order the Treasury to dividend all China tariff revenue to each state government on a per capita basis (ie a state with twice the population gets twice the revenue), ensuring fair and equitable distribution. With the influx of cash, each state government can recycle the tariff revenue into their economy as they see fit (lower taxes, infrastructure, or more school spending) with no strings attached.
  10. Trump should direct every regulatory body to streamline permitting and regulatory processes and hasten coordination with private sector bodies and companies to increase apprenticeships and job training to increase US domestic manufacturing capacity as quickly as safely possible.
  11. Finally, the Administration should begin “break-glass” preparations to freeze and seize China’s US Treasury holdings in the event the Chinese government tries to sell to disrupt financial markets. The treasuries could be placed in the Medicare and Social Security trust funds to improve their financial health. Such a move would cripple China financially but should only be taken if China retaliates in a particularly destructive fashion.

 

This policy playbook, combined with already announced policy actions, would show that the Administration is taking the China threat seriously. Increased tariffs and sanctions would put tremendous pressure on the Chinese economy while coordinated policy-making from the executive branch, Federal Reserve, and congress or state governments can ensure the domestic economy continues to run hot. Policy coordination is absolutely critical.

As we stare down China, history will remember this moment as a generational opportunity to protect our industrial base and a free world. It is a time for choosing; will we be a nation of Churchills or Chamberlains?

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How to Protect Social Security and Medicare

Recently, the social security trustees offered yet another stark reminder that America is nearing an entitlement crisis. Within a decade, the Medicare hospital trust fund will be insolvent; within two decades, social security will be. When that happens, each program will be forced to automatically cut benefits—in the case of social security by over 20%. To fully fund the shortfall for the next 75 years, we would need to immediately inject about $17.5 trillion into the two programs, $3.5 trillion into Medicare and $14 trillion into Social Securitya financial impossibility. 

Over time, it is a financial necessity to make some changes to the programs, like a gradual increase in the retirement age, to improve their financial situation and ensure they will be there for future generations. Donald Trump promised to govern on behalf of the forgotten men and women of the working class who in particular rely on these programs in their sunset years, which is why it is critical he takes steps to sure up their finances. 

 

Now, not only is it financially impossible to fully fund these programs for perpetuity today, it is unnecessary. The $17.5 trillion shortfall is a best-efforts estimate that can shift materially if for instance economic growth is faster than forecast, which would result in higher tax revenue. Nonetheless, Social Security and Medicare clearly face shortfalls, and we should find ways to extend the trust funds’ lives. Fortunately, there actually is a way to materially extend these programs’ lives, reduce today’s budget deficit, make mortgage rates lower, and not reduce benefits by a dollar. 

 

The United States Treasury should sell $2 trillion in zero  couponputable, perpetual bonds (more on their structure below) to the Federal Reserve, America’s central bankIn turn, about $600 billion would be granted to the Medicare hospital trust fund and $1.4 trillion to Social Security’s trust fund. With these additional sums, Medicare would be able to meet current benefits into the mid-2030s, about a 10 year improvement, and Social Security into the mid-2040s, about a 5 year improvement. This step would provide more security and certainty to older Americans and give us more time to make gradual changes to the programs for future beneficiaries to further extend their solvency. 

 

Now as is the case with existing trust fund sums, this $2 trillion would be invested over time in US treasury debt. With the budget deficit likely to surpass $800 billion annually in coming years, the trust funds’ buying power would essentially cancel out 2-2.5 years of new budget deficits. By buying US debt, we would be selling fewer treasuries to private investors, this reduced supply would mean we can sell our debt at a higher price, all else equal. In other words, we would sell debt at a lower interest rate. Paying less in interest would bring down the US budget deficit somewhat. Additionally, US treasury interest rates are the benchmark off of which most banks determine their mortgage rates, business loan interest rates, and so forth. So, a lower treasury rate will translate to lower mortgage rates, making home buying more affordable. 

 

To some, this may sound too good to be true. If we are putting more money into entitlement programs, and bringing down the cost of debt in the process, there must be a catch, and they would point to the $2 trillion in bonds the government would sell to the Federal Reserve. Note though that the bonds sold to the Fed are “zero coupon,” which means they pay no interest, meanwhile the trust funds would be using the proceeds to buy US treasury debt that does pay interest. Additionally, these zero-coupon bonds are “perpetual,” meaning they never have to be paid back. In reality, these Fed-owned bonds hold no economic value. However, the Fed would “print” $2 trillion to send to Medicare and Social Security in exchange for them. At this point, some may say I am merely proposing printing money to pay for entitlements, which will cause inflation and weaken the dollar. As I will explain, that is actually not what I am proposing, but first, let me rebut the case that printing money in the first place would definitely be inflationary.

 

Over the past ten years, the Federal Reserve has printed about $3.4 trillion buying treasury and mortgage bonds, nearly quintupling its balance sheet to $4.3 trillion. During this time, the US dollar has actually strengthened by over 26% on a trade-weighted basis and core inflation has averaged less than 1.6%, below the Fed’s target of 2%. The many predictions that Fed policy would create runaway inflation simply have not come true. 

 

Moreover, it is worth noting that the fashion in which the Federal Reserve operates its monetary policy has exacerbated income inequality and the stagnation of median incomes for the past two decades. Targeting 2% inflation, the Fed tends to raise interest rates as we near full employment. Now, it is during periods of at or near full employment where workers are more in demand than in supply, meaning they enjoy the greatest wage increase. Immediately after a recession, even as business improves, there are many people eager for work, so businesses don’t have to increase wages even as the business grows, leading to higher profit margins. Periods of full employment reverse this with workers getting a bigger share of the pie. However in its fear of inflation, the Fed raises rates as the labor market improves, truncating the time spent in a tight labor market relative to the time in a loose labor market

 

As this continues over each economic cycle, business owners get a gradually increasing piece of the economic pie at the expense of workers, widening inequality and leaving our middle class behind. In fact, over the past twenty years, core inflation has averaged 1.7%, missing the Fed’s 2% target and showing its preference for low-inflation periods when businesses have the bargaining power to tight labor market periods when workers do. Using the Fed balance sheet to support entitlement programs that particularly benefit middle and working class Americans would help counteract this bias. 

 

Now to those still unsatisfied by my argument that using the Fed to create money is not problematic, I wish to explain why I am not proposing printing money. Rather than have the Fed print $2 trillion, I recommend selling $2 trillion in zero coupon, putable, perpetual bonds. True, zero coupon perpetual bonds have no economic value, but note the word “putable.” Putable means the Fed can “put back” (sell) the bonds at face value to the treasury if certain conditions are met. Namely, in any month when the core PCE index (the Fed’s preferred inflation measure) rises by 3-3.5% year over year, $50 billion of bonds are put back, 3.5-4% $75 billion, 4-4.5% $100 billion, 4.5-5% $125 billion, and over 5% $150 billion.

 

Essentially if I am wrong, and this program causes inflation to rise materially above the Fed’s 2% target, the Fed would be able to sell the bonds back, taking the US dollars back out of circulation, thereby tightening policy to bring inflation back down. Given that inflation hasn’t passed 3% on an annual basis in 26 years, it is likely that little if any of this $2 trillion bond is ever put back to the treasury. And if such a period comes sufficiently in the future, the amount saved on interest payments thanks to Social Security and Medicare buying treasury debt may well exceed the cost of buying back these putable bonds. I would venture a prediction that this $2 trillion bond issuance does not lead inflation to breach the putable levels over the forecastable horizon.

 

Given the structural undershoot of inflation, a middle class that has been left behind, and the pressing need to provide support to Medicare and Social Security, selling these bonds to the Federal Reserve is a gamble well worth taking. I would recommend beginning with this $2 trillion program, because the sum is large enough to postpone our entitlement crisis several years, but I wouldn’t attempt to fund all of the $17 trillion shortfall today as that would raise the risk of causing excess inflation, undermining the purpose of the program. Rather, it is best to take one step likely to succeed today, and then, 5-10 years down the road, the exercise can always be repeated if it proves as successful as I anticipate.

 

While virtually all Americans agree it is critical to preserve these programs as best as possible, some may question the wisdom of perpetuating them in their current form, and to them I would highlight some key points. First, we should ask honestly ourselves whether Congressional Democrats and Republicans, who both clearly like to spend money when in power, would actually permit Social Security and Medicare to cut benefits when their trust funds run dry? Or rather, would they either raise taxes or sell more debt to the public to fund the shortfall? It seems clear to me that it is better to try my strategy of issuing perpetual debt than issuing debt that has to be repaid to investors or raising taxes on hard-working Americans.

 

Some others may argue that it is unwise to take this course of action when there would remain a $15 trillion problem. To them, I would make two points. First, I think it better to solve part of the problem than none of it. Second, I don’t pretend this plan is a be-all, end-all solution. Rather, it is intended to add several years of viability to these programs to ensure they can meet the promises made to those at or near retirement who need certainty. It would be fantastic if this $2 billion Federal Reserve bond were paired with measures like gradually lifting the retirement age by 2 years starting in 2024 and moving future Social Security benefit cost of living adjustments to chained-CPI from headline CPI. These measures combined with the $2 trillion cash infusion would greatly extend the lives of Medicare and Social Security. Like President Reagan in 1986, I believe Republicans should take the lead in solving entitlement problems before the crisis is upon us. However, I would rather issue this zero-coupon bond then permanently raise taxes.

 

Last, it is critical to emphasize again that while America faces a public debt problem and a deficit problem, it does not face an inflation problem. That is largely because the Federal Reserve has run a structurally hawkish monetary policy that has led to below target inflation and lackluster median wage growth. While the Fed, through its quantitative easing program, has been happy to buy bonds to push up asset prices and make the rich richer, it has consistently acted to raise rates and slow the economy as it senses that upward wage pressures are increasing.As such, the one risk my policy increases, inflation (albeit as highlighted above, I emphasize my skepticism inflation would materially rise), is one the economy can afford, if only to counteract the years of overly hawkish Fed policy that have left the middle class behind. Moreover, given the putable nature of my bonds, any period of higher inflation would be short-lived as the Fed puts the bonds back to the Treasury and takes dollars out of circulation. All told, these risks stack up attractively versus the potential of putting $2 trillion into entitlements without issuing debt that has to be repaid or raising taxes.

 

Donald Trump was elected President because he promised to bring new thinking to our politics, and given the size of their problems, new and innovative thinking is needed to secure Social Security and Medicare. Issuing $2 trillion in zero coupon, putable, perpetual bonds to the Federal Reserve would greatly enhance these programs’ viability at no cost to taxpayers. In fact, by pushing down treasury bonds’ interest rates, taxpayers would save money in coming years.

 

Let’s act now to protect the retirements of America’s forgotten men and women.