Sargen on China – U.S. Tensions…Diminish for Now


  • Notwithstanding adverse political news at home, the Trump rally has continued amid favorable economic news and investor optimism about pending corporate and personal income tax cuts.  Diminished tensions between the Trump Administration and China have also lessened the risk of a trade war.
  • The key event was President Trump’s reaffirmation of the “One China” policy to President Xi in a telephone exchange earlier this month.  At the same time, Defense Secretary Mattis talked about the need for a diplomatic rather than military solution to the dispute in the South China Sea, which the Foreign Ministry in China welcomed.
  • With Steve Mnuchin assuming the helm as Treasury Secretary, market participants are awaiting the stance the Treasury will take on whether to declare China a “currency manipulator.”  Press reports suggest the Trump Administration may change tactics, so that China is not singled out.
  • The bottom line: The risk of an escalation in tensions between the U.S. and China has lessened, and it appears moderates in the Trump Administration are calling the shots.   Nonetheless, circumstances could change if the dispute in the South China Sea heats up or if China’s trade surplus with the U.S. were to increase.

President Trump Moderates His Stance on China

At a time when the Trump Administration has been engulfed with a series of adverse political developments, market participants appear oblivious to them, and the so-called Trump rally lives on.  The principal reasons are that news on the economic front has been favorable, consumer and business confidence readings remain high, and investors are focused on the prospect for significant cuts in both corporate and personal tax rates.

In addition, a potential negative factor –namely, the prospect for a trade war between the U.S. and China – has also diminished recently.  The key development was a sudden reversal in President Trump’s stance toward China.  Throughout the presidential campaign, Mr. Trump took a hard line on China, claiming that its trade policies were unfair, and on several occasions he called for imposing tariffs of 35% on Chinese imports into the U.S.  Immediately after assuming office, President Trump upped the ante by congratulating the leader of Taiwan and by indicating he was open to reviewing the One China policy that China’s leaders regard as non-negotiable.

During the past month, however, the Trump Administration has softened its stance considerably.  In a telephone conversation with China’s leader, Xi Jinping, the President retreated from his earlier statement, and he indicated the White House had agreed to honor the One China policy “at the request of President Xi.”

The timing of the call was significant, coming just before President Trump met with Japanese Prime Minister Shinzo Abe to discuss the commitment of the U.S. to East Asia. It also coincided with a trip to Japan and South Korea by Defense Secretary Mattis, during which he talked of the need for a diplomatic rather than military solution to the dispute over islands in the South China Sea. The Foreign Ministry in Beijing welcomed the remarks and the Chinese press called them a “mind-soothing pill” that “dispersed the clouds of war.”1

Looking behind the scenes, these developments suggest that moderates in the Administration such as Secretary of State Rex Tillerson, Defense Secretary James Mattis and National Economic Council Director Gary Cohn are calling shots on China policy for the time being.  This is reassuring to those who worried that Peter Navarro, Wilbur Ross, and Robert Lightziger, who have a more protectionist bent, could be in charge of trade policy.

Is China a Currency Manipulator?

With Steven Mnuchin now confirmed as Treasury Secretary, market participants will now be watching to see whether the Treasury declares China to be a “currency manipulator,” as Mr. Trump suggested during the presidential campaign.  Since 2015, the criteria that the Treasury has used for making such a designation has been three-fold: (i) the country has a large current account surplus, defined to be in excess of 3% of GDP; (ii) it has a large bilateral trade surplus with the U.S.; and (iii) it intervenes in the currency markets to weaken its currency versus the U.S. dollar.

Based on these criteria, China meets only one condition – namely, it has a large bilateral surplus with the U.S.  Its overall current account surplus, by comparison, has fallen steadily over the past decade, and is currently less than 3% of GDP.  And while the Chinese authorities intervene regularly in the foreign exchange markets, since 2014 they have been primarily sellers of U.S. dollars.  The reason: China has experienced massive capital flight that far exceeds its currency account surplus, and the authorities have been trying to limit the depreciation of the RMB versus the dollar.

Weighing these considerations, the Treasury in the past has refrained from declaring China to be a currency manipulator.  If it were to do so now, the rationale would be political rather than economic.  Even then, it is unlikely the Trump Administration would want to escalate the issue at this time when it already has moderated its stance.

A recent Wall Street Journal article (February 14, 2017) stated that the White House is exploring a new tactic to discourage China from undervaluing its currency.  Under the plan the Commerce Secretary would designate the practice of currency manipulation as an unfair subsidy, without singling out China, and U.S. companies could then bring complaints to the Commerce Department.  While this tactic is in keeping with the stance adopted by previous administrations, Chinese officials reportedly are bracing for an unprecedented number of trade disputes, and they are considering possible retaliatory actions.

Avoiding a Full Scale Trade War

Both the United States and China for the time being are seeking to avoid a full scale trade war that would produce a “lose-lose” situation.  Investors, nonetheless, must consider the possibility of such an outcome in the future, especially if China’s bilateral trade surplus with the U.S. were to widen, while the RMB would weaken further against the dollar.

The latter outcome remains a distinct possibility for two reasons.  First, U.S. import demand is likely to surge if the U.S. economy continues to gain traction, and imports from China would in turn be boosted. Second, a stronger economy is likely to bring the Fed into play, and a widening in interest differentials between the U.S. and China would place added pressure on the RMB. In these circumstances, the Trump Administration could very well come down on the side of those who contend China is manipulating its currency, even if the Chinese authorities intervene to limit the depreciation of the RMB.

In these circumstances, markets are likely to focus on whether any sanctions imposed by the U.S. are targeted to specific items or are broadly based and severe. In the former case, markets would likely take the news in stride, as there are numerous instances in which the U.S. has imposed sanctions on select items.  However, if the Trump Administration were to up the ante by imposing broad-based sanctions – including high tariffs across a wide range of goods – markets would likely sell off, as investors would anticipate retaliation by the Chinese authorities and other countries that are affected.

Our assessment is the risk of a full scale trade war has lessened for the time being.  However, political developments such as a widening in the dispute over islands in the South China Sea or adverse developments in the U.S. could result in an escalation of trade tensions at some point.  In this respect, the risk of a trade war cannot be ruled out entirely.

1See Goldman Sachs report “Top of Mind,” February 6, 2007.

NY Financial Services Department Adopts Final Revisions to Cybersecurity Requirements

The New York Department of Financial Services (“DFS”) adopted final revisions to its new cybersecurity regulations, which apply to a wide range of insurance, banking and financial services companies (“Covered Entities”) under its supervision (see previous coverage of the proposed revisions). The regulations will take effect on March 1, 2017 and, starting in 2018, will require a Covered Entity to prepare and submit a Certification of Compliance annually by February 15 to the DFS concerning the firm’s cybersecurity compliance program.

Required elements of the program include (i) the means to prevent and detect cyber events, (ii) the development of a cybersecurity policy, (iii) the appointment of a “qualified” chief information security officer, (iv) testing programs, (v) audit trails and (vi) access controls.

New York Governor Andrew M. Cuomo praised the new regulations:

“These strong, first-in-the-nation protections will help ensure [the financial services] industry has the necessary safeguards in place in order to protect themselves and the New Yorkers they serve from the serious economic harm caused by these devastating cyber-crimes.”


Lofchie Comment: New York State has been very aggressive in regulating and sanctioning firms engaged in financial activities. In their original form, the rules proposed by New York State to regulate “money laundering” set impossible-to-meet compliance standards. (Ultimately, the rules adopted by New York State were less draconian than those that were proposed originally, but that is saying very little.) The adopted Cybersecurity regulations are open-ended, complex and burdensome and will result in creating many new ways for the government to collect fines when something goes wrong. The fact that New York State rushed to declare itself “first in the nation” to adopt such a detailed set of rules suggests that its local government is too eager to place onerous requirements on the financial sector and, as a consequence, expand opportunities to collect fines.

That said, firms must abide by the new compliance obligations and do their best not to give New York State an opportunity to collect.

An Interview with William A. Barnett

CFS Director William A. Barnett is interviewed by Apostolos Serletis.  The conversation covers Bill’s life as a rocket scientist, work at the Federal Reserve Board, pioneer of monetary aggregation and complex dynamics, founding journals and societies, work at CFS, and more.

The interview is similar in construct to discussions with eminent economists in Bill’s book co-edited with Nobel Laureate Paul Samuelson – “Inside the Economist’s Mind.”

To view the full interview:

I hope that you find the exchange about Bill and his remarkable career informative and enjoyable.

FINRA Sets Effective Date for Mark-up/Mark-down Disclosure Requirements

FINRA notified member firms that the SEC approved FINRA amendments to Rule 2232 in order to require the disclosure of markups on certain transactions in corporate debt or agency securities with retail customers (i.e., customers that are not institutional accounts as defined in FINRA Rule 4512(c)). For covered transactions, the amendments require dealers to disclose mark-ups or mark-downs from the prevailing market price for the relevant security on the customer confirmation that the dealer sells or buys the security to or from a retail customer, and then buys or sells the same security as principal in an equal or greater amount on the same day from another party.

FINRA noted that the final amendments will become effective on May 14, 2018, which is the same date as the effective date for the MSRB’s parallel confirmation disclosure requirements.

Lofchie Comment: Firms should allow sufficient time for putting the technology and processes in place to comply with the new rules, which could be fairly complicated to implement given the need to “match” prices on particular purchases and sales that often will not bear any particular relationship to one another. Markups will be required to be disclosed on certain transactions for which there is deemed to be an offset, but not on similar trades that cannot be matched to a trade on the other side of the market. Even after the trade matching and markup calculation system is implemented, ongoing checks will be required in order to ensure that it is functioning.

CFS Monetary Measures for January 2017

Today we release CFS monetary and financial measures for January 2017.  CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.9% in January 2017 on a year-over-year basis versus 5.1% in December 2016.

For Monetary and Financial Data Release Report:

For more information about the CFS Divisia indices and the data in Excel:

3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

FINRA Expels Broker-Dealer from FINRA Membership

A FINRA hearing panel expelled Red River Securities, LLC from FINRA membership, and barred its CEO from associating with any FINRA member in any capacity. The sanctions stem from the panel’s findings that the firm and CEO (together, the “Defendants”) intentionally misrepresented and omitted material information regarding sales of joint venture interests that the panel found constituted “securities.” FINRA ordered the defendants to jointly and severally pay $24.6 million in restitution to investors.

In addition, the panel found that (i) the firm improperly approved two customers as suitable, who, in fact, were not suitable, to invest in the joint ventures, and (ii) the Defendants failed to maintain and enforce written supervisory procedures and an adequate supervisory system. The hearing panel dismissed, without discussion, allegations by the FINRA Enforcement Department made in July 2015 that the firm violated the general solicitation prohibition for the private placement of securities under Regulation D.

Lofchie Comment: From a legal standpoint, the most interesting aspect of the case was the holding that, under the “Howey analysis” (who remembers this “orange grove case” from law school?), the general partnership interests were “securities,” since the investors were expecting not to take part in the management of the business, but to rely on the efforts of the sponsors of the joint venture.

CFTC Commissioner Bowen Describes “Four Disruptive Elements” Driving Regulatory Activity

CFTC Commissioner Sharon Y. Bowen identified “four disruptive elements” that are “substantially responsible” for recent regulatory activity: technology, demographics, economics and institutions. In a speech at Northwestern University as part of the 2017 Brodsky Family Northwestern JD-MBA Lecture Series, Commissioner Bowen described these “disruptive elements.”

  • Institutions. Commissioner Bowen contended that the United States is experiencing a “crisis in our institutions, and that is a crisis for our markets, for our government, and for our society.” In order to “increase trust in institutions,” Commissioner Bowen stated, the CFTC must be “willing to be more aggressive in enforcing our rules fairly, including being willing to take individuals and institutions to court rather than just settle with them.” She asserted that the CFTC should fulfill the Dodd Frank Act requirement to “promulgate a regulation to improve governance” and “rebuild faith in institutions.”
  • Economics. Commissioner Bowen urged market regulators to be more aware of “how the overall economy is functioning and what effect market regulations are having on the economy.” She highlighted position limits rulemaking by the CFTC as an example of “democratizing . . . markets and making them more accessible and fair to consumers and investors.”
  • Technology. Commissioner Bowen identified technology and cybersecurity issues as key marketplace disruptors. She expressed optimism that the CFTC will complete its work on Regulation Automated Trading, and noted that the CFTC adopted enhanced cybersecurity safeguard requirements. She urged regulators to be “mindful of the human dimension of these changes and watch for ways to encourage technology while also supporting the people displaced by it.”
  • Demographics. Commissioner Bowen called on regulators to respond to demographic considerations and encourage companies, nonprofits and the government to increase diversity.

Lofchie Comment: Here are four other factors that greatly affect the financial industry in general, and CFTC-regulated entities in particular: (i) the costs of regulation, (ii) the pace of regulatory change, (iii) declines in liquidity and cross-border markets caused by regulation, and (iv) uncertainty about the imminence and outcome of regulatory enforcement actions based on ambiguous trading requirements. Those might not be the most impactful factors, but they certainly are worth Commissioner Bowen’s consideration.

Commissioner Bowen should consider why the number of registered futures commission merchants has dropped so precipitously in the last few years. It isn’t because of demographics or a loss of trust; it’s because firms can’t operate profitably. (Seee.g.this information from the CFTC. Note that the data is from year-end 2014 and the decline has since continued.) In the absence of any meaningful evidence that more expensive regulatory requirements are necessary, the notion that imposing more of them (e.g., more rules on position limits) in order to help sustain futures seems ill considered. Commissioner Bowen should acknowledge the problem that futures commission merchants have become too big to fail because all but a few have shut down. In that regard, it seems ironic that the story of Commissioner Bowen’s call for more regulation appears on the same day as a story about a major firm dropping out of the clearing business.

Click here to read other news stories regarding Commissioner Bowen.

Federal Reserve Governor Tarullo Resigns

Board of Governors of the Federal Reserve System (“Board”) Governor Daniel K. Tarullo submitted his resignation letter to President Trump. The resignation is effective April 5, 2017. Governor Tarullo’s departure will leave the Board with three vacancies.

Governor Tarullo served as Chair of the Board’s Committee on Supervision and Regulation and Chair of the Financial Stability Board’s Standing Committee on Supervisory and Regulatory Cooperation. He also served as the informal “Vice Chairman of Supervision,” a Dodd-Frank created position that was never filled by President Obama. In that capacity, Governor Tarullo has been recognized as the architect of much of the Board’s post-crisis policy and regulatory decision-making.

The four current Governors are: Stanley Fischer (term expires January 31, 2020); Janet Yellen (term expires January 31, 2024); Lael Brainard (term expires January 31, 2026); and Jerome H. Powell (term expires January 31, 2028). The term of current Chair Janet Yellen expires February 3, 2018. President Trump will have the opportunity to influence the direction of the Board by filling the three vacant seats, naming a new Chair, and filling key leadership positions.

Lofchie Comment: Governor Tarullo pursued an expansionary regulatory philosophy. He believed that financial market participants fell into two categories: banks that were at least indirectly regulated by the Federal Reserve Board, and shadow banks that were improperly avoiding regulation by the Board. (See Fed Governor Examines Post-Crisis Financial RegulationGovernor Tarullo Delivers Speech Regarding Shadow Banking and Systemic Risk Regulation.) Throughout his tenure, Governor Tarullo seemed to be oddly hostile to the securities financing markets and largely indifferent to declines in liquidity in the financial markets. (See Federal Reserve Board Governor Tarullo Calls for Regulatory Approach to “Runnable Funding”.)

Governor Tarullo could have remained to complete his full term set to expire on January 31, 2022. It is clear, however that the Governor’s expansionary regulatory philosophy would have come into direct conflict with the views of the new administration. Governor Tarullo’s resignation is significant given the influence that he held over the regulatory direction at the Board.

Bank of England conference in honor of William A. Barnett – Call for papers extended

We are delighted to announce a conference in honor of CFS Director William A. Barnett at the Bank of England on May 23 – 24, 2017.

The call for papers has been extended to March 15, 2017.

Liquidity plays a pivotal role in financial markets, the banking sector, and the economy as a whole. Since the 2008-09 financial crisis, it has become increasingly necessary to understand the creation, dissemination, measurement and management of liquidity.

This conference seeks and invites proposals to understand and assess the macroeconomic implications of liquidity, the liquidity creation process, and the impacts of liquidity on financial markets and economic activity. Theoretical, empirical, quantitative, qualitative, institutional, and historical perspectives that address current theory and policy questions are welcome.

For details to attend the conference or submit papers:

Similarly, excellent peer reviewed papers will be considered for a special issue of the Journal of Financial Stability.

Public Advocacy Groups File Complaint in Response to “2-for-1” Executive Order

The Public Citizen Litigation Group, the National Resources Defense Council, and the Communications Workers of America affiliated with the AFL-CIO (collectively, the “Plaintiffs”) filed a Complaint with the District Court for the District of Columbia arguing that President Donald J. Trump’s “Executive Order on Reducing Regulation and Controlling Regulatory Costs” exceeds the President’s constitutional authority, violates the “take-care” clause of the Constitution, and directs agencies to engage in arbitrary and capricious actions. The Executive Order requires that certain executive agencies rescind at least two regulations in order to issue a new regulation (see previous Cabinet coverage here).

The Complaint claims, among other things, that the Executive Order:

  • “directs agencies to disregard the benefits of new and existing rules,” which will “force agencies to take regulatory actions that harm the people of this nation”;
  • “forces agencies to repeal regulations that they have already determined, through notice-and-comment rulemaking, advance the purposes of the underlying statutes, and forces the agencies to do so for the sole purpose of eliminating costs that the underlying statutes do not direct be eliminated”;
  • forces agencies to violate “the statutes from which the agencies derive their rulemaking authority and the Administrative Procedure Act” (“APA”); and
  • will slow the implementation of governing statutes “to a halt,” due to the new cost assessment requirements of any newly proposed or final rule and at least two existing rules, “although the new rule and the existing rules need not have any substantive relationship to one another and, with approval from OMB, need not even be issued by the same agency.”

Lofchie Comment: The intended point of the Executive Order – that regulators should (i) consider whether the sheer volume of regulations is killing economic growth and (ii) evaluate past rulemakings periodically to consider whether they still (or ever) made sense – is completely reasonable, but the effect is another matter. However sound-bite-worthy the notion of a 2-to-1 rule might be, that is all it should have been: a sound bite. Putting that notion into the actual language of the order made for a needless distraction from the order’s substance.