He believes China can continue on it's current path until 2013, when a major readjustment becomes inevitable. I believe that assesment is correct, if no major crisis occurs and the Fed and ECB do not engage in obscene and unreasonable printing (which probably they are just about to start).
The situation is getting critical by the day, and last Thursday, Yu Yongding, former member of the monetary policy committee of PBoC, voiced in FT a clear warning about pursuing the current course. For those who are familiar with the ways of taking political decisions at the top of Chinese Communist Party, it is obvious that there is already a fraction in PB0C and the Party who has wet their pants thinking at the consequences of a monetary hardlanding. The end of the opinion published in FT sounds as if mister Yongding has been for years an avid reader of UC :
China has run a current account surplus and a capital account surplus almost uninterruptedly for more than two decades. Inevitably this has led to an accumulation of foreign reserves. It is clear, however, that running these surpluses persistently is not in China’s best interests. A developing country, with per capita income ranking below the 100th in the world, lending to the world’s richest country for decades is not reasonable. Even worse is the fact that [...] China essentially lends money it borrowed at a high cost back to its creditors, by buying US Treasuries, rather than importing goods and services.Now, I would like to explain another more obscure detail of the current global financial distortions, which concerns the regime of currency manipulation practised by most of EM.
[...]
One further factor is that any losses in the financial assets held by China will not be realised until their holders decide to cash out. If the US government continues to pay back its public debt, and China continues to pack its savings into US securities, this game may continue for a very long time. However, the situation is ultimately unsustainable. The longer it continues, the more violent and destructive the final adjustment will be.
If there is any lesson China can draw from the US debt ceiling crisis, it is that it must stop policies that result in further accumulation of foreign exchange reserves. Given that many large developed countries are simply printing money [...] China must realise that it can no longer invest in the paper assets of the developed world. The People’s Bank of China must stop buying US dollars and allow the renminbi exchange rate to be decided by market forces as soon as possible. China should have done so a long time ago. There should be no more hesitating and dithering. To float the renminbi is not costless. However, its benefits for the Chinese economy will vastly offset those costs, while being favourable to the global economy as well.
For any currency manipulation there is what we can call a narrow window of profitability. The theory is rather complicated, but in the essence the basics are simple. Assuming for the mercantilist currency a value M0 of Fx equilibrium with respect to the aggregate commodity trade required for that economy we can define:
-a value M1 (M1
Mx c [M1,M2]
Obviously Mx/Cx represents the foreign exchange ratio of the two currencies.
In practice there is always more than one mercantilist country praying on more than one consumer (deficit) economy and we are dealing now with a cumulative effect. Assuming that today we have a single consumer (deficit) golbal currency, since the central banks of G7 act in strict coordination, this consumer currency is lifted with respect to all commodities by the sum of al mercantilist effects produced by all mercantilist countries ranging from China to Lesotho.
I won't put here the math, but basically the consumer currencies are lifted by each mercantilist currency with a share roughly corresponding to the ratio between the GDP of each mercantilist country and the GDP of the G7 (plus minor friends).
If the G7 start to print, the mercantilist countries are pushed out of their sweet spot with respect to the Fx ratios since the value of the consumer currencies with respect to commodities decreases. If the mercantilist countries tried to maintain constant the Fx rate, then they have devalue below M2 and any they have to resort simply to exporting at a loss.
If the mercantilist countries try to maintain themselves at M2 (basically at profit margin) while the consumer countries continue to print, then they have to allow the Fx rates slide slowly while looking at the losses which keep accumulating in the system at an alarming pace. One may look at the USD/CNY rate for the past 5 years to see this trend.
Also what is not very clear understood is that if all the mercantilist countries act as a currency manipulation aggregate and all are keeping their currencies close to M2 values, it is enough to have just one of them loosing control over her currency and in that moment the debt currency is devalued just enough to get them all out of the profitability interval. Of course if Lesotho or Vietnam lose control over their currency the effect is negligible, but if that happens in Brazil, for example, the whole edifice collapses and China won't be able to maintain it's currency manipulation system. It will be a domino effect.
The last observation is with respect to commodities. Any mercantilist currency manipulation scheme results in an artificial increase in the industrial and productive activity, being it for accelerated economic development or for vendor financed trade. As a result the system is pushed into higher levels of consumption of commodities.
When such system collapses, there are are two opposite effects which determine the pricing of commodities with respect to the debt/consumer currency. One is that the debt consumer currency tends to return to it's equilibrium value with respect to all commodities, which would lead to higher prices of commodities in that currency.
The opposite effect is generated by the fact that suddenly there is an overproduction crisis and there is less demand at least for certain commodities. What happened to the price of commodities during the Great Depression is a clear illustration that a a global industrial readjustment can trump the devaluation of consumer/debt currencies if we think at the evolution of the prices of various commodities in a debt currency of the time such as the British Pound.
15 comments:
If the ECB buys $1.2T of bonds in the forest with no one else around, does anyone care? Almost seems like not.
http://www.bloomberg.com/apps/quote?ticker=GSPG10YAR:IND
I guess the Old Money knew to hide at BKNY deposits... man
3MO BankBill/OIS just went stratospheric to 79bps. Up 21bps on FINS weakness, to October 08 levels.
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Old money was right!
Wow yesterday was exciting.
A fresh hell with each passing
hour.
I have a Platonic version of my questions (left out control Lyapunov because I don't want to confuse you all).
Given that the act of borrowing $ for 0.25% at the discount window and placing in reserves @0.25% = free money then what would be the best of all possible worlds for recipients?
-Would I want to buy up assets at high prices or low prices?
-Would this work out better in a weak currency or a strong currency?
-Do I want high equity valuations or low?
-Do I want competition for asset purchases or do I set commercial rates at 5.8%?
-If I purchase Congress do I want high taxes for Everyone Else or low?
-Are parts of BAC a juicy target or is the whole thing worthless?
-If Australia had the world reserve currency would they want metal prices to be high or low?
You get the picture, Plot it
Yourself.
Question CLN
Is the current US monetary base insufficient to repay Treasury debt?
Can this be amended by some judicious discount window borrowing (and reserve creation) to buy up the world on sale?
If the G7 prints for the preservation of the EU, would this be mostly $ neutral?
From MtgSpy:
This is a cap in interest rate. Don't fight the fed. They start with a 2yr cap, then if doesnt work go to 5yr cap, 10yr cap, etc.
Entire yield curve has repriced, 2yr tsy now about 18 bps yield and will go to zero in days.
5yr treasury next.
If it does carry trade, buy it. Don't bother analyzing.
@ GTT- Nope they don't care. Or not yet. As long as EUR doesn't take a dive with respect to USD nobody will care how much trash ECB is buying.
@ qadi - Old Money always knows where to hide since basically they owe Wall Street and the Fed and pretty much everything else.
@ Morgan - The idea is not to pay the debt, but to engage in a stealth debasement default (boiling frogs slowly). If treasury yields are below the debasement/global-inflation rate, then it's obvious that all T paper has negative real interest rates. As a result the best game for Fed and for its masters to let the debt grow as much as possible.
When T paper will be replaced by excess reserves held by foreign central banks (and maybe foreign private banks) on the balance sheet of the Fed there will be no need any more for ballooning the US gov debt.
On the rest basically you are right. By inducing a regime of mild inflation in US while pushing the rest of the global financial system in a dollar deflation, they are creating the perfect environment for buying the rest of the world on cheap. Actually is a twist of the old inflation-deflation scam.They are not interested in buying directly the underlying assets but to get the juicier returns from credit extended on all global assets/collateral.
About the smoke and mirror game of excess reserves the situation is like this:
-the select recipients receive this gift from the Fed but they can't spend or lend most of this money.
- the whole thing is made to dump risk from the balance sheet of some banks into the Fed, which by definition is risk immune as a bank since they have the power of printing.
-the whole exercise is made to create the illusion of proper capitalisation of a few banks, while the rest of their competition is left dry without liquidity. This will result in an unprecedented concentration of the banking system in the hands of a few players.
2@ qadi - I believe MtgSpy is correct. The Fed has to floor the yields and flatten the curve, in order to have this strange show going on. They've announced they will be zirping for at least another year. Until we don't see loads of excess reserves of foreign banks mushrooming on the balance sheet of the Fed I don't see there is any danger to see any normality in the yields or in the yield curve.
In the next stage we should witness how they will pump up the equity markets with capital inflows from overseas. I suspect they will start to do that immediately after the dust settles in the equities markets in ROW.
The game the Fed is playing is actually pretty simple and I am astonished that we don't have more people seeing through their posturing, lies and show of smoke and mirrors.
Anyone have an opinion as to how much of this mini crash was a politically motivated takedown, how much was geniune fear sown by the PIIGS?
One thing we do know - the MSM tagline of "the downgrade was responsible" had nothing to do with it ;)
Very slow here...
Why will foreign creditors see dollar deflation given the dollar depreciation?
What will induce the foreign capital inflow in the next few weeks?
@ GTT - I see things a little bit different. The minicrash was more financially motivated as a move in the ongoing currency war. The PIIGS are not a revelation and the situation in Greece is nothing new. (Actually Greece is not herself the gravest EU problem).
At the lower level of the financial food chain, I believe though that the panic was real. Let's say that the situation in Greece was well speculated to support a move which was going to be implemented anyway.
@ gler - because most of foreign creditors do not have dollar reserves as net wealth accumulation. EU banks are far more leveraged than US banks. China and other EM countries too have their T paper as assets matched on their balance sheets by domestic liabilities.
Some big commodities exporters have also their internal capital markets propped by USD leveraged capital.
For example Russia is getting the air sucked out of its internal markets and was forced today to undertake a massive intervention in order to prevent a new run on the ruble.
We are withnessing some really schizoid reactions of the market. Next we will probably hear that stocks in Asia are rebounding on the news that the Fed will keep the zirping going for at least one more year, since if the tap of dollars is left on, the export of mercantilist Asian countries can continue (until the first piece of the domino falls).
I am not sure though that we will see massive foreign capital inflows in just a few weeks, unless the yuan breaks of PBoC control and crashes up. IMHO this is highly unlikely but not impossible by any means.
I don't think we will see an influx of foreign capital flowing into US equities until the gold price doesn't have it's dive and gets to some kind of subdued bottom.
As long as the gold price soars and the T yields remain floored (with the yield curve hit by a train of deleveraged foreign investors), and the Yuan is still kept under control, there isn't too much chance to see massive foreign capital inflows into US markets.
The immediate next move to follow is a divergence between gold price and Tsy yields. which should be preceded by negative gold leasing rates (if we get to that point of high panic).
The big problem is that now we are living in a regime of command economy, where the best investment strategy is to be able to guess what is going to be the next brutal distortion implemented by the Fed and Gov and then to figure out how exactly this distortion will affect the market. It is as sad at that.
Maybe not massive, but one short term source of capital might be all that money in Swiss bank accounts. With the Swissy at $1.32 and US stocks 20% off, these people are getting a massive discount on US equities compared with just a few weeks ago.
@ GTT - I don't see the Swiss money as a major component. we are talking here about herding and netting.
I would expect for a while to see a net outflow from US equities. Even if Swiss investors find now that US stocks are cheap due to CHF soaring, I guess they will be more inclined to short their own currency, then to dump money into a falling Dow.
I believe we will see net inflows in US equities from ROW, starting to pour as a result of worsening of domestic markets and the collapse of various over-investment bubbles.
Repeat as long as gold still surges and T yields are being floored, IMHO we have little chance to see massive net inflows into US equities. Once the we see a divergence between gold price and yields, then we can count on US stock markets bottoming and expect capital inflows.
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