China, the Fed and emerging markets

Yuan thing after another

A cheaper yuan and America’s looming rate rise rattle the world economy

Aug 15th 2015

THE cloud hanging over emerging markets seemed to darken in the past week. As it was, fears that the Federal Reserve is about to raise rates, pushing up debt-servicing costs and sucking capital out of emerging markets, had been weighing on currencies and stockmarkets from Brazil to Turkey (see chart). Now a fresh worry is blotting the horizon. On August 11th China engineered a small devaluation of the yuan, prompting concerns that, with growth sputtering, its government was ready to risk a global currency war.

The angst about the state of the world’s two biggest economies is understandable. China’s economy has slowed markedly: it is likely to grow by 7% this year, its most languid rate in a quarter-century. In addition the government has been trying to reorient the economy from investment to consumption.

For emerging markets that had been catering to China’s investment binge—those selling it coal and iron ore, copper and bauxite—the past few years have been little short of brutal. The economy’s slowing and rebalancing explain much of the 40% fall in commodity prices since their peak in 2011 and, by extension, the travails of countries which make their fortunes digging stuff out of the ground, from Peru to South Africa.

For other emerging markets, the importance of China as a source of direct demand is less pronounced. Exports to China account for less than 9% of total shipments from developing countries, calculates Jonathan Anderson of Emerging Advisors, a consultancy, whereas exports to the rich world account for 55%. For countries exporting food and fuel—the majority of the global resource trade—China’s slowdown has had a limited impact. Except for a small group of countries heavily concentrated on exports of ores and minerals, “China has hardly mattered at all,” he says.

China can make itself felt in other ways, however. A slowdown in the world’s second-largest economy, for instance, is bound to have second-order effects on demand. Deflation in China puts pressure on firms in other emerging markets to cut prices. And some worry that the yuan’s fall may initiate a series of competitive devaluations, with other exporters racing to weaken their exchange rates or, perhaps, resorting to trade barriers as a last resort.

Fortunately, the changes to China’s exchange-rate regime do not seem nearly big enough to set such a vicious cycle in motion. Even after its devaluation, the yuan remains stronger than it was a year ago in trade-weighted terms. Moreover, the authorities are now intervening to slow its decline. In other words, the depreciation is a small, belated step to keep the yuan’s value in line with those of its peers, not a dramatic shift in exchange-rate policy.

China’s slowdown continues to amplify jitters about the Fed’s impending “lift-off”. The sensitivity of developing countries to changes in policy at the Fed was amply illustrated by the “taper tantrum” of 2013, when the announcement that it would slow and eventually stop its huge purchases of government bonds led to turmoil in emerging markets.

An American rate rise, which may come as soon as September, could put pressure on emerging markets in a variety of ways. Rising rates will add to the allure of American assets, potentially making the dollar even stronger. For the governments, households and firms in the developing world that have borrowed trillions of dollars in recent years, interest and repayment costs will climb in terms of local currency. If fears about their debts lead to more outflows of capital, central banks in the weakest countries will face an invidious choice between letting their currencies plummet and ratcheting up interest rates to defend them. The former will only aggravate the burden of their foreign-debt load; the latter will stifle growth. Bill Gross, the world’s best-known bond manager, has spoken of a “currency debacle” for emerging markets.

Not all agree that higher American interest rates need spell doom. That the Fed has been edging towards lift-off is no secret. Anticipation of this is one reason for the dollar’s recent strength. If its tightening is gradual, as expected, emerging markets may fare better than feared.

The presumption that the dollar strengthens when the Fed raises rates is not borne out by evidence. In the first 100 days of its four big tightening cycles of the past 30 years, the dollar has actually weakened every time, according to David Bloom of HSBC, a bank. The notion that Western central banks’ efforts to keep interest rates low sent a torrent of money into emerging markets that is now about to drain away may also be wrong. Average quarterly flows from America to emerging markets were actually higher before the crisis, according to Fitch, a ratings agency. If so, monetary policy in America may not be the be-all and end-all for emerging markets. That, at any rate, will be their hope.

No Stick Save Thursday For S&P 500
Dave´s Daily
August 20, 2015

Read This, Spike That

Making Sense of the Market’s Big Selloff

There are plenty of reasons for Thursday’s broad-based stock decline. Here’s a round-up of opinions.

By John Kimelman           

Last week, the U.S. stock market took a big one-day hit because of a surprise devaluation of the Chinese yuan. But today’s big drop in stocks appears like it’s coming from many directions, including the U.S.

The Dow Jones industrial average closed down 358 points, or 2.06% taking it to a close of below 17,000 for the first time since last October. The index has fallen 4.5% for 2015. The more tech-focused and riskier Nasdaq fell 2.8% on the day.

A piece by CNNMoney does a decent job summing up the many reasons for the market’s big drop. While some articles simply point to the uncertain tone about the U.S. economy in the minutes of the July Federal Reserve’s rate-setting committee meeting, there’s clearly more going on.

For example, the piece points out that oil fell to a new, six-and-a-half year low Thursday morning before rallying up in the afternoon. “Not only is there an excess of oil globally, but China’s slowdown is driving a collapse in commodity prices. It has hurt many countries whose economies are based on oil, metals and agriculture,” writes CNNMoney. “The commodity bust is bad news for the economic outlook for several countries and the American companies that do business there.”

A piece by Yahoo Finance columnist Michael Santoli discusses the overall investor climate that has contributed to today’s big selloff.
A long-time student of stock-market behavior, Santoli writes that “the August Wall Street vacation evacuation is well underway, markets are facing an absence of inflation, huge air pockets underneath commodities and emerging-market currencies — and a vexing lack of clarity about what the Fed might do in less than a month’s time. The collective response to this environment devoid of strong conviction has been to pull cash out of riskier markets and wait.”

Santoli cities data from Barclays Capital stating that more than $90 billion has sought the shelter of money-market funds in the past six weeks. “That’s roughly the same magnitude of flight response seen in other risk-off spasms of the past four years, from the 2011 Euro debt crisis, the fiscal cliff drama of 2012 and the taper tantrum in 2013,” he adds.

Investors can only hope that this event is like the others that Santoli cites: that it won’t lead to further declines that take stocks into correction territory.

But at times like this, the C word is bound to be brought up.

In a short piece on the site, David Greenberg, president of Schaeffer Greenberg Advisors, wonders whether today’s drop is just the start of something worse rather than a dip worth buying.

Underlying his concerns are what he views as a fragile U.S. economy and an uncertain political outlook.

He writes that the economy is “built on artificially low interest rates and earnings growth derived from firing employees and cutting costs — not from producing and selling more products. The political outlook makes it worse: There is no one (from either side) standing out as someone who understands real fiscal policy.”

He adds, “I am not concerned about this short-term selloff, but I am deeply concerned that the market is setting itself up for a major and long overdue correction.”

Fed Could Be Constrained by Shifting Growth and Inflation Outlook

By Jon Hilsenrath

The Federal Reserve’s official policy statement in July described the risks to U.S. economic growth and employment as “nearly balanced,” but the minutes of the meeting released Wednesday suggested officials don’t strongly believe their own assessment. Officials and Fed staff seem to see risks accumulating on the downside for economic activity, as well as inflation.

Take the staff first. Forecasts for growth and inflation were trimmed. A stronger dollar would weigh on exports and lower oil prices would weigh on inflation, the staff concluded. Since the meeting, the dollar has gotten stronger and oil prices moved lower, likely intensifying that worry.

Moreover, staff was worried that the Fed would be poorly equipped to respond if another shock hits the economy. In other words, the Fed’s own limited policy toolkit – an issue the Wall Street Journal explored in a recent article – was seen as another threat.

“The risks to the forecast for real GDP and inflation were seen as tilted to the downside, reflecting the staff’s assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks,” the minutes showed.

The assessment among policy makers that risks to the outlook for growth were balanced included a qualifier in the minutes that didn’t show up in its official policy statement. Officials are worried about the rest of the world: “Although many continued to see some downside risks arising from economic and financial developments abroad, participants generally viewed the risks to the outlook for domestic economic activity and the labor market as nearly balanced.”

Since the meeting, Chinese officials have devalued their currency, a move that could be seen as another sign of worry in China about its own growth outlook. Meanwhile growth figures in Europe for the second quarter were anemic and Japan’s economy contracted.

The minutes also included multiple references to risks to the inflation outlook: “Some members continued to see downside risks to inflation from the possibility of further dollar appreciation and declines in commodity prices.”

Taken altogether it sounds like a group that needs to be bucked up by stronger economic data in the weeks ahead if it is going to decide to act at its September policy meeting. If Fed officials end up going into their September meeting with lower projections for growth and inflation this year or next, it is going to be hard for them to act.

Reading the renminbi runes

John Authers

China’s economic problems, rather than the PBoC, could drive a devaluation

A commuter walks past the People's Bank Of China (PBOC) headquarters in the financial district of Beijing, China, on Friday, Sept. 12, 2014. Chinese Premier Li Keqiang’s options have narrowed: stimulate or miss his 2014 growth target. The weakest industrial-output expansion since the global financial crisis, and moderating investment and retail sales growth shown in data released Sept. 13, underscore the risks of a deepening economic slowdown led by a slumping property market. Photographer: Brent Lewin/Bloomberg©Bloomberg

“Whatever did he mean by that?” That, at least as far as folklore has it, is how the 19th century diplomat Metternich reacted to the death of his French counterpart Talleyrand.

Many of us have felt the same way as we tried to interpret this week’s events in China, as its highly managed currency suffered its greatest devaluation, of 1.9 per cent, in two decades.
That action was clear. It came the day after China had announced awful export numbers, with the long-time maker of almost everything the rest of the world wanted saying that exports had fallen 8 per cent, year on year. And so the first response was natural enough: this meant war, currency war.
Devaluing a currency makes its exports cheaper for others, and makes life harder for rival exporters. Plenty of different actors on the world scene have complained of currency wars and competitive devaluations over the years since the financial crisis, as exceptionally easy monetary policies kept currencies low. Now China — whose huge stack of foreign exchange reserves makes it uniquely able to enforce any given exchange rate — was joining in.

A wholesale Chinese devaluation has long been included in investors’ “nightmare” scenarios. When the renminbi opened down a further 1.6 per cent on Wednesday, that scary hypothesis appeared to be confirmed. And so we saw two days of sell-offs for almost anything that relied on selling to China (even Apple, which derives some 20 per cent of its sales from the country, was briefly negative for the year).

Then came a burst of signals. At the end of Wednesday’s trading, the renminbi rose 1 per cent — a move that in itself was bigger than any single day’s trading for the previous year. Then on Thursday, another fall at the opening was quickly cancelled out, by intervention, and the People’s Bank of China gave a rare press conference to try to make its intentions clear.
It presented the move as an attempt to ready the renminbi to move freely on world currency markets, and to form a part of the International Monetary Fund’s special drawing rights, an attempt to add market discipline to China. But it had no intention of leaving the currency to go wherever the market wanted it to go — market forces would almost certainly force it much lower at present — and was happy with its new level for now.

So that, it appears, is what the PBoC meant by that. As a result, Apple rebounded 5 per cent, bonds and gold sold off again and stocks recovered. By week’s end, most mainstream markets were much where they had started.

Central banks — and not just Chinese ones — are notoriously inscrutable. That is why a small industry exists to try to interpret them. But for now, the PBoC’s actions are consistent with its words. It is trying to hasten the introduction of its currency to the world system, while ensuring that it does not suffer any precipitate fall. If this turns out to be true, it ratchets up uncertainty and foreign exchange volatility, but it is in line with exactly what the rest of the world might want it to do. The calm response on bond, foreign exchange and stock markets shows that for now they accept this benign interpretation.

But other market signals suggest a different question remains, to which the answer is not necessarily benign. Commodity prices continue to fall. West Texas Intermediate crude, after signs of recovery, hit another post-crisis low this week, as did copper.
Those western stocks that derive most of their income from China continue to have a torrid time. With US companies almost having completed announcing their profits for the second quarter, only one sector has disappointed the forecasts set for it two months ago. That is industrials, the most directly exposed to China, where earnings are down 1.3 per cent year on year, according to Thomson Reuters.

According to Citi, the 48 largest developed market stocks that get at least 30 per cent of their sales from China have collectively fallen 10 per cent since June, while markets have generally been flat. And while the widely disbelieved official data show China’s gross domestic product growing at an annualised rate of 7 per cent in the second quarter, a host of measures of economic activity, such as rail freight, electricity production or housing starts, suggest outright decline.

China’s economy is plainly faring worse than hoped a year ago. Further, its attempt to reorient around services, and away from construction and exports, naturally mean that any slowdown may be felt worse among its suppliers abroad than it is at home.

This explains the fall in the price of the commodities China uses, and in the stocks and currencies of the nations that produce them, particularly large emerging markets such as Brazil, whose stock market has almost plumbed its worst depths from the 2008 crisis.

It is best to assume that the PBoC really means that it merely wants to bring market discipline to its currency and does not want to devalue; and instead to focus on the risk that problems in the Chinese economy end up forcing a devaluation anyway.

That is a more complicated question. Until it is answered, commodities, emerging markets and cyclical stocks will remain in the doldrums.

Surge in Commercial Real-Estate Prices Stirs Bubble Worries

Soaring demand for commercial property has drawn comparisons to delirious boom of the mid-2000s

By Art Patnaude and Peter Grant     

Investors are pushing commercial real-estate prices to record levels in cities around the world, fueling concerns that the global property market is overheating.

The valuations of office buildings sold in London, Hong Kong, Osaka and Chicago hit record highs in the second quarter of this year, on a price per square foot basis, and reached post-2009 highs in New York, Los Angeles, Berlin and Sydney, according to industry tracker Real Capital Analytics.

Deal activity is soaring as well. The value of U.S. commercial real-estate transactions in the first half of 2015 jumped 36% from a year earlier to $225.1 billion, ahead of the pace set in 2006, according to Real Capital. In Europe, transaction values shot up 37% to €135 billion ($148 billion), the strongest start to a year since 2007.

Low interest rates and a flood of cash being pumped into economies by central banks have made commercial real estate look attractive compared with bonds and other assets. Big U.S. investors have bulked up their real-estate holdings, just as buyers from Asia and the Middle East have become more regular fixtures in the market.

The surging demand for commercial property has drawn comparisons to the delirious boom of the mid-2000s, which ended in busts that sunk developers from Florida to Ireland. The recovery, which started in 2010, has gained considerable strength in the past year, with growth accelerating at a potentially worrisome rate, analysts said.

“We’re calling it a late-cycle market now,” said Jacques Gordon, head of research and strategy at Chicago-based LaSalle Investment Management, JLL 1.40 % which oversees $56 billion of property assets.

While it isn’t time to panic, Mr. Gordon said, “if too much capital comes into any asset class, generally not-so-good things tend to follow.”

Regulators are watching the market closely. In its semiannual report to Congress last month, the Federal Reserve pointed out that “valuation pressures in commercial real estate are rising as commercial property prices continue to increase rapidly.”

Historically low interest rates have buoyed the appeal of commercial real estate, especially in major cities where economies are growing strongly. A 10-year Treasury note is yielding about 2.2%. By contrast, New York commercial real estate has an average capitalization rate—a measure of yield—of 5.7%, according to Real Capital.

By keeping interest rates low, central banks around the world have nudged income-minded investors into a broad range of riskier assets, from high-yield or “junk” bonds to dividend-paying stocks and real estate.

Lately money has been pouring into commercial property from all directions. U.S. pension funds, which got clobbered in the aftermath of the crash, now have 7.7% of their assets invested in property, up from 6.3% in 2011, according to alternative-assets tracker Preqin.

Foreign investors also have been stepping on the gas. China’s Anbang Insurance Group in February paid $1.95 billion for New York’s Waldorf-Astoria, a record price for a U.S. hotel. Another Chinese insurer, Sunshine Insurance Group Co., in May purchased New York’s glitzy Baccarat Hotel BCRA 3.60 % for more than $230 million, or a record $2 million per room.

China Life Insurance Group Co. and Ping An Insurance Co. 601318 0.83 % in April bought a majority stake in a $500 million development project in Boston.

China is looking to other markets as well. Last month, its sovereign-wealth fund bought nine office towers in Sydney and Melbourne, as well as 10 shopping centers in France and Belgium.

“What has been fascinating has been their speed of deployment,” said Iryna Pylypchuk, director of global research at global real-estate services firm CBRE Group Inc.

In Europe, buyers are venturing into markets like Madrid and Dublin, where property values haven’t regained precrisis peaks. U.K. firm M&G Real Estate last month made its first investment in Spain, paying €90 million for a vacant 35,000 square meter (376,740 square feet) office building in central Madrid that it will refurbish and rent to U.K. advertising agency WPP WPPGY 0.47 % PLC.

“We’re still buying at the low point in Spain,” said Simon Ellis, manager of M&G’s European core property fund, which has spent €360 million in Denmark, Italy, Germany and France since March.

The turbocharged activity is a far cry from the depths of the bust. Commercial real-estate prices and sales volume plummeted after the 2008 crash. They began to rebound in a few office markets like New York City and Washington, D.C. in 2010. Investors also began buying multifamily buildings on the correct assumption that the carnage in the housing market would result in surging demand for rental apartments.

RXR Realty, which began buying Manhattan office buildings in 2009, earlier this year sold a roughly half of its stake in six buildings to Blackstone Group BX 0.18 % LP in a deal that valued the buildings at $4 billion, more than twice what RXR paid for them.

A valuation index compiled by Green Street Advisors fell to 61.2 in 2009 from 100 in 2007. It crossed 100 again in 2013. Last week it was at a record 118.

Analysts warn that property values could fall if interest rates rise sharply. The Federal Reserve has signaled it’s moving toward interest-rate increases later this year. A surge in rates could have repercussions throughout global financial markets, especially if falling prices trigger a wave of defaults on mortgages.

But bulls counter that even if interest rates rise, property values might not necessarily be hurt if higher interest rates are accompanied by higher inflation, which typically allows landlords to raise rents. They also point out that so far this cycle hasn’t seen the kind of overbuilding that has destabilized real-estate markets in the past.

The Fed and others have noted that banks have been loosening their lending standards. In all, banks had $1.7 trillion worth of commercial real-estate loans outstanding at the end of the first quarter of this year, just 2.6% shy of the record hit in the first quarter of 2009, according to Trepp LLC, a real estate data service.

New issues of commercial mortgage backed securities are on pace to clock in at about $110 billion this year, a postcrash high and a 17% jump from 2014, according to Commercial Mortgage Alert, an industry publication.

Moody’s Investors Service MCO 0.95 % also has sounded the alarm about loosening credit standards.

“We would have hoped the lessons from the financial crisis would have been more durable,” said Tad Philipp, Moody’s director of commercial real-estate research.

China cannot risk the global chaos of currency devaluation

China has nothing to gain from triggering a deflation shock. Its economy is recovering as stimulus builds, creating 1.2m jobs a month

By Ambrose Evans-Pritchard

9:25PM BST 12 Aug 2015

"The world economy is sailing across the ocean without any lifeboats to use in case of emergency" Photo: Bloomberg

If China really is trying to drive down its currency in any meaningful way to gain trade advantage, the world faces an extremely dangerous moment.

Such desperate behaviour would send a deflationary shock through a global economy already reeling from near recession earlier this year, and would risk a repeat of East Asia's currency crisis in 1998 on a larger planetary scale.
China's fixed investment reached $5 trillion last year, matching the whole of Europe and North America combined. This is the root cause of chronic overcapacity worldwide, from shipping, to steel, chemicals and solar panels.
A Chinese devaluation would export yet more of this excess supply to the rest of us. It is one thing to do this when global trade is expanding: it amounts to beggar-thy-neighbour currency warfare to do so in a zero-sum world with no growth at all in shipping volumes this year.

It is little wonder that the first whiff of this mercantilist threat has set off an August storm, ripping through global bourses. The Bloomberg commodity index has crashed to a 13-year low.

Europe and America have failed to build up adequate safety buffers against a fresh wave of imported deflation. Core prices are rising at a rate of barely 1pc on both sides of the Atlantic, a full six years into a mature economic cycle.

One dreads to think what would happen if we tip into a global downturn in these circumstances, with interest rates still at zero, quantitative easing played out, and aggregate debt levels 30 percentage points of GDP higher than in 2008.

"The world economy is sailing across the ocean without any lifeboats to use in case of emergency," said Stephen King from HSBC in a haunting report in May.

Whether or not Beijing sees matters in this light, it knows that the US Congress would react very badly to any sign of currency warfare by a country that racked up a record trade surplus of $137bn in second quarter, an annual pace above 5pc of GDP. Only deficit states can plausibly justify resorting to this game.

Senators Schumer, Casey, Grassley, and Graham have all lined up to accuse Beijing of currency manipulation, a term that implies retaliatory sanctions under US trade law.

Any political restraint that Congress might once have felt is being eroded fast by evidence of Chinese airstrips and artillery on disputed reefs in the South China Sea, just off the Philippines.

It is too early to know for sure whether China has in fact made a conscious decision to devalue. Bo Zhuang from Trusted Sources said there is a "tug-of-war" within the Communist Party.

All the central bank (PBOC) has done so far is to switch from a dollar peg to a managed float.

This is a step closer towards a free market exchange, and has been welcomed by the US Treasury and the International Monetary Fund.

The immediate effect was a 1.84pc fall in the yuan against the dollar on Tuesday, breathlessly described as the biggest one-day move since 1994. The PBOC said it was a merely "one-off" technical adjustment.

If so, one might also assume that the PBOC would defend the new line at 6.32 to drive home the point. What is faintly alarming is that the central bank failed to do so, letting the currency slide a further 1.6pc on Wednesday before reacting.

The PBOC put out a soothing statement, insisting that "currently there is no basis for persistent depreciation" of the yuan and that the economy is in any case picking up. So take your pick: conspiracy or cock-up.

The proof will now be in the pudding. The PBOC has $3.65 trillion reserves to prevent any further devaluation for the time being. If it does not do so, we may legitimately suspect that the State Council is in charge and has opted for covert currency warfare.

Personally, I doubt that this is the start of a long slippery slide. The risks are too high. Chinese companies have borrowed huge sums in US dollars on off-shore markets to circumvent lending curbs at home, and these are typically the weakest firms shut off from China's banking system.

Hans Redeker from Morgan Stanley says short-term dollar liabilities reached $1.3 trillion earlier this year. "This is 9.5pc of Chinese GDP. When short-term foreign debt reaches this level in emerging markets it is a perfect indicator of coming stress. It is exactly what we saw in the Asian crisis in the 1990s," he said.

Devaluation would risk setting off serious capital flight, far beyond the sort of outflows seen so far - with estimates varying from $400bn to $800bn over the last five quarters.

This could spin out of control easily if markets suspect that Beijing is itself fanning the flames. While the PBOC could counter outflows by running down reserves - as it is already doing to a degree, at a pace of $15bn a month - such a policy entails automatic monetary tightening and might make matters worse.

The slowdown in China is not yet serious enough to justify such a risk. True, the trade-weighted exchange rate has soared 22pc since mid-2012, the result of being strapped to a rocketing dollar at the wrong moment. The yuan is up 60pc against the Japanese yen.

This loss of competitiveness has been painful - and is getting worse as the shrinking supply of migrant labour from the countryside pushes up wages - but it was not the chief cause of the crunch in the first half of the year.

The economy hit a brick wall because monetary and fiscal policy were too tight. The authorities failed to act as falling inflation pushed one-year borrowing costs in real terms from zero in 2011 to 5pc by the end of 2014.

They also failed to anticipate a “fiscal cliff” earlier this year as official revenue from land sales collapsed, and local governments were prohibited from bank borrowing -- understandably perhaps given debts of $5 trillion, on some estimates.

The calibrated deleveraging by premier Li Keqiang simply went too far. He has since reversed course.

The local government bond market is finally off the ground, issuing $205bn of new debt between May and July. This is serious fiscal stimulus.

Nomura says monetary policy is now as loose as in the depths of the post-Lehman crisis. Its 'growth surprise index' for China touched bottom in May and is now signalling a “strong rebound”.

Capital Economics said bank loans jumped to 15.5pc in June, the fastest pace since 2012. "There are already signs that policy easing is gaining traction," it said.

It is worth remembering that the authorities are no longer targeting headline growth. Their lode star these days is employment, a far more relevant gauge for the survival of the Communist regime.

On this score, there is no great drama. The economy generated 7.2m extra jobs in the first half half of 2015, well ahead of the 10m annual target.

Few dispute that China is in trouble. Credit has been stretched to the limit and beyond. The jump in debt from 120pc to 260pc of GDP in seven years is unprecedented in any major economy in modern times.

For sheer intensity of credit excess, it is twice the level of Japan's Nikkei bubble in the late 1980s, and I doubt that it will end any better.

At least Japan was already rich when it let rip. China faces much the same demographic crisis before it crosses the development threshold.

It is in any case wrestling with an impossible contradiction: aspiring to hi-tech growth on the economic cutting edge, yet under top-down Communist party control and spreading repression.
That way lies the middle income trap, the curse of all authoritarian regimes that fail to reform in time.

Yet this is a story for the next fifteen years. The Communist Party has not yet run out of stimulus and is clearly deploying the state banking system to engineer yet another mini-cycle right now.

One day China will pull the lever and nothing will happen. We are not there yet.

Germany, Not China, Is Today’s Real Trade Culprit

By Jon Hilsenrath

China’s decision to allow its currency to drop in value looks like an act of economic war, an effort to cheapen its currency to boost exports and prosperity at home while hurting trade partners. But Germany, not China, is the real winner in global currency and trade wars right now.

Take the 2008 financial crisis as a benchmark. Between June 2008 and June 2015, the euro has dropped 12.5% in value against a broad basket of currencies, according to the Bank for International Settlements. That has added to Germany’s export advantage with the rest of the world. China’s exchange rate appreciated 34% during the same period of time, hurting its trade position. The depreciation of the yuan in the past few days is a small fraction – so far at least – of the appreciation it experienced in the years since the financial crisis and of the depreciation the euro experienced.

Germany has soaked up a larger share of global output, thanks in part to the reduced value of the euro which helps its exports and restrains its imports from the rest of the world. Germany’s current account surplus – a broad measure of its excess of exports over imports – increased from 5.8% of gross domestic product in 2008 to an estimated 7.5% of GDP in 2014, according to the International Monetary Fund. The IMF sees Germany’s trade surplus shooting up to 8.4% of GDP in 2015. The only countries projected to have larger trade surpluses with the world are Singapore, Botswana, Kuwait, Taiwan, Timor-Leste, Netherlands and Papua New Guinea.

China ranks 29th in the world based on its projected current account surplus for 2015 and it was 42nd in 2014. During the 2008-2014 stretch, its surplus plummeted as a share of GDP, from 9.2% to 2.0%. Growth in Chinese imports from the rest of the world has averaged 9.8% per year in the 2008 to 2014 period, far outpacing annual growth in imports to Germany from the rest of the world of 2.7%.

Of course, Germany can’t be accused of manipulating its currency for a trade advantage. It is part of the euro-area currency zone controlled by the European Central Bank, and Germans have generally resisted the ECB’s easy money policies that have cheapened the euro. China might now be intentionally cheapening its currency for trade advantage as its domestic growth slows. Still, on the global stage it is Germany that has gotten the actual advantage and ought to be asked by the rest of the world: What have you done for us lately?

Bank Profits Must Yield to Market

Optimism about Wall Street’s earnings power was too strong already. Then this week happened.

By John Carney

Aug. 20, 2015 4:46 p.m. ET

Bank of America shares slid more than 4% Thursday. Bank of America shares slid more than 4% Thursday. Photo: Justin Sullivan/Getty Images

The more optimistic talk among bank investors and analysts over the past year has centered on the potential for rising rates to drive earnings growth. Banks themselves have taken to including estimates of how much additional net interest income they would earn in a hypothetical scenario of rates rising by one percentage point instantaneously.

Forecasts for 2016 earnings generally show that analysts expect net interest income to grow by between 5% and 8% at the biggest banks, according to Sanford C. Bernstein’s John E. McDonald. Bank of America, BAC -4.24 % viewed by many as the most rate sensitive of the big banks, is expected to see a 7.5% increase.

That growth was seen as particularly important as the boost to profits in recent years from cost-cutting and releases from reserves tails off.

Yet those forecasts looked overly optimistic even before this week’s collapse in market expectations for a September rate increase from the Federal Reserve. Now, it is possible banks could even see their interest income contract next year. The sector accordingly took a beating on Thursday, with BofA down more than 4%.

The yield curve has shifted in a way that is particularly unfriendly to banks, with short-term rates rising and long-term rates falling. As of Thursday, any Treasury with a maturity longer than five years had a lower yield than it did 12 months ago. That squeezes net interest margins by making short-term funding more expensive relative to the rates banks can charge for longer-term loans.

Since a large part of net interest income flows through to bank bottom lines, this could have a big impact on next year’s earnings—and today’s share prices. For many of the big banks, shares may have to fall by more than 5% if their forward earnings multiples stay constant. So even after Thursday’s tumble, further declines loom.

How the IMF Failed Greece

Arvind Subramanian

Christine Lagarde finance ministers meeting


NEW DELHI – Democracy is about real choices. But, throughout their country’s crisis, the Greek people have been deprived of them. For this, the Europe Union and especially the International Monetary Fund bear considerable responsibility.
Greece was offered two stark choices: Leave the eurozone without financing, or remain and receive support at the price of further austerity. But Greece should have been offered a third option: Leave the euro, but with generous financing.
This option should have been put on the table, recognizing that Greece has broader political reasons for staying within the eurozone. Although exiting the monetary union would have yielded considerable benefits, “Grexit” would have entailed sizeable costs as well.
The benefits would have included a massive devaluation, which would have restored some dynamism to what was once a fast-growing economy. But the costs were terrifying. The government would have had to default, the banks would have been ruined, and both would have struggled for years to regain the trust of financial markets. As a result, interest rates would have remained high for a long time to come, impeding efforts to restore growth. Is it any wonder that the Greek government shrank from this horror and chose the “safe” option of austerity?
But this option may not be safe at all. It is in fact, to quote T.S. Eliot, that “awful daring of a moment’s surrender...” Greece will now need to grind away at austerity, hoping that in some distant future “internal devaluation” – that is, wage and price deflation – will help to spark a recovery.
Only the IMF could have offered the third option of an orderly exit. Greece should have been told that it could reap the benefits of devaluation, while the international community would act to minimize the attendant costs. The precise terms of Grexit – agreed by the troika (the IMF, the European Commission, and the European Central Bank) and Greek authorities – surely would have included a negotiated reduction in Greece’s debts, as well as a strategy for recapitalizing the banking system in order minimize uncertainty, pain, and disruption.
Still, the costs would have been sizeable, so the IMF would have needed to offer generous financing, covering the country’s import requirements for, say, two years while providing the liquidity to manage the transition to a new currency. Of course, this would have increased the IMF’s already-large exposure to Greece; but this would have been a worthwhile trade-off, because it would have served a strategy that would have had a much better chance of success.
But is there any strategy that could have succeeded in restoring the Greek economy? After all, under any scenario, Greece will need to run a primary surplus and undertake structural reforms to transform its economy. And many insist that this will not happen, because Greece simply refuses to change.
And yet such assessments overlook the record of the past few years, during which successive governments have taken some fairly radical measures to strengthen Greece’s fiscal position and scale back the public payroll. Moreover, the skeptics overlook the fact that incentives to carry out structural reforms are partly endogenous. After all, without devaluation and the prospect of debt relief, reform merely spells more short-term pain, not less.
The reason why an assisted Grexit was never offered seems clear: Greece’s European creditors were vehemently opposed to the idea. But it is not clear that the IMF should have placed great weight on these concerns.
Back in 2010, creditor countries were concerned about contagion to the rest of the eurozone. If Grexit had succeeded, the entire monetary union would have come under threat, because investors would have wondered whether some of the eurozone’s other highly indebted countries would have followed Greece’s lead.
But this risk is actually another argument in favor of providing Greece with the option of leaving.
There is something deeply unappealing about yoking countries together when being unyoked is more advantageous.
More recently, creditor countries have been concerned about the financial costs to member governments that have lent to Greece. But Latin America in the 1980s showed that creditor countries stand a better chance of being repaid (in expected-value terms) when the debtor countries are actually able to grow.
In short, the IMF should not have made Europe’s concerns, about contagion or debt repayment, decisive in its decision-making. Instead, it should have publicly pushed for the third option, which would have been a watershed, for it would have signaled that the IMF will not be driven by its powerful members to acquiesce in bad policies. Indeed, it would have afforded the Fund an opportunity to atone for its complicity in the creditor-driven, austerity-addled misery to which Greeks have been subject for the last five years.
Above all, it would have enabled the IMF to move beyond being the instrument of status quo powers – the United States and Europe. From an Asian perspective, by defying its European shareholders, the IMF would have gone a long way toward heralding the emergence of a new institution: a truly International Monetary Fund, in place of today’s Euro-Atlantic Monetary Fund.
All is not lost. If the current strategy fails, the third option – assisted Grexit – remains available. The IMF should plan for it. The Greek people deserve some real choices in the near future.

Owing More Than Half Of The World's Gold

By: Hubert Moolman

Gold has bottomed in terms of just about everything like oil (in 2005), platinum (2008) and the Dow (1999). One important measure in terms of which it has not bottomed is the amount of currency (US adjusted monetary base).

This monetary base, as the name suggests, is at the root of debt or money creation in this debt-based monetary system. If this system was honest, then this monetary base would basically reflect gold available at the Treasury or Federal Reserve to redeem currency issued by the Federal Reserve.

Yes, the Federal Reserve does not promise to pay the bearer of US currency gold anymore; however, "paying gold" is the measure by which we will know how corrupt and leveraged the system is.

According to the Federal Reserve Bank the adjusted monetary base on 5 August 2015 was $4.019 trillion. With gold at $1 090 that is roughly 3.69 billion troy ounces or 114 771 tonnes of gold that is owed. In comparison, during March 2008 when gold peaked at $1 000 per ounce, it would have been 0.857 billion troy ounces of gold (26 656 tonnes) that was owed.

In their May 2015 report, The US Treasury claims to have 0.262 billion troy ounces or 8 149 tonnes of gold. That is a massive shortage of roughly 3.428 billion troy ounces or 106 622 tonnes of gold, if all the debt represented by the monetary base is settled in gold.

According to some estimates total world gold reserves could be roughly between 155 244 (4.991 billion oz) to 171 300 (5.51 billion oz) tonnes (estimates by James Turk and GFMS respectively).

So, the US Treasury should have about 67% to 74% of all the world's gold in order to settle most of its obligations.

Also, 22 000 tonnes is the most gold reserves the US has held at any point in time. Even this is nowhere close to 114 771 tonnes owed. It is scary to think that a debt of about half of all the estimated world gold reserves has been amassed in 7 years. (from owing 0.857 billion ounces in 2008 to owing 3.69 billion ounces in 2015).

It is clear that the system is way over-leveraged and obligations will never be settled. This over-leveraged system will at some point de-leverage as it has done before. To gain more insight regarding this let us look at the chart below:

Larger Image - chart generated at

Above, is a chart that shows the ratio of the gold price to the St. Louis Adjusted Monetary Base back to 1918. That is the gold price in US dollars divided by the St. Louis Adjusted Monetary Base in billions of US dollars. So, for example, currently the ratio is at 0.27 [$1 090 (current gold price)/ $4 019 (which represents 4 019 billions of US dollars)].

On the chart, I have indicated the three yellow points where the Dow/Gold ratio peaked: point 1, 2 and 3. After the peak in the Dow/Gold ratio, the Gold/Monetary Base chart made a bottom at the red points 4 and 5 respectively. It is at these points that the monetary base could not expand relatively faster than the gold price increased.

Point 4 (about Oct 1932) on the chart, represents an approximate point where the constraint or limitation due to the fixed gold price at $20 and ounce was being adversely felt by the US due to, the need to increase the money supply. As the ratio started to increase from this point due to people redeeming their gold (stopped to an extent by gold confiscation order); they were eventually forced to revalue gold to $35 an ounce in 1934. In reality, this actually represented a downward revaluation of the US dollar of 42.9%, which also indirectly increased the money supply.

Point 5 (about January 1971) on the chart, represents a time when the US was losing a significant amount of gold due to the nations demanding redemption of their US dollars for gold. Due to being unable to cover all the foreign holdings of US dollars with the related amount of gold, the US suspended (really ended) the convertibility of the US dollar into gold, on 13 August 1971. Not only was this a debt-default, but also a downward revaluation of the US dollar. This is because now those nations holding US dollars had to go to the open market to get gold. Instead of getting their gold at $35 and ounce, they had to pay $43.40 on 13 August 1971, and much higher prices as gold increased significantly over that decade. Now the US could increase the monetary base without any gold obligations to nations as a restriction.

From the above, it is clear that we had two similar patterns playing out in the early 30s and 70s. We had a major peak in the Dow/Gold ratio followed by a huge demand for gold, and an eventual revaluation of the US dollar.

The current situation, from 1999 to today, is shaping up in a very similar way. Point 3 (about August 1999) is when the Dow/Gold ratio made a significant peak. From that time to now, the chart has actually performed in a similar manner to the early 30s and 70s, except for the pattern being much bigger. Now, there is likely to be an incredibly huge demand for gold, which will go together with a great deflation. This is very similar to the redemption of US dollars for gold in the 30s and 70s scenarios above.

This demand for gold will eventually cause point 6 to be in, with the ratio reversing violently upwards. It is very likely that at some point the US will be forced to revalue the US dollar in order to counter the deflation. The gold price will go to incredible highs during this phase.

Based on this chart and the current monetary base, it could go to at least 5 times the monetary base, which is gold at $20 000.

"And it shall come to pass, that whosoever shall call on the name of the Lord shall be saved"