A man checks Chinese yuan bills in Beijing on July 28, 2015. The yuan is declining against the dollar and bitcoin as Chinese move money out of the country. (FRED DUFOUR/AFP/Getty Images)A man checks Chinese yuan bills in Beijing on July 28, 2015. The yuan is declining against the dollar and bitcoin as Chinese move money out of the country. (FRED DUFOUR/AFP/Getty Images)

The Chinese currency, the yuan, is a strange animal. Linked to the dollar, it hardly moves—but when it does, financial markets get jittery, especially when it’s going down.

The yuan lost 1.1 percent against the dollar in October, which doesn’t seem like a lot. It’s what’s behind the one percent move that has markets on edge.

According to investment bank Goldman Sachs, as much as $500 billion in capital has left China this year through September. Chinese companies and citizens, as well as foreigners, convert their yuan holdings into dollars and other foreign currencies, moving the price of the yuan down. Outflows picked up especially in September, reaching $78 billion.   


If there is no additional demand for the yuan from trade, for example, the price of the currency has to move down to adjust for the imbalance in the demand for foreign currency. Fundamentally, this is a vote of no confidence in the Chinese economy. If risks and returns of Chinese assets were favorable—as they were for most of the past decade—capital would be flowing into China and not out.

Regime Meddling

However, the Chinese leadership wants to limit the visibility of this vote of no confidence and give the impression of financial stability, so it is applying two levers to obscure the move.  

First, it is selling off its once mighty stash of official foreign currency reserves, down from $3.33 trillion in January to $3.17 trillion at the end of September. In August of 2014, it was close to $4 trillion.

It is simply a transfer of public Chinese foreign exchange assets to private hands intermediated through global financial markets. If the amount of foreign currency bought by the private sector and sold by the official sector matches, the impact on the price of the currency is limited.

For example, Chinese official holdings of U.S. Treasury bonds are down from $1.25 trillion at the beginning of the year to $1.19 trillion at the end of August. However, Chinese corporates have either completed or announced $218.8 billion in mergers and acquisitions of foreign companies this year, according to Bloomberg data.  



The rest of the record corporate buying spree was financed by Chinese state banks and other foreign exchange reserves held at the People’s Bank of China (PBOC).

Chinese companies have previously invested in steel mills and coal mines like there is no tomorrow. However, because mining and manufacturing have massive overcapacity and debt issues, Chinese companies are looking overseas for better investments.

But it’s not only Chinese corporates that are suddenly discovering the value of foreign assets. Chinese citizens have also been active buyers of foreign real estate and stocks. Purchases of equities traded on the Hong Kong stock exchange by mainland citizens, for example, hit a record high of $12 billion worth of buy orders in September, up 64 percent from August.

Capital Controls

So the Chinese regime is pulling the second lever to limit outflows: capital controls. Transfers of capital for citizens are already capped at $50,000 per year, so people found nifty ways around this limit. Like buying millions worth of life insurance products, a form of capital investment, in Hong Kong for example with their Union Pay debit card. But not anymore.

As of October 29, they can only use their UnionPay cards to buy insurance related to travel, according to UnionPay Co. Mainland visitors bought $3.9 billion worth of insurance products in Hong Kong in the first half of the year, according to the city’s insurance industry regulator, an increase of 116 percent over the same period of 2015.

The regime also continues to crack down on underground banks which facilitate capital outflows. According to reports by mainland paper Financial News, the State Administration of Foreign Exchange (SAFE) seized $8.4 billion in foreign exchange funds during an investigation in late October.

So unlike the mostly state-owned companies which are snapping up foreign assets with the blessing of the regime, Chinese citizens have to find other ways to reduce their exposure to the Chinese economy. They are fed up with the low-interest rates on bank deposits and are increasingly afraid of the risks of the unregulated wealth management products.



One channel that still seems to work is the flow of yuan from the mainland to offshore centers like Hong Kong and Singapore. Goldman estimates $45 billion out of the $78 billion in September outflows was transferred from the mainland banking market to the offshore yuan market, where it was likely converted into foreign currency.

The offshore yuan (CNH) has lost 4.8 percent against the Hong Kong Dollar since May where its domestic counterpart (CNY) only lost 4 percent, indicating more selling pressure on the offshore yuan.   

Another vehicle, mostly used when all else fails, is the electronic currency Bitcoin. After moving sideways for most of the summer, the price skyrocketed since late September, coinciding with the latest measures to restrict capital outflows and the drop in the yuan. Alas, it is a bit more volatile than its official counterpart. It’s up 23 percent to $705 since Sept. 25, without regime meddling and for everyone to see.

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A sign hangs on One Chase Plaza in lower Manhattan on Oct. 14, 2014 in New York City. The iconic building is owned by a Chinese private equity firm as part of its overseas investment strategy.  (Spencer Platt/Getty Images)A sign hangs on One Chase Plaza in lower Manhattan on Oct. 14, 2014 in New York City. The iconic building is owned by a Chinese private equity firm as part of its overseas investment strategy.  (Spencer Platt/Getty Images)

Chinese investments in the United States reached a new record level of $18.4 billion in the first half of 2016, up three times compared to the same period last year, and even higher than all of last year ($15.3 billion).

Strong mergers and acquisitions activity accounted for the majority of the incoming Chinese capital, said research firm Rhodium Group.

With the stock market crash in China that began in June 2015, the flow of outbound investment from China to the rest of the world soared. With growing uncertainty about exchange rates and the economic and political outlook, investors are seeking to stash away capital in safe havens like the United States.

“The rapid growth of Chinese outbound (Foreign Direct Investment) FDI in the first half of 2016 has triggered political reactions both in China and host economies,” Rhodium stated.

Screen Shot 2016-07-25 at 2.07.01 PM

This capital flight has led to a further deepening of FDI deficit in China’s balance of payments. So Chinese regulators are increasing their scrutiny of outbound investment transactions.

“China’s leadership continues to pledge its commitment to further external liberalization, but concerns about capital outflows have clearly grown and the State Administration of Foreign Exchange (SAFE) and other regulators have taken informal steps in recent months to ‘manage’ the outflow of foreign exchange,” the research firm said.

The appetite of private Chinese companies for U.S. investments remains high.

—  Rhodium Group

This has increased concerns about the ability of Chinese companies to close deals, driving up risk premiums and reverse break fees for Chinese buyers.

A sharp uptick in the Chinese deal-making activity in the United States is also keeping U.S. regulators busy.

The Committee on Foreign Investment in the United States (CFIUS), reviews foreign acquisitions for national security threats and China for the last few years has been in the top spot for covered transactions (transactions that result or could result in control of a U.S. business by a foreign person).

A number of transactions have run into delays because of CFIUS and other regulatory reviews including Syngenta, Ironshore, Fidelity & Guaranty Life, according to the Rhodium report.

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Strategic Versus Financial Investments

The Chinese investments in the United States in 2016 were spread across a wide range of sectors including entertainment, consumer products and services, technology, and automotive.

Besides M&A activity, Greenfield projects, where companies start building their operations from scratch, were also strong, driven by capital-intensive projects in real estate and manufacturing.

More than 80 percent of all Chinese FDI transactions in the United States in 2016 are considered as strategic investments (firms investing in their core areas of business). The largest strategic investment was Haier’s acquisition of GE’s home appliances business for $5.6 billion, in consumer products sector. And the second largest was Wanda’s purchase of Legendary Entertainment for $3.5 billion, in the entertainment sector.

Other sectors attracting large investments include information and communication technologies (acquisition of Omnivision Technologies by a Chinese consortium for $1.9 billion) and automotive (Ningbo Joyson’s acquisition of Key Safety Systems for $920 million).

Financial investments (investments for financial returns) amounted to $3.5 billion, or 20 percent of total investment in 2016, according to Rhodium. Most of them were driven by private investors buying commercial real estate assets in major coastal cities.

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The value of announced but not yet completed Chinese investments was still close to an all-time high of $33 billion at the end of June 2016, according to the report. Major M&A transactions include HNA Group’s $6 billion bid for technology distributor Ingram Micro, Anbang’s $6.5 billion acquisition of Strategic Hotels & Resorts, and Apex Technology’s acquisition of Lexmark for $3.6 billion.

There are also pending investment in real estate development projects in New York and California.

“The appetite of private Chinese companies for U.S. investments remains high. … It is reasonable to assume that recent geopolitical shocks (Brexit) and related USD strength will aggravate capital outflows in coming months,” Rhodium said.

“This makes it likely that regulators will continue or even increase scrutiny of outbound FDI transactions, particularly for deals involving large amounts of foreign exchange and those with a financial nature.”

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A bank employee counts 100-yuan banknotes at a bank in Hangzhou, east China's Zhejiang province on December 1, 2015. The International Monetary Fund's recognition of China's currency is a step towards encouraging its global use, but banks will remain reluctant to hold yuan unless Beijing pushes deeper financial reforms, analysts say.          (STR/AFP/Getty Images)A bank employee counts 100-yuan banknotes at a bank in Hangzhou, east China's Zhejiang province on December 1, 2015. The International Monetary Fund's recognition of China's currency is a step towards encouraging its global use, but banks will remain reluctant to hold yuan unless Beijing pushes deeper financial reforms, analysts say.          (STR/AFP/Getty Images)

For most people, SDR sounds like an odd disease. And yet, it could be the word’s next reserve currency, at least if China and the International Monetary Fund (IMF) get their way.

The so-called Special Drawing Rights (SDR) are an IMF construct of actual currencies, right now the euro, yen, dollar, and pound. It made news last year when the Chinese renminbi was also admitted, although it won’t formally be part of the basket until October 1st of this year.

IMF members have it and can trade it with each other for actual currencies, which indebted nations like Greece and the Sudan frequently do. The average Joe or the average company on the street can’t hold the instrument right now, let alone spend it. 

But that’s precisely what the global monetary elite wants in the not too distant future, and it will use China as a Guinea pig. Before the meeting of G20 central bankers and finance ministers in Chengdu, China, from July 22-23 some academics started pushing the idea of an extended use of the SDR (currently worth $1.39)

“Establishing the SDR as the leading global reserve currency would have far-reaching benefits” Jose Antonio Ocampo, a professor at Columbia University, wrote in a post on Project Syndicate on July 8. 

“Beyond the push to use SDRs more actively in IMF programs, governments could issue SDR-denominated bonds. Moreover, private banks could increase their use of this monetary unit, just as some European banks used the so-called European Currency Unit, helping to pave the way for the euro,” he continues.

IMF Is at It as Well

On cue, the IMF itself published a paper on “whether a broader role for the SDR could contribute to [the international monetary system’s] smooth functioning.”

It echoes Ocampo’s idea of private corporations issuing bonds in SDR and banks making loans in SDR, or a special version of it called M-SDR, presumably standing for “market” based instruments like bonds. 

The IMF experimented with these M-SDRs in the 1970s and 1980s when banks had SDR 5-7 billion in deposits and companies had issued SDR 563 million in bonds. A paltry amount, but the concept worked in practice. 

“M-SDRs emerged in the 1970s and early 1980s before the market faded, but there has been renewed interest recently,” writes the IMF, although it is unclear whether there really exists interest outside the IMFs imagination and some government-controlled entities, like supra-national development organizations. 

History of SDR use. (IMF)

History of SDR use. (IMF)

To immediately counter this concern, after the G20 meeting on July 25, the deputy director of the People’s Bank of China’s (PBOC) International Office Zhou Juan said an international development organization like the Asian Infrastructure and Investment Bank (AIIB) could issue SDR bonds in China as late as August, according to Chinese newspaper Caixin. 

Zhu echoed both Ocampo and the IMF and said that “SDR-denominated bonds should be appealing to official investors at their preliminary stage because they can provide diversified investment products and reduce exchange rate and interest rate risks.”

China has openly called for the SDR to replace the U.S. Dollar as the world’s reserve currency. “China has been pushing for the SDR to become more widely used for some time, as a way to challenge the dominance of the dollar without pushing the renminbi as a direct competitor,” Julian Evans-Pritchard, a China economist at Capital Economics in Singapore, told Reuters. 

The IMF did an analysis and concluded  financial instruments denominated in SDR would lower volatility and risk compared to holding assets in individual currencies and save costs, just as Zhu said as well. “M-SDRs could, therefore, be attractive to investors and issuers by offering a prepackaged diversification option,” the fund writes.   

A Solution for China’s Capital Outflows? 

China insider David Marsh, the founder of finance think tank OMFIF (Official Monetary and Financial Institutions Forum) wrote on Marketwatch in late April about another benefit of launching the M-SDR in China, although he did talk about a wider range of applications rather than the issuance by the development institution. 

Beijing’s SDR capital market initiative will allow domestic Chinese investors to subscribe to domestic bond issues with a significant foreign currency component, a means of helping dampen capital outflows that have gained prominence in the last 18 months as a result of progressive capital liberalization.

In other words: If Chinese investors can buy bonds or other debt instruments in SDR in China, they could circumvent the capital controls and hold a diversified portfolio of euros, dollars, yen, and pounds with a small amount of renminbi mixed in. And they don’t have to go out of their way smuggling gold across the border to Hong Kong or buying up Italian soccer clubs.  

China lost $676 billion in capital in 2015 alone and foreign currency reserves are nearing the critical level of $2.7 trillion (now $3.2 trillion), the minimum the IMF thinks the country needs to run the economy. 

So it’s safe to say the IMF had the same issue in mind when it wrote its paper, whose authors we don’t know. In mid-July it stated:  

In China, there may be untapped demand among domestic investors for exposure to reserve
currencies as capital controls are gradually lifted. From this perspective, M-SDRs issued in the onshore market could potentially reduce demand for foreign currency and reduce capital outflows by allowing domestic market participants to diversify their foreign exchange risk.

Of course, China, the IMF, and global academics will find a host of problems implementing their plan, including no market clearing mechanism and liquidity issues or simply a lack of demand for a superfluous product that nobody knows or understands.

Superfluous because institutions from central banks to sovereign wealth funds already run their own diversified currency portfolios and don’t need the IMF to tell them which weight is appropriate for their own needs.

There is no demand for the product because it has been around for more than 40 years and it hasn’t been adopted by private players. The only people who are calling for it are government officials and academics and the only vehicle for early adoptions are Chinese state banks or state-controlled international institutions that can’t make a decision on their own.  

But practical problems like these have never deterred the IMF or China. 

Follow Valentin on Twitter: @vxschmid

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A woman counts Chinese yuan bills worth thousands of dollars in Vancouver, Canada, on Oct. 27, 2015. (Benjamin Chasteen/Epoch Times)A woman counts Chinese yuan bills worth thousands of dollars in Vancouver, Canada, on Oct. 27, 2015. (Benjamin Chasteen/Epoch Times)

The chief economist of Citigroup is not your average economist. Yes, Willem Buiter studied plenty of economic theory at Yale and Cambridge but then he says funny things like the New York State Driving Test was his “greatest educational achievement.”

He is also very outspoken for someone who works for one of the biggest banks in the world. He thinks Citigroup “must have decided that it was better to have somebody who tells the truth occasionally than to have somebody who tells what people want to hear.”

Epoch Times spoke to Mr. Buiter about a possible financial crisis in China, a devaluation of the currency and potential solutions. [Skip to 19:00 in the video]

They are going to have a financial crisis.

— Willem Buiter, Citigroup

Epoch Times: What are China’s problems?

Willem Buiter: China has three problems. It has a madly over-leveraged corporate sector, banking sector, and shadow banking sector that really need restructuring and consolidation. It has massive excess capacity in many of the crucial industries, so it has a cyclical problem.

And then it needs to rebalance: From export growth to domestic demand that goes from investment growth to consumption; from physical goods growth to services; from I can’t breathe to green; and a growing role for the private sector. This simply isn’t happening at the moment.

Citigroup Chief Economist Willem Buiter at an interview with Epoch Times in New York on July 6, 2016. (Epoch Times)

Citigroup Chief Economist Willem Buiter at an interview with Epoch Times in New York on July 6, 2016. (Epoch Times)

Growth has stopped falling at the moment, though it is significantly lower than what it was, but only by unsustainable stimulus measures.

This is credit growth that adds to the excessive leverage. Investment in sectors where there is already excess capacity, basically building up a bigger and harder landing by postponing the necessary adjustments.

The rebalancing has been put on hold because this requires active and innovative policy making. With the anti-corruption campaign still in full swing, in its fourth year now and if anything intensifying, all senior civil servants in the ministry or the party are unwilling to stick their necks out and do something untried and new. The stuff that is required both in terms of financial stability management, in terms of stabilization policy, the right kind of fiscal stimulus and in terms of rebalancing.

Epoch Times: What can be done?

Mr. Buiter: We need to increase the role of the private sector to cut back on state-owned enterprises. What is happening? We’re growing state-owned enterprises because that is the path of least resistance because we know how to do that.

So then China is in a holding pattern, and I think it won’t change until there is a long-run rebalancing, until the political issues that are reflected in the anti-corruption campaign are settled, it won’t be supported by the right fiscal policies.

Unless they are willing to go for Chinese helicopter money, fiscal stimulus targeted mainly at consumption not at investment. Yes, some capital expenditure like social housing, affordable housing, yes, even some infrastructure.

But organization supporting infrastructure, not high-speed trains in Tibet. It has to be funded by the central government, the only entity with deep pockets and it has to be monetized by the People Bank of China.

That is what the country needs and at the moment it is incapable politically—not technically—of reaching that kind of resolution. I think it is unlikely that they will be able to achieve that without at least a cyclical downturn of some severity. How deep depends on how quickly they respond when things start visibly going pear shaped.

Workers go about their chores at a construction site for new shops in Beijing on November 28, 2011.  (Goh Chai Hin/AFP/Getty Images)

Workers go about their chores at a construction site for new shops in Beijing on November 28, 2011. (Goh Chai Hin/AFP/Getty Images)

Epoch Times: What’s your estimate of Chinese GDP growth at this moment?

Mr. Buiter: Somewhere below 4 percent. The official figure is still around 7 percent, but those data are made in the statistical kitchen.

Epoch Times: So if growth is 4 percent and interest rates are 8 percent, doesn’t this create problems?

Mr. Buiter: Real interest rates are high in China. Especially for what I call honest, private borrowers. The relationship of the interest rate to the growth rate drives the debt to GDP dynamics. The so-called snowball effect is adverse when the interest rate exceeds the growth rate and that is probably the case now.

So there’s a problem there. They are solvable. That’s nothing beyond the ken of man. The wheel doesn’t have to be reinvented but having the tools and being politically able to use them and willing to use them are different things. China has the tools but not yet the willingness and ability to use them in the way that is necessary to avoid a hard landing.

Financial Crisis

Epoch Times: So we are talking about a somewhat similar problem than in Europe. We would have to write down a lot about of bad debt. We recapitalize the banks and then stimulate the consumer to get inflation?

Mr. Buiter: In Europe of course, we should really fund the capital expenditure. Investment rates are notoriously low in Europe. China has the opposite problem. They need to boost consumption. So there’s an obvious win-win situation that we could have.

Debt restructuring, haircuts if necessary and then a well-targeted fiscal stimulus funded ultimately through the European Central Bank (ECB), people’s helicopter money. China will be aiming at consumption. The composition is different because China invests too much.

You can have a good old financial crisis without having the 1997-1998 Asian foreign debt issue, which China does not have.

— Willem Buiter, Citigroup

Epoch Times: What if China doesn’t address the problem?

Mr. Buiter: They are going to have a financial crisis. It can be handled because 95 percent of the bad debt is yuan-denominated, but you have to be willing to do it, you have to be proactive.

The United States didn’t have a foreign currency denominated debt problem when it had the great financial crisis. Banks fell over. These were all dollar denominated liabilities. You can have a good old financial crisis without having the 1997-1998 Asian foreign debt issue, which China does not have.

So a financial crisis is a risk. Then, of course, a sharp depreciation of the yuan which would be the consequence if the reserves would have to be used to safeguard systematically important entities that do have foreign currency debt. This would be the consequence of a failure to act, a recession and, in the worst case, a financial crisis. Again, something that’s survivable; not the end of the world, but very costly and politically destabilizing.

The official figure is still around 7 percent, but those data are made in the statistical kitchen.

— Willem Buiter, Citigroup


Epoch Times: But the currency would have to go down.

Mr. Buiter: I cannot see the yuan following the dollar over the next year, let alone two years, no. I do think that at the moment, the market is no longer afraid of an eminent sharp depreciation. So capital outflows driven  by expectations of a sharp depreciation have ceased. But they could be back like that, especially if there are more kerfuffles in Europe, another flare up. Maybe the banking crisis, and as a result further upward pressure on the dollar and other safe-haven currencies.

And the Chinese currency is being dragged along? I don’t think so. They will have to decouple. So that is a channel which for external reasons, the yuan peg might become hard to manage.

Epoch Times: How do you see the rest of the year?

Mr. Buiter: Continued subdued growth. China is flirting with the loss of faith in its ability to manage its currency and flirting with a sharp slowdown in activity. Europe and the rest of the industrial world, assuming that the Brexit negotiations remain orderly, not too hostile and growing more slowly than it did last year but not dramatically more slowly.

If Brexit becomes a dog fight between the 27 and the U.K. If Brexit becomes contagious, through general elections in the Netherlands in March next year, in France, Germany. If the Italian referendum in October or November this year goes against the government and fear of emulation of the British example takes over, then there could be a further, deeper slowdown in activity.

The United States again should putter around roughly the same way as last year. So mediocre growth at best with mainly downside risks. A few emerging markets—Russia, Brazil—will do better this year than they did last year simply because it’s impossible to do worse.

The wheel doesn’t have to be reinvented but having the tools and being politically able to use them and willing to use them are different things. 

— Willem Buiter, Citigroup

The specific shocks, home-made mainly in Brazil, partly external like oil prices in Russia and sanctions. These things are no longer slowing them to the same extent. So some recovery is possible.

It’s going to be a secular stagnation world, unless we provide the combined monetary fiscal stimulus and the longer term, supply side, enhancing measures to promote growth, higher capital expenditure, better education and training including vocational training, sensible deregulation, less disincentivizing taxation and all that.

All these things are necessary to keep potential output at a level that allows fulfilling our ambitions, but even the miserable level of the growth rate of potential output won’t be achieved unless we have additional stimulus.

 Epoch Times: So no way for stocks to go up another ten percent from here?

 Mr. Buiter: Everything is possible but I think the fundamentals say no.

Follow Valentin on Twitter: @vxschmid

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A woman counts Chinese yuan bills. (Benjamin Chasteen/Epoch Times)A woman counts Chinese yuan bills. (Benjamin Chasteen/Epoch Times)

He was right about subprime, right about gold, and early in his call for a Japanese crisis. Is Texan investor Kyle Bass too early in his call for a China banking crisis and currency devaluation within the next two years?

“It’s a foregone conclusion but we don’t know about the timing, it feels like it’s happening as we speak,” he told Grant Williams of RealVisionTV in an interview. Bass had first stated his pessimistic view of China in late 2015 when the currency was under pressure and the country was bleeding capital to the tune of $100 billion per month.

Since February of this year and so-called Shanghai Accord or the G20 finance ministers, outflows have abated, although the currency has declined to a multi-year low of 6.66 per U.S. dollar.

There are so many perfect parallels to the U.S. mortgage credit system or the European banking system and the Chinese banking system.

— Kyle Bass, Hayman Capital
The exchange rate of the Chinese yuan versus the U.S. dollar over a year (Bloomberg)

The exchange rate of the Chinese yuan versus the U.S. dollar over a year (Bloomberg)

So why does Bass think the situation in China is intensifying? Everybody knows China has too much debt, especially corporate debt. As a result, the country’s total debt to GDP ratio is higher than 250 percent according to a range of different estimates. This is not much higher than Japan’s government debt ratio of 245 percent of GDP, so why focus on China now?

“The Chinese corporate bond market is freezing up. Since April 11th the Chinese corporate bond markets had 150 cancellations out of 210 announced deals,” says Bass. And indeed, the Chinese corporate bond market, which has helped keep unsustainable corporate debt afloat and also backs trillions in repackaged loans called Wealth Management Products (WMP) is in trouble in 2016.

Source: McKinsey

Source: McKinsey

According to Bloomberg, Chinese companies raised 1.85 trillion yuan ($280 billion) of onshore bonds between April and July this year, 30 percent less compared to the three preceding months.

Bankruptcies are also on the rise. Although corporate defaults are still in the low double digits, Chinese courts handled 1028 bankruptcy cases in the first quarter of 2016, up 52.5 percent compared to a year earlier.

“There are so many perfect parallels to the U.S. mortgage credit system or the European banking system and the Chinese banking system. There are things that go on in those systems that show you there are problems,” says Bass, emphasizing the acuteness of these problems. “We see it starting now.”

While there are clear parallels to what happened in the United States in 2008 and Europe in 2010, Bass says that China’s problems are a magnitude larger. “They have asset liability mismatches in wealth management products that are more than 10 percent of their system. Our mismatches were 2.5 percent of the system and you know what they did,” he says. 

According to Bass, the bad loans will first hit the banking system and then lead to a sharp devaluation of the Chinese yuan. 

“How they deal with this, it’s not armageddon. They are going to recap the banks, the are going to expand the People’s Bank of China’s (PBOC)  balance sheet, they are going to slash the reserve requirement, they are going to drop their deposit rate to zero, they are going tot do everything the United States did in our crisis,” he said.


All of these policy measures would lead to a depreciating currency all other things being equal. But China’s currency is already under pressure as mostly Chinese citizens are taking their money out of the country because they don’t trust the banking system any longer. Bass estimates that bad loans could lead to losses of up to $3 trillion or 30 percent of GDP. Chinese citizens’ savings are backing these loans and they don’t want to wait around to find out whether Bass’s number is correct or not.  “In China, the credit excesses are already built in,” says Bass. 

They are going to do what’s best for China. And what’s best for China is to materially devalue their currency.

— Kyle Bass, Hayman Capital

Goldman Sachs estimated that net capital outflows from China in the first quarter of 2016 were around $123 billion according to a report, 70 percent of which came from Chinese citizens funneling money out of the country. They do this in spite of harsher capital controls in 2016 and use either illicit methods like smuggling or legal ones like buying up Vancouver and New York real estate.

According to Bass, there is no way out for the regime, which is trying to manage the devaluation as much as it can. “The Chinese government wants a devaluation, they just want it on their terms.”

Reuters had previously reported that the Chinese central bank would not mind seeing the currency slip to 6.80 against the dollar, a target it will likely overshoot if things don’t change materially.  

Bass also shines light on why the regime would not be opposed to devaluing the currency, albeit measuredly. He says one of president Xi Jinping’s closest aides, vice premier Wang Yang, thinks the Japanese made a mistake by not devaluing in the mid-1980s, right when they were blowing up their own credit bubble. 

“Wang has said that he thinks Japan’s critical error was agreeing to the Plaza Accord. Japan decided to be submissive to the United States once again, to sacrifice their economic growth for that of the United States,” as the dollar devalued and the Japanese yen strengthened, the United States finally emerged out of a decade of stagflation. what happened to Japan at the beginning of the 1990s was less flattering. According to Bass, however, this time will be different: “They are going to do what’s best for China. And what’s best for China is to materially devalue their currency.”

After the devaluation and the recapitalization of the banking system, however, it’s time to buy again: “If you have any money left, it will be the best time in the world to invest. It will be the greatest time ever to invest in Asia.”

Read the full article here

A Chinese bank worker prepares to count a stack of US dollars together with stacks of 100 Chinese yuan notes at a bank in Hefei, Anhui Province, on March 9, 2010. (STR/AFP/Getty Images)A Chinese bank worker prepares to count a stack of US dollars together with stacks of 100 Chinese yuan notes at a bank in Hefei, Anhui Province, on March 9, 2010. (STR/AFP/Getty Images)

One thing is for sure, the Chinese yuan just had its worst drop on record ever since the last currency in 1994. The yuan lost 2.9 percent against the dollar since the end of March to 6.64 on June 30. 

Another sure thing: Brexit didn’t help as the yuan devalued almost one percent in a single day on the Monday after the historic vote. This is where the certainties end and where speculation and confusion starts.

Performance of the Chinese yuan (Bloomberg)

Performance of the Chinese yuan (Bloomberg)

It is speculation that China used the cover of Brexit to ease renewed pressure from capital outflows, which ebbed off to $20-$30 billion per month after $100+ billion run-rates in the first two months of the year. The 1 percent drop on Monday took the currency close to six year lows and could have been a welcome opportunity to do this, as everybody else was watching how markets in Europe reacted to the Brexit. Before, China’s currency has been dominating headlines and global markets since the first surprise devaluation in August of last year and any sharp devaluation was not received well.  

On the other hand, traders could have just taken some risk off the table because of the global spike in volatility. Another indication that the Chinese currency will enter the safe haven status anytime soon. 

On the policy side, things are even more confusing. Despite the steep drop and relative volatility, Chinese state newspapers want the world to believe that there is no pressure on the currency. “Although the yuan’s mid-point fell against the U.S. dollar on consecutive days, the mood in both on-shore and off-shore markets is basically stable with no signs of panic-selling or a scramble for foreign currencies,” the Shanghai Securities News reported, citing industry experts as saying.

Panic selling is a vague term and may be more applicable to the British pound, but stability in the onshore and offshore yuan markets also looks different. 

Although the regime is maximizing for stability, it doesn’t mind that Reuters quotes other government economists later in the week who claim the central bank would be happy to see the yuan at a rate of 6.8 per dollar. “The central bank is willing to see yuan depreciation, as long as depreciation expectations are under control,” Reuters cites unidentified sources.

The place to start getting things control: Unidentified economists.   

Read the full article here

This long exposure picture shows apartment buildings and office blocks clustered tightly together in Hong Kong's Kowloon district, with the famous skyline of Hong Kong island in the background, on Oct. 28, 2013.  (Alex Ogle/AFP/Getty Images)This long exposure picture shows apartment buildings and office blocks clustered tightly together in Hong Kong's Kowloon district, with the famous skyline of Hong Kong island in the background, on Oct. 28, 2013.  (Alex Ogle/AFP/Getty Images)

On the surface, China’s capital outflows were only $30 billion in May, far below the $100 billion clip seen earlier this year.

So all is well in China? Not quite. We have seen that anecdotally people still strap cash around their waist and try to smuggle it across the border.

Chinese companies still make strange acquisitions to be able to move capital to other countries, like this home appliance maker buying an Italian soccer club.

Another statistic is quite telling that not all is as it seems. Chinese imports from Hong Kong skyrocketed 242 percent in May compared to last year and 21 percent compared to last month.

Why is this strange? Because Hong Kong exports to China (exactly the same thing, except for it’s a different agency reporting the numbers) have been falling this year, like 4.8 percent year over year in April. Also, total imports including Hong Kong were down 10.3 percent over the year.

“Another interesting contrast is the trade data of Hong Kong, though it has not out for May yet, Hong Kong exports to China has contracted for 12 months when for most of the time China imports to Hong Kong was rising,” writes investment firm Natixis in a note to clients.



The discrepancy is literally off the charts. So how can this be? Most analysts agree that Chinese companies hand in fake invoices to the regulator so they can wire money to Hong Kong and circumvent the limits on outbound money flows.

“The over-invoicing of imports, particularly via Hong Kong, remains a source of capital flight, though it only accounts for around 2 percent of total imports,” the International Institute of Finance (IIF) writes in a note.

In the past and during the time when China accumulated its vast stash of foreign exchange reserves ($4 trillion at the peak in 2014) this flow was reversed and exports to Hong Kong from China were rising while Hong Kong imports from China were stable.

“The China-Hong Kong trade is a channel of speculative flows. We called these flows ‘speculative’ because these flows ride on the trend of the yuan movement and brought capital into China when the yuan appreciated. It is logical that the reverse happens now as the yuan depreciates,” writes Natixis.



According to Natixis, trading companies in Hong Kong and the mainland partner with commodity companies dealing in scrap metal and scrap plastic. “The goods do travel across the borders although the value of the goods could be in question.”

Given the discrepancy in what essentially should be the same number, there is no question the value of the good is inflated to funnel money out of the country. According to Natixis, this could even be beneficial for regulators:

“For regulators, knowing the existence and the size of speculative flows is better than closing down the channel and knowing little about a black market.”


Follow Valentin on Twitter: @vxschmid

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After market crises, it sometimes takes a while for the real picture to emerge, the reasons why Western stocks followed the Chinese currency down at the end of 2015.
So it is only now that we learn how much money international banks withdrew from China in the fourth quarter of 2015 and how this unwind of lending caused a liquidity squeeze, thanks to minute data aggregation from the Bank of International Settlements (BIS).
“The $114 billion decline in cross-border lending to China was the second quarterly drop in a row, and it pushed the annual growth rate down to –25 percent,” the BIS states in its quarterly review published this June.
The trend of lending to China has clearly turned. (BIS)
In other words, global bank lending to China crashed by one full quarter. No wonder the currency weakened and liquidity in global financial markets decreased throughout the year as volatility peaked right around the first Fed rate hike in December. In total, cross-border banking liquidity decreased by $651 billion to $26.4 trillion.
These $26 trillion in cross-border claims could be anything related from trade finance to derivative contracts which cross two banking jurisdiction. For example, a U.S. bank lending money to a Chinese company in the form of a loan or a bond. It also includes interbank lending. Once the loans are paid back, this credit money goes out of existence, thereby decreasing overall system liquidity.
Total bank lending to China is now down $304 billion, or 27 percent from a high of $756 reached in September of 2014, which also coincides with the peak of Chinese foreign exchange reserves of $4 trillion (now $3.2 trillion).
This repayment of debt to foreign banks is only part of the $676 billion which left China in 2015 according to the International Institute of Finance (IIF). The rest has been mostly Chinese households and companies moving their money abroad and Chinese companies repaying debt to non-bank creditors.
The $800 billion decline in foreign exchange reserves over two years resulted from the People’s Bank of China’s (PBOC) intervention in the currency markets to keep the yuan stable against the U.S. dollar.
(Capital Economics)
Global Contagion
The BIS report also details how closely Chinese banks are tied into the global financial system.
Chinese banks, after paying back much of their international liabilities in 2015 are still lending $529 billion U.S. dollars to the international financial system. According to the BIS, they have a $300 billion surplus (more assets than liabilities) and are funding these assets with dollars obtained from mainland companies and households.
The BIS cautions that shocks can come not only from debtors like the Asian Tigers in the late 1990s but also from creditors as well:
“As the Great Financial Crisis of 2007–09 demonstrated, it is as important to monitor potential shocks emanating from creditors as those from borrowers. Furthermore, the existing  international banking statistics underestimate the overall increase in the indebtedness of those countries relatively more reliant on credit from China.”
At this moment, Chinese citizens and companies are still trying to get their money out of the country and are happy to do so with the help of Chinese banks. If that situation changes and Chinese players want to hold their dollars outright or need to service debt obligations in yuan because of a falling economy, this liquidity could very quickly disappear from the global financial system.

Read the full article here

While Chinese capital flows dominated headlines earlier this year, they have not garnered much attention since the end of February.
But as the yuan is slipping again against the dollar, outflows are back in May and the People’s Bank of China’s (PBOC) stash of foreign reserves declined as well (down $28 billion to $3,192 trillion).
Most of this was due to the so-called valuation effect, which decreases the value of assets in currencies other than the dollar as the dollar rises in international markets.
However, research firm Capital Economics estimates Chinese still moved around $30 billion out of the country. ” an increase in outflows would seem to make sense given the weakening of the renminbi against the dollar last month,” the firm writes in a note to clients.
(Capital Economics)
Looking at actual transactions happening on the ground, it seems Chinese are still quite desperate to move their money out or to safety. They are overpaying for Bitcoin and are loading up on gold for example.
Other go the traditional route, like this Chinese man, who tried to smuggle $74,000 worth of U.S. dollar bills out of the country to Hong Kong on June 3, according to the South China Morning Post. The legal limit is $5000.
Other take the legal route, like Chinese home appliance retailer Suning Commerce Group. They just bought a 68.55 percent stake in Italian soccer club Inter Milan for $307 million.
While being perfectly legal and in accordance with PBOC rules—Suning got approval for the acquisition—it is nonetheless unclear what value added there is for a home appliance retailer to own a soccer club. As long as the cash it out of the country, this does not seem to matter, though.
For Suning president Zhang Jindong, the move is still strategic: “The acquisition of Inter is a strategic move. Ours is an international business and our brand will soon be big in Europe too.” 
Despite these seemingly desperate measures of Chinese citizens and companies to get out of the yuan and into relative safety, Capital Economics is optimistic we won’t see a repeat of last year’s currency crisis. It began with a surprise devaluation of the yuan in August, the biggest risk factor being a Fed rate hike next week.
“Depreciation expectations remain much more manageable than in late-2015 and early-2016 when China was witnessing outflows of over $120 billion per month. But rate hikes by the Fed are likely to be back on the agenda soon and, when that happens, there is a good chance that outflows could pick up again.”
Follow Valentin on Twitter: @vxschmid

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Chinese traders love speculating in anything that’s not bolted down. So they effectively took over the virtual currency Bitcoin, representing 90 percent of global trading volumes. And if trading the volatile Bitcoin cryptocurrency wasn’t enough, BitMEX offers them the opportunity to use leverage as well.
“Our goal is to let anyone bet on anything at any time,” BitMEX founder Arthur Hayes told Bloomberg. The 30-year old ex-Citigroup trader founded BitMEX in Hong Kong two years ago, modeling it after the Chicago Mercantile Exchange (CME). The CME allows traders to buy or sell vast quantities of commodities or financial instruments putting little money down.
This process is called speculating on margin, a process BitMEX has taken to the cryptocurrency world. Traders have to deposit Bitcoin (or other cryptocurrencies) instead of dollars or euros or yuan to fund their accounts.
They can then use one Bitcoin to buy a contract worth 100 Bitcoin—100 times is the exchange’s maximum leverage—and BitMEX charges a fee of 0.005 percent for each transaction.
Similar to the real futures exchange in Chicago and elsewhere, all the traders are doing is entering a legal contract, which is settled in cash (or cryptocash in this case) after it expires or the trader is stopped out. Real bitcoins, altcoins, ether, or daos—all cryptocurrencies—don’t change hand.
In the example above, a trader could buy a contract worth 100 bitcoin for only one bitcoin. If the price goes up 5 percent the trader makes 5 bitcoin or a 500 percent return on his original 1 bitcoin investment. However, if the price falls 1 percent, he loses 100 percent or all of his initial investment. There is no chance to buy and hold, or wait until the price recovers.
This is similar to regular spread-betting exchanges like Alpari or the bucket shops of the roaring 20s. 
A preview of the BitMEX trading dashboard (BitMEX)
The exchange’s algorithms and computer programs make sure winners and losers always net out to zero, again similar to the real futures exchange. However, unlike the role-model, winners may be asked to subsidize losers at times. 
“BitMEX contracts have high leverage. In very rare cases, profits may be reduced during certain time periods if there is not enough money on the exchange to cover user profits,” it states on the company’s website.
The company wants to expand its offering beyond cryptocurrencies so Chinese speculators can bet on Western financial indices and stocks and Westerners interested in Chinese stocks can bet on mainland financial markets.
While China has regulated inbound and outbound money transfers and investments, bitcoin can flow freely, making it possible for mainlanders and Westerners to found their account and start betting.
Because they aren’t really buying or selling anything and merely entering into contracts, BitMEX doesn’t need to worry about moving around the underlying financial products.
So far, the company is far away from its goal to have “anyone bet on anything,” however. Chinese can only bet on U.S. dollar interest rates (one contract) and Westerners can only bet on the FTSE China A50 share index (one contract.)

Read the full article here

Last time around, the love affair with China and the virtual currency Bitcoin didn’t end well. In December of 2013, the Chinese central bank barred financial companies from having anything to do with Bitcoin and the price crashed from $1095 to $105.
However, this love has been rekindled as the virtual currency quietly rose from $200 in August 2015 to $525 now.
“It went down for many reasons in 2014, the most important one was that it was too high. These days Chinese activity is driving the ascent in the price of Bitcoin. There is not a lot of other factors going on right now,” says Gil Luria head of technology research at Wedbush Securities.
If you are willing to get capital out of China badly, then you are willing to take the risk. — Gil Luria, Wedbush Securities

Coincidently, Bitcoin reached its bottom just after the surprise devaluation of the Chinese yuan against the dollar and about the time ordinary Chinese started to move money out of the country in earnest. Some of it leaves China via Bitcoin.
“In countries … that struggle with high inflation and capital controls you see a move toward bitcoin,” Tuur Demeester, editor in chief at Adamant Research, said in an interview with RealVisionTV.
Safe Haven?
The Chinese economy is struggling and the banking system is loaded with bad debt.
Demeester likens the recent rise in Bitcoin to what happened in Cyprus in 2013 when Bitcoin first became mainstream news. As the banks in Cyprus closed down, the virtual currency rose from $15 to over $230 in the span of a couple of months.
Price of Bitcoin against the U.S. Dollar (Coindesk)
“The price was going nowhere for the last two years, but in the past year, we have seen these trends. Back in 2013, Cyprus was the reason why Bitcoin spiked in April 2013. Bitcoin survived but the money that was in the bank didn’t,” Demeester says.
Bitcoin during the Cyprus banking crisis (Coindesk)
That may be the reason why Chinese are willing to pay hefty premiums to buy Bitcoin to get rid of the risk of holding bank deposits in yuan.
For example: The price of one bitcoin in yuan on June 1 was 3608. This is equivalent to $548. But the dollar price of Bitcoin was only $525, a 4.4 percent premium.
In addition, even if the objective is to get rid of yuan, there are violent price moves even in U.S. dollars, like during the 2014 crash. So an ordinary Chinese citizen is paying up and taking a lot of price risk just to get rid of the Chinese currency.
The amount of money that can be transacted via Bitcoin is unlimited.

“If you are willing to get capital out of China badly, then you are willing to take the risk,” says Luria.
Since there are no transaction costs for shifting from yuan into Bitcoin and from Bitcoin into dollar, it means traders think the Chinese currency is at least 4.4 percent overvalued compared to the U.S. dollar. 
“Even though 60 percent of the new supply of bitcoin comes out of China, despite that you have these positive spreads on Chinese exchanges,” says Demeester.
The amount of money that can be transacted via Bitcoin is unlimited—at least in theory—as Bitcoin is not part of the limitation on overseas money transfers and investment opportunities.  
“You can take Bitcoin out to anywhere in the world and that’s a way to get capital out of China,” says Luria.
Chinese can open overseas bank accounts while traveling and then exchange their bitcoins for foreign currency in their new bank accounts. Direct transfers to overseas bank accounts are limited, but this roundabout way is not.
While the price moves and discrepancies are exciting, but the total amount of Bitcoin in circulation ($8.3 billion) is tiny compared to the Chinese banking system ($35 trillion) and even compared to the total amount of capital that left China in 2015 ($676 billion).
We cannot ignore the revolutionary changes it brought to the financial sector. , Cyberspace Administration of China

However, China is the world leader in Bitcoin mining (the mathematical process through which new bitcoins are created) as well as Bitcoin trading. Chinese Bitcoin exchanges account for as much as 92 percent of global volumes (around $22.5 billion during the last 30 days).
Bitcoin Ban
So didn’t China ban Bitcoin at the end of 2013? And why did the price crash so much?
In short, the answer is no, China did not ban Bitcoin. China barred financial companies (including the big, non-bank payment providers like Alibaba’s Alipay) to deal with Bitcoin. It did not ban Bitcoin exchanges like Huobi or the transfer of bank deposits in exchange for bitcoins.
“The Chinese government [was] highly worried that, if the banks and Alipay connect directly to the Bitcoin infrastructure, the banks or Alipay will do something really stupid and the government will have to bail them out,” Joseph Wang of Bitquant wrote in a blogpost.
So there was a good reason for the steep price decline after the Chinese added this regulation. By prohibiting big payment companies like Alipay to use the virtual currency, China ensured that Bitcoin would not become the currency of choice for sales of goods and services, especially in its booming online market.  
“Merchant fees in China are lower than in the West and platforms such as Alipay and WeChat or Tenpay dominate the mobile and non-bank payment market,” writes Coindesk’s Aiga Gosh.
Using Bitcoin for real live transactions is an important driver of demand for the virtual currency. If this factor of demand is removed, the price must fall, although the Cyberspace Administration of China has recently used softer tones when talking about the currency in October of 2015:
“Although some people think that Bitcoin and its underlying technology, the Blockchain, is not stable, we cannot ignore the revolutionary changes it brought to the financial sector. The new technology has led to the expansion of a distributed payment and settlement mechanism, which will innovate financial transactions.”
(Wall Street Journal)
Pure Speculation
So using Bitcoin as a payment for goods and services in China has been removed from the equation,

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Recently, Chinese have been associated with getting their money out of the country because of the weak economy and a possible debt crisis.
Those who are not getting their money out by buying Vancouver real estate or Italian soccer clubs have found another solution to the economic uncertainty: Gold ETFs.
The Chinese segment of this almost 2000 ton global market is tiny (20 tons), but those holdings doubled in the first quarter of 2016 compared to the first quarter of 2015, according to a report by the World Gold Council.
(World Gold Council)
The most popular Chinese Gold-backed ETF (Huaan Yifu Gold) increased its holdings by almost 30 percent to 13.5 tons in the first quarter compared to the end of 2015.
Globally, gold ETFs increased their holdings by 364 tons, the highest number since the first quarter of 2009 contributing the most to gold’s strongest first quarter of the year on record. Total demand was 1290 tons, up 21 percent compared to the same period in the year before.
“The noxious atmosphere of uncertainty created by global monetary policies and shifting expectations for U.S. interest rate rises were cause for concern. Investors sought the safety of gold,” the report states.
(World Gold Council)
The report also mentions the threat of a Chinese devaluation caused the spike in gold demand. Being at the epicenter of these worries, Chinese also loaded up on physical gold and increased their purchases 23 percent compared to the end of 2015. They bought 62 tons.
“I think many Chinese understand if they buy gold in China with renminbi, they are also hedged against such a devaluation, so there is no need for normal Chinese to use gold and bring it out of the country when they made their money in an honest way,” says Willem Middelkoop, author of “The Big Reset.”
Another reflection of this shift in consumer sentiment in China is the fact demand for gold jewelry actually decreased 4 percent over the quarter and 17 percent over the year (216 tons to 179 tons). 
The Chinese central bank, while defending its currency against massive capital outflows has also continued to load up on gold.
“Russia and China–the two largest purchasers last year–continue to accumulate significant quantities of gold,” states the report. China added 35.1 in the first quarter and it looks like the made a good investment. Gold outperformed all other asset classes in the first quarter:
(World Gold Council)

Read the full article here
May 26, 2016

Nobody knows whether the Fed will raise rates again in June, not even Fed officials.
So it seems kind of pointless Chinese officials would ask their U.S. counterparts whether there would be a rate hike as Bloomberg reports, citing people “familiar with the matter.”
In fact, U.S. officials may ask their Chinese counterparts whether raising rates would not hurt anybody. San Francisco Fed President John Williams said as much during a speech at the Council on Foreign Relations this week.
“I don’t know what will happen in June, it depends on the data,” with data meaning uncertainty and capital flight in China. “It’s a factor in the decision for June and we could hold off until July.”
One thing, however, is certain. When a Fed rate hike becomes more likely, the Chinese currency feels the pressure—it’s down almost one percent over the past month to 6.56, which is a lot for the centrally managed exchange rate and very close to the 6.59 level reached in January this year.
(Google Finance)
And with the best estimate for second quarter U.S. GDP, a key input for the Fed in its rate decision, being upgraded from 2.5 percent to 2.9 percent, the rate hike is becoming ever more likely.    
(Atlanta Fed)
This dynamic, of course, isn’t new. Ever since the Fed stopped it’s Quantitative Easing (QE) program in December of 2013, the U.S. dollar hit rock bottom against the yuan and has appreciated 8 percent. She steepest increase happened in the second half of 2015 when markets finally believed the Fed would hike rates for the first time since 2006.  
(Google Finance)
“That means the Fed still has a ‘China problem’: any effort it makes to tighten policy will, once more, activate the feedback loop and suck capital from China with what are now predictable consequences,” Citigroup’s David Lubin writes in a blog post.
Investment bank Nomura, however, believes that this episode is different from what happened last year in August when the yuan devalued 4.5 percent over a few days:
“[The yuan] is trading close to the actual fix [the central bank sets this rate], which suggests the downward pressure on the yuan is not as severe as last year. Moreover, the yuan has generally been underperforming its peers since the August devaluation.”
According to the investment bank, the weakness against other currencies already includes some of the weaker Chinese economic data and therefore does not necessitate another sharp devaluation.
“The August devaluation thus occurred with falling confidence in the economy and market participants saw the devaluation as confirmation of a much weaker Chinese economic picture than before.”   
But what about the Fed? Nomura thinks the first rate hike in December was as bad as it gets: “While there have been gyrations around Fed hike expectations, the first hike is behind us.”
If the worst is not behind us in terms of market volatility and a crashing Chinese currency, John Williams has the solution: “We can always move interest rates back down.”

Read the full article here

After the market fireworks at the beginning of the year, things started to quiet down at the end of February right after the G20 meeting in China. This quiet is about to end if we take the Chinese currency as an indicator.
Markets were worried the yuan would crash against the dollar with some hedge fund managers even betting on a 50 percent decline in 2016. China’s stock market crashed some 25 percent in January and the S&P 500 lost almost 10 percent at its low point in February.
After the unofficial Shanghai Accords—named after the place of the G20 meeting—this concern receded as the U.S. dollar weakened and emerging market currencies including China’s yuan appreciated. The Federal Reserve played a part as it skipped raising interest rates during its first meetings in 2016 and Chinese capital outflows markedly slowed from March onwards.
So the yuan hit a relative high against the dollar in March at 6.45, the S&P 500 made it to green for the year, but it seems this was as good as it gets.
For no apparent reason, the yuan then started to decline and is approaching the January lows of 6.60 per dollar.

At the beginning of May, Australia defected from the rest of the world’s central banks by cutting interest rates in an effort to weaken its currency, breaching the agreement to let the dollar weaken across the board.
On May 18, the Federal Reserve released the minutes of its March meeting, indicating it may just raise rates again. This led to a sharp sell-off in the Chinese currency and prompted the People’s Bank of China (PBOC) to intervene in the currency markets to strengthen the yuan.
The Chinese economy and possible capital outflows are coming to the forefront of analysts and traders again.
Read MoreChina Expert Evan Lorenz Says Yuan Devaluation Will Happen
“China’s macro [economic picture] may weaken (against the recent consensus of a cyclical upturn) and there is a risk that capital outflows will pick up again,” the investment bank Nomura writes in a note to clients.
Ever since the Fed started to tighten global liquidity at the end of 2013, the U.S. dollar has steadily crept higher, conversely pulling the yuan lower. Since 2015, the falling Chinese currency has preceded market turmoil in the fall of last year and at the beginning of this year.  
Now all eyes are on the Fed which meets on June 16-17 and is highly likely to raise rates, at least according to best-selling author James Rickards:
“I think in June, particularly after having skipped March, they’re going to want to get back on track. They’re going to raise rates, but the market expectation is still not better than 50 percent that they will,” he said right when the dollar put in a bottom in March.  

Read the full article here

On the surface, things are quite straight forward: China has been growing fast thanks to a historic expansion in debt and recently failed to transition its economy from investment in things that don’t move to consumers who move around and buy stuff.
It has taken the market quite some time to come to that conclusion as most people thought the central planners in Beijing were invincible. Now, the sentiment is more negative, despite another ramp up in debt and investment to stabilize the economy in early 2016.
Investment bank Macquarie, however, goes against the grain and says China’s debt problem is misunderstood and there is untapped potential in the Chinese economy.
First of all, Macquarie states the debt is not the problem: “Focusing on debt misses the main point: debt under state capitalism is different from that in market economy,” it states in a report.
State capitalism in China’s case means China controls who lends and who borrows by owning most of the banking system as well as the State Owned Enterprises (SOE). It also writes the accounting rules and can tell banks to roll over debt indefinitely. China’s banking system was bust at the end of the 1990s and the regime swept the problem under the rug by setting up bad banks and using accounting gimmicks to forget about the problem.
In principle, the regime could do this again, although it likely won’t get away scot-free this time. “The hope, again similar to the 1999 crisis, is that nominal growth will grow enough to reduce the debt to GDP ratio to a manageable proportion. However, given the environment of slow growth amid collapsing productivity, such a strategy could instead lead to the scenario of Japan’s ‘lost decade’,” the Institute of International Finance states in a report.
Declining capacity utilization rates are only one indicator that a lot of capital and labor was wasted and therefore won’t generate much nominal GDP growth in the future without further increasing debt.  
Another thing has changed from 15 years ago: China doesn’t control its depositor base as tightly as before. Chinese savers, who are the ultimate lenders in the Chinese economy, were mostly confined to saving money in the form of bank deposits. And although bank deposits still make up the majority of savings, Chinese savers have used the liberalization of the financial system to get money out of the country.
Even the state controlled companies (who can also be savers, depending on the sector and company) have ramped up overseas investments, contributing to the  $676 billion in outflows in 2015. Macquarie also notes “foreign asset accumulation is more of a concern,” now and that outflows have a significant impact on China’s monetary policy.

As for the positives, Macquarie buys into the themes of further urbanization as well as increases in productivity, consumption, and services. The key point according to Macquarie, which may indeed be missed by the markets, is that more than 56 percent of the population lives in the cities, but only 40 percent have been properly registered under the Hukou residency system.
It also notes that China’s top four cities contribute less to the country’s GDP than either London or Tokyo, which is why there is further upside. And while most observers agree that a reform of the Hukou system would liberate millions of Chinese others doubt the service and consumer revolution that Macquarie thinks is going to happen just because it churns out more college graduate than everybody else.
“Sheer numbers of graduates are not translating into talent that can turn ideas into scalable businesses,” Eric Roth, head of Mc Kinsey’s Global Innovation and Growth Practice, wrote on the company’s blog.
“Chinese companies have an abundance of structures and processes, but suffer from the inability to translate these into an increased stream of value-creating innovation.”

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