A Chinese investor watches the U.S. presidential election on his smartphone at a securities company in Beijing on Nov. 9. (WANG ZHAO/AFP/Getty Images)A Chinese investor watches the U.S. presidential election on his smartphone at a securities company in Beijing on Nov. 9. (WANG ZHAO/AFP/Getty Images)

Immediately after Donald Trump became president-elect, the Chinese yuan fell through key support at 6.80 yuan per dollar, the lowest level since 2010.

The market reaction is hardly surprising, as Trump and his advisers have for a long time accused China of being an unfair trader and currency manipulator. They also vowed they would slap tariffs on Chinese goods if China doesn’t play fair in trade.

Trump adviser Peter Navarro says China has an unfair advantage because it follows lower health and safety standards and uses slave labor to keep labor costs competitive.

“If we learned anything from the World Trade Organization and NAFTA, it is that you have to put in stringent rules for worker health and safety protection,” he said, also mentioning China’s export subsidies and currency manipulation.

According to Navarro, if China doesn’t stop these practices, the United States will impose countervailing tariffs on Chinese products. Tariffs would result in fewer exports to the United States and therefore less demand for the Chinese currency.

“When Donald Trump talks about tariffs, they aren’t the endgame. The goal is to use tariffs as a negotiating tool to stop cheating. But if the cheating does not stop, we will impose defensive tariffs,” he said.

What Can Trump Do?

Victor Sperandeo, president and CEO of Alpha Financial Technologies LLC, thinks the United States could cap trade at a certain level, which “will harm China more than the United States. If we buy $500 billion, they have to buy $500 billion,” he said in an email. The United States absorbs 20 percent of China’s exports, worth $483 billion in 2015.

Other commentators think a Trump administration won’t be able to implement very harsh protectionist policies at all, because the traditionally pro-trade Republican Congress would have to consent as well.

“Big tariff increases on Chinese imports are quite unlikely. The focus will instead be on the theft of American intellectual property—something most people in either party would probably agree is a serious problem,” said Mark DeWeaver, author of “Animal Spirits With Chinese Characteristics.”

Chinese trade has been slowing but the trade surplus with the United States is still high (Capital Economics)

Chinese trade has been slowing, but the trade surplus with the United States is still high. (Capital Economics)

Jim Nolt, professor of international relations at New York University, said that even if a Trump administration can pass draconian sanctions, China could selectively retaliate.

“China may act strategically by targeting sanctions against U.S. exporters located in the states or congressional districts of powerful Republicans in Congress,” he said.

China could also hassle the American companies operating in the country, as it has done in the past, with anti-monopoly and other investigations.

Given these complicated details, a Trump administration will have to make some very good deals with China for its managed trade policy to work.

Involuntary Depreciation

While export subsidies, sweatshops, and a lack of environmental standards are common in China, especially in industries like steel and solar, the issue of currency manipulation is not as clear-cut anymore as it was 10 years ago.

Up until 2005, China pegged its currency to the dollar at a rate of 8.27 yuan, despite enormous exports and capital inflows that would have warranted a much higher exchange rate. China kept the rate stable by buying Treasury securities to the tune of $4 trillion, thereby creating an artificial demand for dollars.

After pressure from the United States, China let the yuan rise to a high point of 6.05 yuan per dollar in early 2014. Since then, however, the rate has not really been in China’s hands anymore.

Systemic economic problems and the creation of $35 trillion in bank credit, as well as regime leader Xi Jinping’s anti-corruption campaign, have led to massive capital outflows, estimated to be between $1.2 trillion and $1.5 trillion since the beginning of 2014. These capital outflows were higher than the trade surplus and placed downward pressure on the Chinese currency.

Capital outflows have accelerated again in the fall. (IIF)

Capital outflows have accelerated again in the fall. (IIF)

But rather than embracing this opportunity to let the currency slide and create an advantage for exporters, China sold off $1 trillion of its foreign currency reserves to keep the yuan relatively stable—and therefore give a fake impression of stability. So if anything, China has been manipulating the currency up, not down, for at least the last couple of years.

This type of manipulation continued after the U.S. elections, as Treasury bonds were sold en masse. Prices fell, and yields rose in a highly correlated fashion with the rise of the dollar against the yuan.

Maybe the Chinese want to wait and see what Trump proposes before letting the currency loose completely. Or would they like to show their power, to tell the president-elect they can move Treasury markets at a whim?

“Don’t look for China to ‘dump’ Treasury bonds. That is a widely mistaken notion. The dollar is the only currency big enough to hold Chinese reserves,” said Christopher Whalen, head of research at the Kroll Bond Rating Agency in New York.

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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.   

gsyuanoutflow

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.  

(Bloomberg)

(Bloomberg)

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.

(HSBC)

(HSBC)

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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World leaders have gathered in Brisbane, Australia, for the annual G20 Summit. (Andrew Taylor/G20 Australia via Getty Images)World leaders have gathered in Brisbane, Australia, for the annual G20 Summit. (Andrew Taylor/G20 Australia via Getty Images)

News Analysis

Inclusive growth, green energy, more trade, and a move away from financial crisis management to long-term planning—those are the official goals of the 2016 G-20 meeting in Hangzhou, China.

And wouldn’t it be great if the leaders of the world’s biggest economies could just flip a switch when they meet Sept. 4–5, forget about the huge economic issues, and focus on a prosperous future?

“China’s leadership steered the debate to facilitate the G-20 to move from short-term financial crisis management to a long-term development perspective,” U.N. Secretary-General Ban Ki-moon told Chinese reporters in New York on Aug. 26, according to state-run news outlet Xinhua.

But reality doesn’t work like that and huge frictions already lie beneath the surface, especially concerning the host. Aside from a very messy geopolitical situation in the South China Sea, the Middle Kingdom faces an economic crisis at home.

Neither the West nor China knows how to deal with China’s overcapacity and debt problems without ruining world trade and globalization altogether, let alone promoting inclusive growth and green energy.

“China is angry with almost everyone at the moment,” a Beijing-based Western diplomat told The Fiscal Times. “It’s a minefield for China.”

Global Effect

Despite China’s relatively closed financial system, the economic growth of many countries, like Brazil and Australia, depends on China’s huge consumption of commodities. Other countries, like the United States, are not vitally dependent on Chinese inflows of capital but have gotten used to trading Treasury bonds and New York real estate for cheap Chinese goods.

Ideally, the West would encourage China in its official quest to reform and rebalance its economy from manufacturing exports and investment in infrastructure to a more service- and consumption-driven economy.

The United States’ and most of Europe’s trade deficit with China would be reduced. The Chinese consumer would have more income to consume at home, importing Western goods and services instead of commodities.

There is no world after the tomorrow where China devalues by 20 percent.

— Hugh Hendry, principal portfolio manager, Eclectica Asset Management

“The necessary structural reforms would make it the largest consumer market in the world. Every other economy would benefit,” independent economist Andy Xie wrote in the South China Morning Post.

Chinese leaders and state media have repeatedly stressed they are behind this goal. “What is called for is not temporary fixes: My government has resisted the temptations of quantitative easing and competitive currency devaluation. Instead, we choose structural reform,” Xinhua quoted Premier Li Keqiang, who said the country has no Plan B.

Regime leader Xi Jinping again stressed the importance of reform in a meeting of the Central Leading Group for Deepening Overall Reform. “The country should focus more on economic system reforms and improve fundamental mechanisms that support these overhauls,” Xinhua wrote about a statement released by the group.

However, China has not entirely followed through with the reforms, which will cause short-term turmoil, and local governments are not prepared to handle worker unrest. Up to 6 million people will lose their jobs because of the regime’s rebalancing program, and the official unemployment rate could reach 12.9 percent, according to a report by the research firm Fathom Consulting.

For example, Hebei Province was supposed to close down 18.4 million tons of steel-producing capacity in 2016. By the end of July, it had only closed down 1.9 million tons, according to Goldman Sachs.

(Goldman Sachs)

Hebei province was supposed to close down 18.4 million tons of annual steel-production capacity and only managed to close down 1.9 million tons by the end of July. (Goldman Sachs)

The economies of Australia, Brazil, Russia, and South Africa—all major commodity exporters—are slowing because Chinese imports have collapsed, falling 14.2 percent in 2015 alone, according to the World Trade Organization. In 2015, world merchandise imports crashed 12.4 percent, while world merchandise exports crashed 13.5 percent.

Australian exports and imports (World Trade Organization)

Australian exports and imports. (World Trade Organization)

This collapse in world trade happened before China even started to implement its goals of reducing overcapacity, liberalizing the capital account, and floating its currency.

Instead, it has been buying time by pushing credit in the economy and spending it on infrastructure investment through state-owned companies and local governments, while private companies have thrown in the towel.

(Morgan Stanley)

(Morgan Stanley)

Debt Problem

China has also told banks not to push delinquent companies into default but instead to make their loans evergreen or swap debt for equity.

The real question the West and China should be asking is how much pain they can endure in the short term to reach the Chinese reform goals and achieve a rebalancing toward a consumer economy.

“To avoid a financial crisis that would be bad for China and the world, the government needs to tighten budget constraints, allow some firms to go bankrupt, recognize the losses in the financial system, and recapitalize banks as needed. … History shows it makes more sense to help the affected workers and communities rather than to try to keep alive firms that have no prospect of succeeding,” the Brookings Institution stated in a paper on the subject.

However, the proposed remedies, which in the long run would be good for China and the world, cannot happen without upsetting the global financial system in the short term.

Billionaire investor Jim Rogers pinpointed the main issue in an interview with Real Vision TV: “I would certainly like to see more market forces everywhere, including in China. If that happens, you’ll probably see more fluctuations in the value of the currency.”

What sounds innocent, however, will be even more detrimental to world trade and the global financial system. If China wants to realize the losses it accumulated through 15 years of capital misallocation, it will have to recapitalize the banks to the tune of $3 trillion.

It’s impossible to do this without heavy intervention from the central bank of the kind Li Keqiang wanted to avoid. On the other side, Chinese savers will try to move even more money abroad to protect the purchasing power of their currency.

In 2015 alone, China lost $676 billion in capital outflows, mostly because residents and companies wanted to diversify their savings, the majority of which are tied up in the Chinese banking system.

If China were to restructure corporate debt and recapitalize banks on a massive scale, the currency would devalue by at least 20 percent, according to most experts.

Trade Collapse

Because China is such a large player, exporting and importing $4 trillion of goods and services in 2015, a 20 percent devaluation of the Chinese currency would destroy the current pricing mechanism for importers and exporters across the world—a mutually assured destruction scenario.

“The world is over. The euro breaks up; there’s just no euro in that scenario. Everything hits the wall. There is no world after the tomorrow where China devalues by 20 percent. Their share of world trade has never been higher. … You would destroy global manufacturing,” Hugh Hendry, principal portfolio manager at Eclectica Asset Management, told Real Vision TV. 

Global trade for the developed economies is already in recession (World Trade Organization)

Global trade for the developed economies is already in recession. (World Trade Organization)

For China itself, a net importer of food supplies, a devaluation would make necessities even more expensive for the vast majority of the population, adding a layer of social unrest on top of the unemployment pressures.

So China is damned if they do and damned if they don’t. Even the West won’t favor a quick and painful devaluation scenario and isn’t in the best shape to offer many alternatives.

The other option, possibly discussed behind closed doors at the G-20, is a Japan scenario. China won’t realize bad debts, will keep zombie companies alive, and will prevent money from moving abroad, defaulting on its ambitious reform agenda.

“In lieu of a quick adjustment, a ‘gradual adjustment approach’ would leave us with the outcome of an extended period of excess capacity, disinflationary pressures, and declining nominal growth and returns in the economy,” investment bank Morgan Stanley stated in a note.  

China, the West, and Japan share the same problem of excess debt and no expedient way to get rid of it. By not naming the real issues at hand and choosing feel-good topics instead, the G-20 has already admitted defeat in finding a solution to the problem.  

Read the full article here

Local Chinese residents walk on a flooded street in heavy rain in Wuhan, central China, on July 6 2016. (Wang He/Getty Images)Local Chinese residents walk on a flooded street in heavy rain in Wuhan, central China, on July 6 2016. (Wang He/Getty Images)

Chinese president Xi Jinping seldom comments directly on the economy. Instead, he lets his premier Li Keqiang do the talking. Or Xi speaks through one of the regime’s mouthpieces like People’s Daily or Xinhua.

On July 21—only one week after China published unexciting GDP figures—it was Xinhua who came out with a commentary on how important reform is for China and that there is no alternative to short-term pain and long-term gain.

“China must push through reform, for there is no plan B,” the mouthpiece states.

The article is just a Xinhua commentary and didn’t cite an “authoritative person” like the People’s Daily usually does, but given the amount of control Xi personally exerts over the media, it probably had his blessing. 

Piecemeal solutions no longer work.

—  Xinhua

The article espouses the reform narrative we have heard previously: market reform, sustainable growth model, innovation, consumer spending, supply-side structural reform, cutting red tape etc. So we can assume that Xi and his premier still stand behind the reform agenda.

“What is called for is not temporary fixes: My government has resisted the temptations of quantitative easing and competitive currency devaluation. Instead, we choose structural reform,” Xinhua quotes premier Li Keqiang. 

Reality Check

The problem, as it is the case so many times with Chinese media and utterances from the Communist Party, is that the claims don’t reflect reality.

With respect to temporary fixes, China just created a record amount of credit in the first quarter, amounting to $712 billion in new loans. These loans did not go into the private sector as Li claims but broadly speaking boosted investment by state enterprises.

Chinese ship-builders, for example, reported a surge in orders by volume of 44.7 percent from January to June this year compared to last year. Private investment on the other hand only grew 3.9 percent in the second quarter of 2016, whereas total investment rose 9.6 percent.

“State Owned Enterprises (SOE) continue to invest in the overcapacity industries, which suffer from slower growth in production,” writes the investment bank Natixis in a note.

However, judging from the Xinhua piece and others before, the regime clearly recognizes the problems: “Problems facing China’s economy, including a troubled property sector, industrial overcapacity, rising debt levels and the lack of new growth engines, are all connected with each other and piecemeal solutions no longer work. The only way to restore vitality to the economy is to push through reforms.” They aren’t happening.

Instead, central bank officials are calling for fiscal deficits of up to 5 percent to support the economy and they admit traditional monetary stimulus is not working anymore. 

“Despite loads of liquidity pumped into the market, enterprises would rather bank the money in current accounts in the absence of good investment options, which is in line with record low private investment data,” Sheng Songcheng, head of statistics and analysis at the People’s Bank of China (PBOC) said recently.

You can have a good old financial crisis without having the 1997–1998 Asian foreign debt issue.

— Willem Buiter, Citigroup

Willem Buiter, the chief economist of Citigroup says China needs to recapitalize the banks and go through a round of central bank financed deficits to clear up past excesses. He thinks China won’t avoid a financial crisis otherwise:

“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’s Bank of China.”

Debt Semantics

Speaking about debt and a financial crisis, naturally, Xinhua has a differing view: “Most of China’s debts are domestic, and its debt levels are within control and lower than other major economies. A moderate deficit level (2.4 percent in 2015 and a target of 3 percent for 2016), large household savings and massive foreign exchange reserves strengthen the country’s ability to endure risk.”

Forget about the fact that central bank officials are already calling for a 5 percent deficit, Standard and Poors just released a report warning about China’s dangerously high debt levels. “The downside risks are material, especially if Chinese authorities lose their grip on rebalancing the economy,” it states. 

china debt

Foreign exchange reserves have decreased from $4 trillion in 2014 to $3.2 trillion now. Hedge fund managers like Kyle Bass of Hayman Capital think the crisis threshold is at around $2.5 trillion. 

“They are so far ahead of the world’s excesses in prior crises, we are facing the largest macro imbalance in world history,” he told RealVisionTV.  

Willem Buiter says the debate of external versus internal debt is largely meaningless: “You can have a good old financial crisis without having the 1997–1998 Asian foreign debt issue.” 

Both Kyle Bass and Buiter see a further devaluation of the Chinese currency as highly likely. “The Chinese government wants a devaluation, they just want it on their terms. In the next two years, this is happening,” says Bass.  

One thing Xinhua gets right: The days of double-digit growth are over. “To be sure, China’s economy cannot, and should not, repeat its past growth record. It may be on a bumpy journey, but will maintain a slower, but stable growth.” Which is the best the country can hope for. 

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

Devaluation

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.

Devaluation

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

Germany's Chancellor Angela Merkel, right, and China's Premier Li Keqiang review an honor guard during a welcome ceremony at the Great Hall of the People in Beijing, Monday, June 13, 2016. (AP Photo/Andy Wong)Germany's Chancellor Angela Merkel, right, and China's Premier Li Keqiang review an honor guard during a welcome ceremony at the Great Hall of the People in Beijing, Monday, June 13, 2016. (AP Photo/Andy Wong)

No matter the outcome, there will be certainty about whether Britain will remain within the European Union or exit the European superstate on June 23.

There is uncertainty about what happens if Britain chooses to exit and some risks, but many financial analysts think there is a bigger problem hiding in plain sight, one which will take longer to solve, with less clear-cut outcomes.

“We believe China’s ongoing stealth devaluation of the renminbi is far more important for the global economy,” writes Albert Edwards of investment bank Société Générale. He is talking about the drop in the Chinese yuan against a basket of currencies especially since the beginning of the year, while the yuan remained more or less stable against the dollar.

The yuan is down 10 percent against this basket since last August, the first time the Chinese central bank sharply lowered its fixed exchange rate, surprising markets at the time.

Global excess capacity in the steel industry leads to trade problems historically.

— Lewis Alexander, Nomura

“China is now exporting its deflation, and my goodness it has a lot of deflation to export. In the Ice Age world, countries need to devalue to avoid deflation,” writes Edwards.

Deflation means lower prices for goods and services. If the yuan exchange rate falls against the euro and the Japanese yen, manufacturers in Germany and Japan have to compete with precisely that: lower prices from Chinese exporters.

The U.S. chief economist of investment bank Nomura says overcapacity in the steel industry is part of the problem leading to lower prices worldwide as well as a series of competitive devaluations.

(Société Générale)

(Société Générale)

“Global excess capacity in the steel industry leads to trade problems historically. This is something we are all going to have to manage,” he said at a meeting of the Council on Foreign Relations (CfR) on June 21.  “China is opening up financially which is making itself vulnerable to market dynamics.”

China has announced and carried through a series of reforms which removed certain barriers to trade and the flow of capital in order to gain access to the International Monetary Fund’s (IMF) basket of reserve currencies.

I think that China, financially speaking, is the world’s biggest problem.

— James Grant, Grant’s Interest Rate Observer

James Grant, editor in chief of Grant’s Interest Rate Observer agrees with Edwards in that China poses the biggest risk to the financial system.

“I think that China, financially speaking, is the world’s biggest problem. One day we will all wake up and hear or read that there has been a collapse in the Wealth Management Products (WMP) in the Chinese shadow banking and banking system,” he said the CfR meeting.

Wealth Management Products are pools of bank loans sold to retail investors which have a higher yield than deposits but also have higher risks because banks usually don’t report what exactly is inside these products. Grant says this financial product is close to a Ponzi scheme because maturing WMPs are being redeemed by the issuance of new WMPs.

Emma Dinsmore, co-founder and CEO of r-squared macro, hopes China will be able to reform its economy before it’s too late: “Ultimately the only way to work out the access capacity is to grow the consumer base and accept lower growth in the short term. Moving down the course is very challenging for China,” she said at the CfR meeting. “Either way, they will export more disinflation.”

Exporting more disinflation means having a lower currency, buying growth from the rest of the world, which is struggling to spur growth itself.

“What is going on in China to that end is very worrying,” said Grant.

Follow Valentin on Twitter: @vxschmid

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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.

(IIF)

(IIF)

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.

(IIF)

(IIF)

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.”
(BIS)
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.
(Youth.cn)
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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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,

Read the full article here

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.
(Nomura)
“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

An introduction to lawyer, portfolio manager, government adviser, lecturer, and author James Rickards could easily be five pages long. Sifting through his CV, it’s easier to pick the things he doesn’t do rather than listing all the different jobs and responsibilities he holds and has held over the past decades. This is what is keeping him busy at this moment:
He is the chief global strategist at West Shore Funds, is a registered investment advisor, and he edits the financial newsletter Strategic intelligence. He advises the department of defense and also lectures at Johns Hopkins University among others. What he is best known for, however, are his two best-selling books about the global financial system, “Currency Wars” (2011, Portfolio Penguin) and “The Death of Money” (2014, Portfolio Penguin).
Both books have defined and predicted important trends in financial markets that the mainstream media and other commentators frequently overlook or pick up on years later.
Epoch Times spoke to Mr. Rickards about his new book “The New Case for Gold” (Portfolio Penguin, 2016), the coming reform of the financial system and China’s role as a source of global market volatility.
Read about why the Fed didn’t hike rates at its last meeting and why gold is the real money in part I of this exclusive interview with James Rickards. Skip to 14:16 in the video to directly delve into financial system reform and China.  
The powers will come together, they will reform the international monetary system.

Epoch Times: In your new book you quote the book of Revelations in the Bible, a quote about the new Jerusalem where the streets are paved with gold. But before we get to the new Jerusalem, there is some volatility according to the Book of Revelations. Where do you draw the parallels with our financial system at this moment?
James Rickards: I’ll leave the biblical interpretation to the scholars, I’m more of a financial analyst and a gold analyst. Clearly central banks have pulled out all the stops, they printed trillions of dollars, they’ve swapped trillions of dollars. They guaranteed the money market funds in 2008 and the guaranteed all the bank deposits. They did everything possible.
We might have avoided something worse that might have happened, like the Great Depression, but none of that policy has been reversed. The Fed’s balance sheet is still bloated. A lot of the swap-lines are still in place. They haven’t been able to normalize policy since 2008.
So what’s going to happen in the next crisis? And these crises come every seven to eight years. We go back to 1987, the stock market fell 22 percent in one day. Not a year, not a month but one day, 22 percent. By today’s Dow Jones Index that would be the equivalent of 4000 Dow points.
Now if the stock market fell 400 points I guarantee it would be on every evening business show, front page news, every website. Imagine if it fell 4000 points. That’s the equivalent of what happened in October of 1987. In 1994 we had the Mexican Peso crisis. Then we had a surprise interest rate hike, Orange county went bankrupt. In 1997/1998 we had the Asian financial crisis, the Long Term Capital Management (LTCM) crisis.
James Rickards with his book “The New Case for Gold” (James Rickards)
I was the general counsel for LTCM, and I negotiated that bail-out. I had a front row seat on that one. I know exactly how close global markets came to a complete collapse. We were within hours from shutting every exchange in the world. People forget about that but that’s exactly what happened.
In 2000 we had the dot.com crash, 2007 the mortgage crash, 2008 the Lehman and AIG panic. These things happen like clockwork. Every six, seven, eight, nine years. It’s been seven years almost eight years since the last one. How long do you think before another one comes? And yet they haven’t normalized policy, so what’s the Fed going to do the next time.
Are they going to print another $4 trillion? Legally they could, but they are at the outer limit of what they can do without destroying confidence. And confidence is the key to the whole thing.
Epoch Times: You talk about the concept of world money in your book, sponsored by the International Monetary Fund (IMF).
Mr. Rickards: So what you are going to see is world money. You are going to see the IMF print Special Drawing Rights (SDR). It’s a geeky name but it’s a kind of world money printed by the IMF. They’ll flood the world with trillions of SDRs. It might work because people don’t really understand what SDRs are. It might just blow by everybody.
At best it will be highly inflationary. At worst it won’t work because people will say, we’ve lost confidence in these other kinds of paper money and fiat money, why should we have any more confidence in that.  
And then you’ll see a gold buying panic and the dollar price of gold would skyrocket. It would be better if the leading financial and trading powers in the world sat down today in relatively calm times and did something like Bretton Woods and reform the international monetary system.
I think if they did, gold would play a role. I am not saying it would be a strict gold standard but I am saying gold would have some role. I don’t think that is going to happen. I think we are going to see a crisis first. Going back to your version of the Book of Revelations you have to have some rough times before you get to the good times.
The Chinese citizens love buying gold.

The powers will come together. They will reform the international monetary system, but they’ll do it in a state of collapse and panic rather than in a calm, orderly state.
In that world, people are going to go on their own gold standard. They’re not going to wait for the financial powers to create a gold standard, they’re going to have a gold standard of their own.

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