Notes From Underground: Signs of Madness in the Global Financial System

From time zone to time zone, there are signs of a broken financial system. This past weekend’s issue of Barron’s had a splendid article by Jonathan Laing titled, “Why Beijing’s Troubles Could Get a Lot Worse.” Laing interviews  Anne Stevenson-Yang  from J Capital Research. Stevenson-Yang is a long-time China watcher, speaks fluent Mandarin and has lived in China for many years. In the interview, Laing asks her about many of the problems that the media covers, but one of the keys in the Q&A was the following:

Q: How bad can the situation be when the Chinese economy grew by 7.3% in the latest quarter?

A: “People are crazy if they believe any government statistics, which, of course are largely fabricated. In China, the Heisenberg uncertainty principle of physics holds sway, whereby the mere observation of economic numbers changes their behavior. For a time we started to look at numbers like electric-power production and freight traffic to get a line on actual economic growth because no one believed the gross-domestic-product figures. It didn’t take long for Beijing to figure this out and start doctoring those numbers, too.”

As a long time skeptic of official Chinese economic data it was refreshing to find a similar view from a long-time China analyst. My doubts were raised by a simple viewpoint which is if the Chinese government prevented the free use of Google then I believed that the free flow of any meaningful data was difficult to ascertain.M y view was for the health of China to look at its largest suppliers of goods, especially Australia.

Iron ore prices as well as other raw materials have been sliding for the last year, and, as Ms.Stevenson-Yang said, “I’d be shocked if China is currently growing at a rate above 4%, and any growth at all is coming from financial services, which ultimately depend on sustained growth in the rest of the economy.” My point is to view all things China with a skeptic’s eye before swallowing the “analysts” and talking heads of financial media.

In trying to understand the impact of the YEN weakness on the global economy I ran a YEN/YUAN chart (USDJPY/USDCNY) and saw that the YEN has depreciated almost 50 percent versus the YUAN during the past two years since Japan began its efforts to weaken its currency. In looking at a monthly chart, the current YEN/YUAN price is lower than the June 1998 level when the Chinese government was very unhappy over Japanese efforts to intervene and weaken the YEN. The YEN/YUAN was at 17.49 yen to a yuan in 1998 and is now at 19.32 yen to yuan. In trying to court favor with the Chinese, the U.S. Treasury intervened in the foreign exchange markets and actually sold DOLLARS and BOUGHT yen. This will not happen now as the politics of the globe have changed as the status of China’s economy, but it is a potential flash point within the Asian region, especially if China is slowing. The Japanese are pressing for a weaker YEN but will its neighbors acquiesce in its efforts?

***More madness: The interest rates in Europe reflecting the insanity of global finance. These are all 10-year yields:
France: 0.97%
Spain: 1.81%
Italy: 2.02%
Portugal: 2.82%;
Ireland: 1.34%
In what realm are these rates reflective of the risk involved in any of the above sovereigns? Oh, and in the money printing nations of Japan and Switzerland 10-year JGBs are 0.42% while Swiss bonds are 0.29%. Yesterday, the BIS warned that the rally in the U.S. dollar could destabilize the global financial system. The international system is already under great stress because of central banks printing money in QE programs and is causing the massive mispricing of risk. The money train continues unabated, just wait for real QE in the European Union.
***I  am revisiting last year’s December 24 interview with Rick Santelli (click on the image) in which we discussed the outlook for interest rates and especially the 5/30 yield curve. I have just be invited back for this December 24 so it will be interesting to look ahead. Looking back to look forward.
Yield Curve Volatility

15 Responses to “Notes From Underground: Signs of Madness in the Global Financial System”

  1. Dan Says:

    why do you even consider China’s GDP numbers when you don’t believe them? Look for instance at crude oil consumption by China… it grows by about 8-10% YoY. Crude oil is a very good GDP proxy… cheers

  2. Ven K Says:

    May track China economy better by looking at US imports from China (10/14 ytd +5ish% iirc) and Audi/BMW/Merc sales in China (up 10-15% ytd yoy). Plenty of private sector data like revenues and op profit margins of US/Japanese/German cos. allow one to have better sense of any major macro in world than generally inept/corrupt gvt stats.
    Also stock charts of major companies w/large bizs in various relevant macros reveal truth better/earlier than any aggregate stats. Only gvt stats I use are US/Japanese/German reported tax revenues from wages/withholding: may be surprised by how wage (or VAT) tax revs usu don’t synch w/alleged GDP stats (or claims of no real wage gwth)
    Would be more amazed if there are any successful traders who even look at 99.9+% of any gvt stats (esp after the various rants by guys like Taleb abt the absurdity of such pseudo-quant). I just watch mkt price reaction to any gvt stats or FOMC gibberish to judge trading relevance of any such alleged data/”news”.

  3. Kevin Says:

    Hi Yra
    It’s an economic impossibility to rebalance the Chinese economy without a huge decline in growth rates – investment is so large in the base that even if consumption grows 10-15% (as it is) overall growth will stagnate – e.g. flat investment = 3-4% overall GDP growth. This would not be a problem as the consumer sector (wages, real deposit rates, stronger RMB) is booming so there are no “social stability” issues.

    But the real issue is the political vulnerability of missing the target by so much – another interpretation of “social stability” is the local authority/property developer/infrastructure kleptocrats getting their pound of flesh – squeeze investment too much and these enormously rich and influential parts of the party will squeeze back!

    I suspect the focus on rooting out “corruption” in the party, army, etc. means that currently the rebalancing attempts are on-going, the actual growth is around 3-4% and Xi is holding the kleptocrats at bay. This, if correct, is very bullish, lower growth = more effective rebalancing.

  4. Joe Says:

    Just a comment on China’s current crude oil consumption. I wonder what percentage represents purchases for its strategic reserve?

  5. Alex Says:

    Govt, business/commerce, pro sports – almost everyone is cheating and lying somehow/somewhere these days.

    It’s all so very sad and it’s one of the main reasons I buy some Gold every month. Gold is probably the most honest investment of them all, which is why it’s been bashed. Telling the truth in a dishonest world is itself dishonest.

  6. yra Says:

    Alex–as Jim Grant so beautifully stated:Gold is nature’s bitcoin

  7. yra Says:

    Kevin–absolutely agree with you–the politics dominate everything–the massive move from rural to urban population in so short a time span makes for a very volatile situation–thus the growth at all costs and puts them in a low profit model in order to protect market share–similar to the Japanese model that led to over investment and the slow economy for 25 years–over capacity.Can the Chinese redirect to a consumer based economy in order to absorb the massive mal investment?

  8. Chicken Says:

    The senate report appears to be drowning, while WMD’s remain AWOL

  9. Dan DeRose Jr Says:

    Yra, Great post as always! I agree the yuan peg must be cause for concern but I’m not sure a devaluation is a possibility. An undervalued currency was one of the mechanisms that created the imbalance in China and a devaluation would only exacerbate it. With nom GDP growth likely grinding lower (the point of contention here on which I side w the skeptics), real rates are grinding higher and I think interest rates are the likely lever to deploy the parachute and slow the trajectory of the landing (heck they’ve already cut so maybe they are worried about low GDP!).

    Keep up the great analysis! I’m looking forward to your 2015 predictions!

  10. ARTHUR Says:

    How real is China’s growth? Must read.

    Via THE ECONOMIST: From my (admittedly limited) view of China, arguments that China’s economy is little more than a Ponzi scheme, in which any slowdown will lead to implosion, are mistaken. I left with more questions than answers about the political system, however. I simply can’t say how legitimate and stable the current government appears in the eyes of the Chinese citizenry. But I feel fairly confident that it won’t be that long, perhaps 5 or 10 years, before we find out.

    http://www.economist.com/blogs/freeexchange/2011/05/chinas_economy_1

  11. Chicken Says:

    If anyone has ideas for what the next wave of legislated success might be, I’m all ears of course.

  12. GreenAB Says:

    unrelated to this post i´d like to share the following article:

    http://fortune.com/2014/12/10/securities-based-lending-banks/

    “Securities-based lending, also known as non-purpose lending, is Wall Street’s hottest business. From UBS to Bank of America Merrill Lynch to JPMorgan, high net worth investors are being enticed to take out loans against their brokerage accounts at a blistering pace. ”

    the whole thing is worth a read. imo it spells risk once the stock market experiences a real correction of 15% or more and it explains why so far we haven´t seen one for a long time. it´s not only CBs that have interest in a steadily rising stock market. i always believed that (investment) banks can´t be happy with the low volatility we are seeing these days since it hurts their trading profits. well, turns out that wall street has found a new cash cow and shifted towards security loans.

    the whole scheme reminds a bit of “bullet proof” mortgage lending. but once prices drop deep enough, a wave of liquidation (additionally to traditional margin calls) might set in…

  13. Chicken Says:

    Ai chihuahua, adios pesos.

  14. Chicken Says:

    Perhaps China needs to buy yen. I guess someone bought the $US the Treasury sold, and someone must be buying the Yen Japan is selling.

    Perhaps the money is pumping into the stock market and at some point becomes vaporized? I’m not sure where else it might be going, perhaps roads and bridges or a modern electrical grid?

  15. Chicken Says:

    Seems the market was prepared for accelerated selling last week until it became clear another legislated success was being born…

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