Notes From Underground

Indulge me, my readers. When I saw the movie Fiddler On the Roof 43 years ago with my now-wife, there was a line that made me laugh for it mirrored conversations that we shared about my nose always being buried in a book about history, economics and probably politics. In the movie, the young radical Perchik wishes to ask Tevye’s daughter, Hodel, to marry him. The question takes place in this dialogue:

The basis of the interchange is that everything is POLITICAL. Yes, it may have an economic base for the parties involved but all sides have their own political agendas. When a set policy provides a positive outcome the parties all find mutual contentment, similar to a good investment agreement where all parties share in the rewards. The G20 seeks to be a marriage of the remnants of the old Bretton Woods order, with the U.S. as the keystone of the international financial system coupled with the rising emerging economies of what was previously deemed the third world.

Until the previous decade, the global order was centered upon the G7: Canada, France, Germany, Italy, Japan, U.K. and the U.S. The old world order was finally brought to rest by the rapid development of the so-called BRICS, so the G7 had to make room for Brazil, Russia, India, China and South Africa: A marriage for a new economic reality. The politics as usual are still being worked out as the previous power centers never want to admit to a reality of diminished authority. Everything is POLITICAL.

The G20 met in Washington D.C. on April 16-17, and, as in typical fashion, released a sanitized statement about their discussions and efforts to promote global growth and social goodwill. Most of the communique is gibberish about promises made for a better world that sounds like any political campaign rhetoric. However, sometimes there are potential investment opportunities buried in a paragraph. This COMMUNIQUE had no buried treasure but in the second point this is found:

“In an environment of diverging monetary policy settings and rising financial market volatility, policy settings should be carefully calibrated and clearly communicated to minimize negative spillovers. When dealing with macroeconomic and financial stability risks arising from large and volatile capital flows, the necessary macroeconomic adjustment could be supported by macro-prudential measures and, as appropriate, capital flow management measures.”

It seems to me that there was a great of discussion within the G20 about the destabilizing effects of QUANTITATIVE EASING in some of the emerging markets. IN MY OPINION THE G20 has apparently resigned itself to the potential use of EXCHANGE CONTROLS if needed to stem the financial instability caused by global HOT MONEY flows. This issue of HOT MONEY flows has been a topic presented by the Governor of the Bank of India, Raghuram Rajan, as well as a continuing issue for the Chinese government and People’s Bank of China. In concluding the thought, the paragraph ends with a nod to the established order. “We reaffirm our previous exchange rate commitments and will resist protectionism.”

Prior to the release of the G20 communique, the Financial Times published an interview with Chinese Premier Li Keqiang. The interview included an interesting qualifier by the FT editorial staff: “Unlike many interviews with senior Chinese leaders, this encounter was unscripted  and the FT’s questions were not submitted to the Premier or his staff beforehand. Although the substance of the meeting was initially intended to be off the record, Mr.Li later agreed to the FT publishing the entire discussion without any changes to his remarks–also unusual in the Chinese context.”

Mr. Li is asked about the QE policy of the Federal reserve and says: “It is QUITE EASY for one to introduce QE policy, as it is little more than printing money. When QE is in place, there may be all sorts of players managing to stay afloat in this big ocean. Yet it is difficult to predict now what may come out of it when QE is withdrawn.” The interviewers ask Mr. Li if China will be tempted to devalue the renminbi: “Historically, Beijing has resisted the temptation to enter into competitive devaluation, most notably during the 1997-98 Asian financial crisis.”

This is categorically false  because China DEVALUED its currency by 50% on January 1, 1994, the day that NAFTA officially began (again everything is political). It is interesting that Mr. Li mentions the Asian financial crisis because although China did not intervene to weaken the YUAN it did push President Clinton to have the U.S. Treasury intervene to support a weakened YEN by buying BILLIONS of the Japanese currency as Bill Clinton was heading to China. (See YEN in June 1998.)

The Chinese Premier also states in the interview: “We don’t want to see further devaluation of the Chinese currency because we can’t rely on devaluing our currency to boost exports. We don’t want to see a scenario in which major economies trip over each other to devalue their currencies. That would lead to a currency war. And if China feels compelled to devalue the renminbi in this process we don’t think this will be something good for the international financial system.”

Now, the Chinese dropped its reserve requirement ratio (RRR) by 1% over the weekend after the G20 meeting. This was the largest drop in reserve requirements since the height of the global financial crisis in November 2008. The question for all investors: Was China sending a message to the markets and developed market governments that it will not allow the renminbi to be strengthening as the ECB and Japan continue printing money which results in a weakening of their currencies? If it was a message what impact will it have on the FED, ECB and BOJ? Is there any wonder why the tagline of 2+2=5 is the backdrop to Notes From Underground.

Tags: BOJ, China, ECB, exchange controls, Fed, G20, G7, hot money, Li Keqiang, political, QE, quantitative easing, Reminbi

This entry was posted on April 20, 2015 at 9:00 pm and is filed under China, Currency, G-20. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.