Notes From Underground: The Chinese Send a Message

There is much to talk about after the Chinese sent a shot across the bow of the U.S.S. Financial Complacency. If we glance at the currency charts of various global currencies versus the Chinese YUAN it is easy to see what the authorities setting policy in Beijing are so very concerned about. The YUAN may be very stable against the U.S. dollar but in terms of Brazilian real, Turkish lira, Mexican peso, Aussie dollar, euro, British pound, Japanese yen and Korean won, the YUAN has undergone a MASSIVE appreciation during the last three years. While the Chinese were announcing their intentions to attempt a pivot to a more domestic-consumption economy, a strong YUAN favored a structural change of such magnitude.

Professor Michael Pettis has long argued that an increase in domestic consumption in an economy with large trade and current account surpluses needs a strong currency as currency strength makes imports cheaper, which enhances the wealth of the middle class consumers. DOES LAST NIGHT’S MOVE SIGNAL THAT THE CHINESE POLICY MAKERS HAVE BECOME CONCERNED THAT DOMESTIC CONSUMPTION WILL BE UNABLE TO ABSORB THE CAPACITY CREATED BY PREVIOUS MASSIVE CAPITAL INVESTMENT? This is the critical question for the global economy for if the Chinese are threatening to ramp up its exports to prevent a domestic slowdown then DEFLATION will have a new source of energy as Chinese exports seek to compete in all markets. Yes, last night’s move in the YUAN was a mere 2%, but it is a warning to world economy that the Chinese will not play the fool at the global financial “poker table.” If the deck is fixed the Chinese are demanding a reshuffle with new cards.

One day doth not a trend make but it is important to pay close attention to sustained fallout from the Chinese action. What will the response be from other members of the global financial community and will Madame Lagarde be in favor of the Chinese action? The IMF has warned the FED not to prematurely raise rates as it could upset the fragile state of the emerging economies. If the FED retreats from the “hawkish” statements of Atlanta Fed President Dennis Lockhart, then IMF Director Lagarde will probably see the Chinese action in a positive light.

In a speech that Lockhart delivered yesterday, the mouth of the South said: “As the Committee approaches what I consider a historic decision, I am not expecting the data signals to point uniformly in the same direction. I don’t need this. I’m prepared to see mixed data. Data are inherently noisy month to month and quarter to quarter. Given the progress made over the recovery and the overall recent tone of the economy, I for one do not intend to let the gyrating needle on monthly data be the decisive factor in decision-making.”

Maybe Lockhart can ignore month-to-month swings in the Atlanta GDP NOW survey but can he ignore the deflationary impact from the Chinese depreciating its currency against a basket of global currencies? Remember, the target by Beijing is not the U.S. dollar but all the currencies who have depreciated their currency values versus the Chinese YUAN. Those massive downward  moves have been over a fairly short time frame. The YEN has depreciated almost 40% versus the Chinese currency during the last three years. There will be much more to this story as the Chinese make statements in response to global criticism. A few things to note in market response to the Chinese announcement:

  • Gold/silver is trading below the 200-day moving average, signaling possible strength in the precious metals  but this will be watched through a Friday close for confirmation. Any strength in the precious metals will have silver be the leader. The copper has been weak and was sold hard last night as traders viewed any deflationary impact as a negative for the industrial metal. Also, some analysts have believed a surge in Chinese domestic consumption would give a boost to copper demand, but if Chinese policy is shifting then the outlook for copper may become even more negative;
  • The Euro/Swiss currency cross closed above its 200-day moving average today. The recent strength in the EURO versus the Swiss franc may be a result of diminished tensions with Greece and many trades being on August vacation. Swiss weakness may also be the result of Swiss National Bank intervention in a renewed effort to weaken the franc as the SNB‘s surprise move in January has done much to inhibit growth in the Swiss economy;
  • If the Chinese are sending a message to the global financial community I would expect THE JAPANESE YEN to STRENGTHEN. The Japanese have aggressively depreciated their currency versus the world, under the watchful eye of the IMF and other central banks. The Chinese authorities may be signaling that YEN depreciation has indeed gone far enough.
  • These are just some conjectures. As always, let the markets be your guide and wait for events to unfold further before making a major financial commitment. The object it to limit losses while seeking the greatest return on risk capital.

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    16 Responses to “Notes From Underground: The Chinese Send a Message”

    1. the american limey Says:

      Wow nice analysis and so well written I can understand it, and I REALLY am a novice at all of this macro stuff. I really appreciate the way you combine meaningful indicators with a predictive function couched in “look to this happening if I am right” this really helps people like me put the puzzle together. Thank you Trotsky.

    2. yra Says:

      no problem Rosa L. from the spartacus league

    3. the american limey Says:

      Not Rosa Luxemburg ( Yes I looked it up) more Guy Fawkes, an old boy of my school. Really it was an excellent piece and has helped me formulate my action plan for next week. I have bought a new 12 sided die and made the statutory burnt offerings.

    4. costaselgreco Says:

      Thanks for the great analysis Yra. Does this mean that China’s transition to consumer economy has failed and that it cannot be anything other than an exporter nation?

    5. yra Says:

      costas–way too early to tell.I await to read any analysis Michael Pettis puts forward

    6. Frank Says:

      At the risk of being a conspiracy theorist, is this a back door way for China to unload treasuries into rising prices?

    7. yra Says:

      Frank–I don’t see that.Some conspiracy folks maintain that the move was long in making but kept the YUAN overly strong to allow the politically powerful to move money offshore while the YUAN stayed uber firm

    8. Austin Says:

      Could this be a move to recapture the massive capital outflows China has experienced over the last 12 months?

      China’s large scale selling of U.S. Treasuries looks like profit taking from where I sit. Where did they move the scratch and how does that play into a depreciation move? Seems counterintuitive, unless it was transferred into something not priced in Yuan.

      Food for thought:
      http://www.zerohedge.com/news/2015-07-21/chinas-record-dumping-us-treasuries-leaves-goldman-speechless

    9. James Sinclair Says:

      Good, balanced, pan-determined, highly professional. Jim

    10. yra Says:

      http://www.bloomberg.com/news/articles/2015-08-12/imf-welcomes-china-s-new-yuan-mechanism-no-impact-on-sdr-push

    11. Dan DeRose Jr Says:

      Yra, excellent write up! I’m a disciple of Pettis as well and am a little surprised by the recent moves. (Granted, I don’t know if even 2 days of weaker settings warrant howls of devaluation but, hey, the news editors are in it for the excitement right?) Do you think there could be a quid pro quo at work here? The Chinese settings are ruining the Fed narrative that they are all-powerful and have it all under control; meanwhile the Chinese would like to encourage more capital inflows as they swap their bank debt to bonds and stop the stock market bleeding. The IMF SDR could help in that regard (I see the link above but we all know how Europeans lie when it’s serious). Why waste a rare encounter with the 200 day SMA?

    12. yra Says:

      Dan–good point and as usual with the Chinese there is far more then meets the eye here–but I will wait to see more unfold before drawing any long term conclusion

    13. Danny Says:

      “DOES LAST NIGHT’S MOVE SIGNAL THAT THE CHINESE POLICY MAKERS HAVE BECOME CONCERNED THAT DOMESTIC CONSUMPTION WILL BE UNABLE TO ABSORB THE CAPACITY CREATED BY PREVIOUS MASSIVE CAPITAL INVESTMENT?”

      That question is definitely on point. The transition to a consumer based economy is a long term transition (i.e. decade and probably longer) and will not likely transpire without hiccups along the way – as we are now seeing. Foreign Affairs covered China within the past few issues which highlighted how China has benefitted from reforms that relied upon relatively low hanging fruit for success over the past decade but…going forward, the next stage of reforms required to make the transition to a consumer based economy will be substantially more challenging to successfully pulloff – and in my own reading of it, there is a “non-zero probability” that they fail.

      An interesting chart came across my desk earlier this week showing growth in global trade vs. growth in global GDP. From 2002-2007, global trade was growing at a faster rate vs. GDP – coinciding with the commodity market boom and BRIC sensation. Since 2011, global trade has grown somewhat, albeit at essentially the same rate as GDP which, in my mind, lends substantial credibility to the argument that China could drive a resurgence of deflationary pressures across the world as they attempt to capture a larger share of global trade pie – since the pie is not getting larger at a pace sufficient to keep the wind in the Chinese sails.

    14. yra Says:

      Danny–great add .Thanks for the input

    15. arthur Says:

      Is this the ‘treadmill to hell’ that Jim Chanos said China was on? Investors should worry more about China’s politics than the economy. Whatever it takes.

    16. yra Says:

      Arthur–as a long time reader you know it is politics and economy that makes this blog —to use economic data alone is the road to perdition

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