Notes From Underground: Reissue, April 24, 2014

Almost 18 months ago I wrote a blog in response to an Ambrose Evans-Pritchard piece in the London Telegraph. I think readers of NOTES will find it more than a passing interest. More importantly, Mr. Evans-Pritchard wrote a new piece in yesterday’s London Telegraph, “China Cannot Risk the Global Chaos of Currency Devaluation.” Evans-Pritchard stresses the deflationary shock from a significant Chinese yuan devaluation in response to the Chinese plague of overcapacity from an excess of capital investment for a Chinese effort to increase exports to ease the burden of excess production would weight heavily on an over indebted world struggling with falling prices.

This is the greatest fear for the world ‘s central bankers and why I always referred to Bernanke and Yellen as the ultimate 1937ers for Bernanke promised Milton Friedman that the FED would not repeat the errors of 1937 and allow deflation to become the major dynamic in the world economy and certainly not the U.S. Evans-Pritchard is hopeful that the recent weakness of the YUAN is not really a new policy:

“The slowdown in China is not yet serious enough to justify such a risk. True, the trade-weighted exchange rate has soared 22% since-mid-2012,the result of being strapped to a rocketing dollar at the wrong moment.The YUAN is up 60% against the Japanese Yen.”

Read the article and be aware that the Chinese are not targeting the dollar but are very concerned about the YUAN strength versus the rest of the world.

From April 24, 2014:

Pritchard Raises An Important Issue– Is China Exporting Deflation?

Making the rounds with the rumors of Russian troop movements was the talk about a London Telegraph article by a Notes From Underground favorite,Ambrose Evans-Pritchard[AEP]. The column, titled, “Suspicion Grows That China Is Exporting Deflation Worldwide By Driving Down Yuan,” is a very balanced piece as even the Evans-Pritchard maintains that he takes no view on “how far china intends to go with this” but is making his readers aware of the opinion of Albert Edwards of SocGen bank.

Mr. Edwards maintains that deflation is taking hold in China and in an effort to prevent a massive slowdown in its economy is seeking to drive down the value of the YUAN to protect its export markets. The operative process is that China is busy buying U.S. and European bonds to in an effort to weaken its own currency. The YUAN is 3.1 percent lower on the year, hardly an aggressive depreciation, but it is an issue that some U.S. politicians have also raised. For the global economy, it is the idea of exporting deflation that is the biggest POTENTIAL PROBLEM. Again, this a theory and not in any way proven conclusive but let’s play with the potential fallout from the Chinese exporting deflation.

  1. “The true picture has been masked by unsustainable levels of investment.” China through its own savings and foreign direct investment (FDI) has developed enormous productive capacity and if the Chinese economy fails to make to the move to a domestic consumer-based economy that huge amount of productivity will have to find a way into the world markets, putting pressure on prices everywhere. Japan, Europe and the U.S. are all trying to create a “modicum” of inflation to reduce their own homegrown deflationary pressures. If Chinese goods are flooding the markets it will put great pressure on corporate profits and remember that the world is awash in high yield corporate debt that is anything but high yield and not priced at all to the impact of China exporting deflation.

  2. The recent action in the U.S. yield curves may be the result of China’s efforts to buy huge amounts of long-term Treasuries easily supplanting the effects from the Fed’s tapering. For now, I don’t believe that the moves in the 5/30 are the direct result of China but reflect a trading battle between giants. However, if the 2/10 curve were to break decisively out of its recent range I would be more receptive to the “China exporting deflation” school of thought, which would justify a flattening of all the yield curves where there is not a solvency issue.

  3. If the Chinese are exporting deflation, then the ECB, BOJ and Federal Reserve are going to have a more difficult time igniting the inflation they are trying so hard to create to help relieve their own debt-burdened economies. The boogeyman of Chinese deflation will also act to pressure politicians in the U.S. and Europe to raise the scepter of Chinese mercantilism as the chief cause of high unemployment and low wages. Fed Chair Yellen  is very openly concerned about raising U.S. employee wages and downward price pressure from China will add to pressure on the Fed in how to resolve this dilemma.

  4. If the issue presented by Mr. Evans-Pritchard proves correct then BUY GOLD. I know this will cause head scratching but it is not present inflation that is bullish gold but rather the fear of how CENTRAL BANKS WILL ACT TO DIVERT A DEFLATIONARY SPIRAL. It was interesting today that the GOLD/YUAN and GOLD/YEN both tested their 200-day moving averages before embarking on a violent corrective short rally. Again, nothing is proven with the Evans-Pritchard article but it does raise some important issues going forward.

***Quick Hit: The gaining popularity of Chancellor Merkel in the polls is a result of her firm stance in the Greek negotiations. Some talking heads are trying to spin this as a positive for the European Union. It is anything but and President Hollande of France needs to be very concerned as the German-French relationship is at a dangerous crossroads. I will discuss more next week.

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6 Responses to “Notes From Underground: Reissue, April 24, 2014”

  1. Chicken Says:

    Deflation is a green anti global warming policy.

  2. arthur Says:

    Druckenmiller-gold via Barrons http://blogs.barrons.com/focusonfunds/2015/08/14/stanley-druckenmillers-13-f-shows-big-new-stake-in-gold-etf/

  3. ShockedToFindGambling Says:

    Yra- The USA has what may be the most valuable asset in the world……a huge consumer market that seems resilient, in all but the most dire economic conditions.

    We let the Chinese and others take advantage of this market, and are repaid with no regard for our intellectual property and cyber attacks.

    Why give away this market and gut our manufacturing sector? We are getting little back in return.

    Fair trade is good, but this is hardly fair trade.

    Also, is the Renimbi basically under or overvalued, or do we know?

  4. the american limey Says:

    Shocked
    speaking as a recent American I can offer a little insight into the merits of America as well.

    I agree that lashings of disposable income sloshing around is excellent BUT let’s not forget the free THINKING environment that comes up with stuff to sell, that’s an asset as well. Rule of law is pretty neat. How about a pretty robust financial system which works (when the dullards don’t tool with it), so we can put money at risk more readily. Most things are traded in the reserve currency, wait a moment that’s the Dollar! AND to top it all off we could have lived anywhere in the world and we chose the USA, hmmm, ok so that could be considered a minus.

    In short America is best all the others can f#$k off and die…

    But seriously, we have to keep looking out of the window to see what threats are coming down the pike, quantify and determine the most rational way to deal with them. I mentioned all the pluses above because they are many of the reasons that England ( Scotland, Ireland and Wales are like Narnia, Fictitious :-)) hit the ground running moving from an agricultural society to industrial.

    China has the same problem right now on steroids AND when they get to industrial who says that they will be able to employ a third of their population. I can’t really see how we will do it in the near future given the trend towards more skilled jobs is NOT being addressed by our educational system ( bloody unions). We had the same crap when I was a kid but we had Pm Thatcher, she really had a pair ( in her handbag which she ripped off some poor idiot who crossed her).

    So when the Chinese get to where they need to be maybe people won’t need steel ( nano composite materials) won’t need TVs ( Msft holo lens) the list of our creativity is endless and that is how it should be. :Later today I will be meeting with some of the lads who will help build that future with real cash, relationships and, more importantly, THE FREE WILL, to effect the change. Incidently if you want to listen to a person with his head on straight it’s John Doerr of KPCB,

    Yes they come from California but Illinois’s free will is taking a break right now. See the wonders of the multistate system, one screws up and I can EASILY go to another.

    sorry about the rant, I have had 5 coffees already and meeting with the guys from Sand Hill later, so I should be massively amp’d by then. I think they kind of like it.

  5. ShockedToFindGambling Says:

    Limey….Interesting rant.

  6. the american limey Says:

    here’s another along the same vein. Watching candidate Trump I am mindful of how life follows Art. In this case an episode of Newsradio where Jimmy James runs for President ( ONE press conference) because he wants to get women’s phone numbers. I am wondering IF he is planning a Trump Immigrant resort built just on the other side of the border in conjunction with funding from US and Mexico, It would be constructed by the recently deported thus creating jobs and built to the Trump quality we have all come to expect. I would imagine the final result to resemble a real resort so it could be retasked. I HOPE I am only joking but he now has a HUGE publicity engine as did Jimmy James…

    There really IS something magical about this fine country.

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