Notes From Underground: No Chinese Devaluation or Massive Liquidation of U.S. Treasuries

There are many questions swirling around what possible responses President XI can bring forward to counteract the heightened rhetoric from the Trump administration on imposing tariffs on Chinese goods exported to the U.S. Many news agencies have carried stories about the Chinese responding to Trump tariffs by entering into a policy of depreciating the Chinese yuan, which is currently trading at 6.3075 against the DOLLAR.

This is an interesting view but it would force China to act against the G-20 accord of not manipulating one’s currency. The XI-led government is looking for international support in its effort to combat a trade war so alienating the international economic community would be detrimental to the Chinese interest of global support. The narrative some analysts are spinning is to recall China’s 2 percent devaluation of its currency in August 2015, which sent global currency and markets into a frenzy, especially as stocks were reeling from deflationary fears.

I am linking to a CNBC hit I did with Rick in February 2016, in which we discussed the impact on the world from a 25-30% depreciation of the YUAN. It is an oldie but the analysis is especially relevant when considering the impact from a potential YUAN depreciation to retaliate against U.S. tariffs.

It would be a HUGE policy mistake if the Chinese directed a devaluation similar to what U.S. Treasury Secretary Steven Mnuchin and Commerce Secretary Wilbur Ross did at Davos when they mentioned a weaker dollar was good for U.S. trade. Ross made his comment about using the currency as similar to sending “soldiers to the ramparts” to fight the trade wars that go on everyday. ECB President Mario Draghi attacked the U.S. suggestion of a weaker dollar policy as being in violation of the G-20 accord. China would risk the ire of many of its major trading partners. There is also discussion of China liquidating some of its massive U.S. Treasury holdings sending the U.S. interest rate market into a major drop as BOND YIELDS RISE IN RESPONSE TO A LACK OF BUYERS.

Ambrose Evans-Pritchard wrote a piece last week in which he discusses the “nuclear option” of liquidating its U.S. Treasuries. Pritchard answers his own question by noting the Fed could counteract the Chinese action by essentially announcing a new QE program which would disarm the Chinese weapon but would lead to a massive sell-off in the DOLLAR, totally throwing the global financial system in chaos. This would also be in direct contravention if depreciating the YUAN but it would bring to the light the need to be long gold and eventually sell all currencies against the time-honored precious metal. The take away from the Pritchard piece and my analysis is that China can afford to be patient and let the Trump tweets cause an increase in global financial uncertainty. If the U.S. is creating uncertainty the outcome will be that financial uncertainty breeds evermore contempt. And so it goes.

***On Friday, Fed Chairman Powell delivered a speech to the Economic Club of Chicago. The content of the prepared speech was very much in line with what Powell and other FED members had been discussing for the past few months so the markets has little to discuss and could remain focused on the tweets and media interviews emanating from the White House. The Economic Club of Chicago did disappoint many watching the speech and listening to the Q&A for the questions were written and then screened with the moderator acting as a censor. Two years ago the Chicago Global Initiative had then-Governor Powell as a speaker and the format allowed open mic questions with the interlocutor stating their names. The sanitized method invoked by the ECC resulted in milquetoast questions.

However, one item that did arouse my interest was how Powell answered a question on why wages have failed to be more robust as the jobs market tightens. To paraphrase the answer: Anything can be made in a cheap labor market resulting in some downward pressure on wages around the globe. This enhances the discussions Santelli and I have had for several years. It is NEHRU, NOT NAIRU.

Powell was giving credence to the fact that the Phillips curve is a domestic-based model that is antiquated as the global economy has allowed KAPITAL TO INTERNATIONALIZE A WORLD LABOR POOL. (Powell’s remarks on this can be found at the 37 minute mark of the recording.) The Fed chairman displayed his cunning as he would not discuss the immediate impact of the tariff issues on the economy. The issue facing the FED will be when to tailwinds turn into headwinds? And if the winds are shifting will we see only two fed funds rate hikes? Will Mao’s prophecy of the EAST WIND PREVAILING OVER THE WEST BE BLOWING STORMS?


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9 Responses to “Notes From Underground: No Chinese Devaluation or Massive Liquidation of U.S. Treasuries”

  1. asherz Says:

    With China blinking on auto tariffs, they apparently seem to realize that they still are junior to the superpower (or the Great Satan as he is known to its west). As their GDP gains on equaling the US which will probably occur in the next decade or so, and domestic consumption replacing a larger share of their exports, the time will come when they will then be in a position to stare down their arch rival. As long term planners, Xi recognizes that a real confrontation now would not be in his nation’s best interests. He may even become more helpful in the coming week’s meeting of Kim and Don, while he continues to build up Chinese presence around the globe. The petroyuan and accumulating PM bullion are adding to the credibility of his currency.

    The great danger remains the unwieldy Debt/GDP of his nation. Reducing that ratio will become a high priority, reducing the growth rate in their economy and internationally. Xi’s feint at a trade war is being successfully countered by the master of the Art of a Deal. The time was not propitious, said the Oracle.
    Nevertheless, the volatility in the markets after a long period of calm and low VIX, portends turbulence ahead regardless of the trade situation.

  2. Stefan Jovanovich Says:

    More dumb questions from the Fama section of the bleachers: How would China’s selling its Treasuries reduce the dollar price of yuan? How would an administrative lowering of the dollar price work against Trump’s argument that American workers need protection?

    • yraharris Says:

      Stefan–if the Chinese dumped U.s. Treasuries ,which they won’t,it would result in a pivot to buying other bonds –euroope,aussie,canada,U.K. and a host of others–out of dollars and into a basket similar to SNB—any move away from dollars would push dollar lower and of course import prices move up–and as the Trump team would say that is short term pain for a better future–or was that Bernanke and yellen who said that to savers.But the YUan would not weaken on a global basis like a planned devaluation.The impact on the U.S. treasury market would be absorbed by the FED’s new QE or swap for Chinese held bonds–more dollars in the system—I know you are practicing your Socratic methodology so I will play the sophist

      • Stefan Jovanovich Says:

        As always, much appreciated, Yra. I think Trump is happy to have rates increase and even invert because he wants to pre-empt the Fed and have Mnuchin extend maturities so that a much smaller part of the total debt comes due during his tenure. Having the banks once again become the boxes that people put money in (Giannini’s wonderful description of B of A’s invention of branch banking) is the President’s ultimate goal. A world of 3% 1 year CDs would, for him, be the best of all possible worlds.

  3. Chicken Says:

    Perhaps Xi will wave import duties?

    • Chicken Says:

      Pretty sure I heard in a news clip this morning inflation has returned to a few sectors….

      • yraharris Says:

        Chicken—like in casablanca there is nothing going on here.No gambling at all—your winnings Monsieur

      • Chicken Says:

        True, with the caveat I’m not convinced it qualifies as gambling (in the classic sense) when you’re using OPM.

  4. Arthur Says:

    The GOAT (aka, Stanley Druckenmiller) laid out in a Barron’s interview from the late 80’s exactly how this process plays out. He said, with emphasis by me:

    The major thing we look at is liquidity, meaning as a combination of an economic overview. Contrary to what a lot of the financial press has stated, looking at the great bull markets of this century, the best environment for stocks is a very dull, slow economy that the Federal Reserve is trying to get going… Once an economy reaches a certain level of acceleration… the Fed is no longer with you… The Fed, instead of trying to get the economy moving, reverts to acting like the central bankers they are and starts worrying about inflation and things getting too hot. So it tries to cool things off… shrinking liquidity… [While at the same time] The corporations start having to build inventory, which again takes money out of the financial assets… finally, if things get really heated, companies start engaging in capital spending… All three of these things, tend to shrink the overall money available for investing in stocks and stock prices go down…

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