Notes From Underground: Did Xi Just Provide a Clue to China’s Yellow Brick Road?

In the past week, we have heard from the Bank of Canada and Bank of Japan. There were no surprises as both institutions noted softness in the global economy. The BOC, as reported by Bloomberg, “fully abandoned its bias toward raising interest rates at the economy grapples with a slowdown.” The BOC overnight rate remains at 1.75 percent, which is deemed appropriate by the Governing Council until the global economy removes some of the uncertainties it is struggling to overcome.

The BOJ statement continued to maintain that it is paramount for Japan to raise its inflation numbers because a failure to do so means this current period of “extremely low levels of short-and long -term interest rates” will continue “for an extended period of time, at least through around spring 2020.” This is aggressive forward guidance, and as the BOJ maintains, is representative of POWERFUL MONETARY EASING.

In an effort to justify its aggressive policy the BOJ said, “The Bank, decided to make clearer its stance to persistently continue with powerful monetary easing while examining uncertainties regarding economic activity and prices including the effects of the scheduled consumption tax hike and developments in overseas economies.”

The enhanced forward guidance is a bow to the possible negative impact from the scheduled increase in the consumption tax in October. The overnight rate will remain at -10 basis points and its present asset purchases will continue as the bank sees fit. From the U.S. perspective, the end result is that the BOC and BOJ force the FED to be very patient for any U.S. efforts to tighten policy would result in a strong dollar rally in the face of ultra-dovish foreign central banks.

The BOJ position is even more important as the U.S. and Japan are meeting this week in Washington to discuss trade policy. President Trump is expected to meet with Prime Minister Abe and trade concerns on the agenda. Japanese Finance Minister Taro Aso told Secretary Mnuchin that Tokyo would not accept trade concerns to be linked to monetary policy.

In a Reuters article on Thursday Aso said, “Japan won’t discuss exchange-rate matters in the context of trade talks.” It would be out of character for U.S. Trade Representative Robert Lighthizer to accept any limitations in his negotiations on trade. Instead, I will be carefully listening to see if Trump openly gives this advantage to Abe in an effort to secure a trade agreement with the Japanese — especially in light of currency issues being a significant point in the U.S./China discussions. Currency valuations provide transparency and help promote “enforcement mechanisms” for the ability to promote punitive actions in violation of agreements.

While the BOC and BOJ headlined the week of central bank meetings, there were two other announcements, both of which underscored the importance of using dovish policy to weaken the currency. First, the Swedish Riksbank said it intends to keep its overnight rate negative longer than expected, and announced an 18-month BOND BUYING program. As a result, the krona fell to versus the dollar and weakened against the euro.

Then, Thomas Jordan, head of the Swiss National Bank (SNB) told financial institutions harmed by the central bank’s negative interest rates that the current policy was good for the entire population and would remain.

The WILLINGNESS to intervene in the foreign exchange market is a key component of SNB resolve to keep the Swiss franc competitive, especially versus the euro. Again, it is the desire by myriad governments to keep downward pressure on their fiat currencies that keeps Fed Chair Powell in a reactive position. The Fed is captive to global institutions.

There was a critical speech last week from Chinese President XI at the Belt and Road Forum. In particular, there were two lines that hearken back to Chairman Mao in their effort to titillate with hidden meanings. But before I discuss these points, the Xi speech itself seemed to be directed at President Trump rather than those in attendance at the forum. The  South China Morning Post reported that Xi maintained that the Chinese would seek to keep the YUAN stable and not involve in beggar-thy-neighbor currency devaluation policies. Xi  was very consistent in maintaining efforts to cooperate with the global community for the benefit of all nations: from trade and intellectual property protections, to sustaining GREEN growth.

In attempting to assuage the world and promote China’s promotion of global growth and not mercantile practices Xi said, “The great rivers and oceans are deep because they are open to all trickles. If inflows of streams and rivers are cut off, even a big sea will dry sooner or later.” The second quote I DEEM TO BE OF MAJOR SIGNIFICANCE for its cryptic reference to a GOLD-BACKED CURRENCY: “China treasures its promises and commitments with a thousand taels of gold.” (Taels is the historic unit of measure for gold in China.) I know  this is not the accepted view of this speech but in the spirit of Mao I draw out this inference.

There is no question that the Chinese and Russian central banks have the largest purchasers of physical gold over the last few years in an effort to reallocate from vast DOLLAR reserves. The question always arises: FOR WHAT THE PURPOSE?

After President Xi’s speech there was an Nikkei article by Takashi Nakano titled, “China Lobbies ASEAN on Yuan Use, Cracking Dollar Dominance.” This week, the Thai and Chinese are going to  recommend changing the 2000 Chiang Mai Initiative in which Asian nations built a framework for pooling dollars to aid other nations in the advent of a currency crisis. The protocol has never been used but its structure is in place. The Chinese, with other nations’ support, are seeking to increase the use of yuan and yen in the pool to lower the dependence on the dollar.

The Chinese know that until they have made the YUAN a highly respected tool for reserve currency status something more will have to be done. I THINK THAT XI JUST LAID OUT THAT SOMETHING: A GOLD-BACKED YUAN. In an effort to acquire financial respectability it would behoove the Chinese authorities to support the Road initiative with gold paving stones.

Is President XI riding the global financial ocean of liquidity as the Great Helmsman? This is truly the realm of Notes From Underground where 2+2=5.

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26 Responses to “Notes From Underground: Did Xi Just Provide a Clue to China’s Yellow Brick Road?”

  1. drdjf Says:

    This is a great “note”. You pack more insight into a few paragraphs than the television financial media does in a month.

    • yraharris Says:

      Drdjf—thanks for your feedback and as you can read the iscussionmakes it all very worthwhile

  2. Chicken Says:

    Perhaps selective perception is blinding me but given better than expected GDP results (some apply the term “blowout”), it becomes increasingly difficult to trend dovish?

  3. kevinwaspi Says:

    I believe your second point about Xi’s address is prescient. As all western developed economies struggle with the paper chase of cleaning up the last fiat money inspired liquidity crunch by creating the next, use the cover of fiat finance to lever up, build out, and quietly assemble a metal reserve alternative to the bales of colorful Zimbabwe bucks multiplying like bacteria. China plays the long game of wei ch’i while the west entertains itself with a three card Monte street hustle.

  4. Tader 1 Says:


    To clarify the question in your previous post:

    Do still hold the opinion Draghi will raise the Neg. Rate on bank reserve depoists by June? As the reporter asked in the press conference it puts EU Banks at a $50 billion disadvantage to USA banks

    • yraharris Says:

      Trader 1—ok with that i agree with you—they will become more discretionary in regards to the tiering of the negative deposit rates—probably will take it to zero so at least it stops being a negative drag on the banks

  5. TraderB Says:

    Yra- As we all file our 2018 tax returns, most will find that there is no longer a tax benefit from their State Taxes, Property Taxes, and Mortgage Interest. We are all now much more likely to take the standard deduction. For folks in high value, high tax places like CA, NY, NJ, and IL this is a tough pill to swallow.

    Fiscal policy just gave homeowners an incentive to pay down their mortgage. This is not the backdrop Fed officials want if they are trying to stoke inflation. For rates to approach a level that entice more borrowers, those mortgage rates must now be attractive on their own without the assistance of the tax code. I think the Fed will be forced to cut interest rates very soon.

    Lower rates, lower fed credibility, and higher fiscal debt are all setting the stage for the next move in gold.

    • Chicken Says:

      Are you perhaps referring to a home equity loan, or the reduction on the qualifying amount of the mortgage loan?

      • TraderB Says:

        The reduction on the qualifying amount of a mortgage loan. Due to these changes, many will lose the tax benefits from these things they have historically deducted. I have to think this will have a negative impact on consumer spending and on CPI.
        Last two CPI numbers were 1.5% and 1.9%, after being in the mid to high 2’s for most of 2018. If we see CPI increase again on May 10th, it would be hard to justify a rate cut.
        Lower inflation and low wages persist while government deficit spending and low rates keep fueling corporate profits and stock multiples. When does it end?

  6. Robert Says:

    Gold is the settlement of last resort, when all else will not be accepted. (Think about this in terms of Canada, who had over 700 tons and sold every last bit of it at or approaching the bottoms, which was the thing to do at the time, leaving only spare change, literally, which they also just sold off. Who ended up with it? And what if things get urgent in Canada?).
    An example is when Zimbabwe wanted a loan many years ago – it got it, only by cleaning out their gold reserves as collateral.
    I don’t think Xi (or anybody) would be talking about a gold-backed Yuan, because gold backing is based on convertibility. If it can’t be converted, it’s not gold-backed, meaning every significant currency would have to be convertible. Otherwise, I could take my suitcase of whatever, and convert it to yuan, thence gold. That’s why the US suspended convertibility in 1971 – it was being drained of gold by Europe, especially France.

    • yraharris Says:

      Robert—-good points indeed and as you note it was Jacques Reuff the key french economist who wrote the Monetary Sin of the West[US] who labelled Bretton Woods a GOLD EXCHANGE STANDARD

  7. Bosko Says:


    Isn’t the yuan still pegged to the USD? If Xi decides to back the yuan with gold, then by default the USD could be backed by gold via the yuan? Wasn’t there talk in the 80’s that the Japanese Yen would de-thrown the USD as the world’s reserve currency? I guess that didn’t happen. According to SWIFT the yuan is FAR behind the USD and the EUR in global trade settlement, where the USD, EUR combined control about 70% of trade settlement in the bank wire system and the yuan is only 1.8%. Should the yuan become a reserve currency it would increase its value, making China’s goods less attractive. I think if Xi decides to go this route, he would have to un-peg from the USD first and float the yuan which would make China’s economy more transparent and vulnerable to market forces. Is China ready for full transparency? I don’t see how China could back the yuan with gold and still maintain a peg to the USD? Maybe this is where the magic of blockchain technology comes in?

    • yraharris Says:

      Bosko–they can’t and will do it only when they are ready to forgo the synthetic peg.When the Chinese wish to promote domestic consumption as the largest component of its economy a stronger YUAN will be needed

  8. Michael Temple Says:

    A gold-backed yuan would seemingly be a “play” at a later date during more treacherous times when the USD has peaked after the coming USD squeeze higher, wouldn’t you think?

    If the Chinese could successfully hypothecate gold at a 10:1 ratio to create yuan backing, they could leverage their supposed 8000 tonnes of gold into 10X worth of yuan.

    In a world of floating currencies that float only against other electronic bits, the creation of a lodestar/North Star gold-backed yuan would be a new Breton Woods market, to say the least.

    While this certainly bears watching, gold is caught in the vise of this USD squeeze and dash for good collateral.

    But, it seems to me that QE could soon be upon us. Seems Fed needs to boost the “excess” reserves in the banking system from the current “paltry” $1.5 Trillion. Cutting rates won’t do it. Halting QT now and not in September would be first step. Next step would be re-activation of QE.

    Until then, I think gold remains contained. Will Xi try to Hoover up more gold, buying when he can courtesy of Trump helping to boost the USD through his trade wars and the still tight strictures of Dodd Frank?

    Very provocative piece. Gold may have its day. But somehow I think it happens after your feare$ replay of a 1998 LTCM-ish Disaster.

    • yraharris Says:

      Michael Temple–thanks for the great response and the fractionalized GOLD backed system that you portray is the keep method which I have argued in this BLOG for seven years in regards financing the IMF by utilizing its gold hoard—see Bosko’s newly minted out of Canada—Gold -In -Motion very intriguing business plan—maybe Bosko will with my permission post the link

  9. Arthur Says:

    Pedro Sanchez (PSOE, socialist) ”victory” in Spain. What does mean from a macro view?

    • yraharris Says:

      Arthur–it was expected so I don’t think much at this juncture—but let us see what happens in the coming European wide election

  10. Michael Temple Says:

    Food for thought

    If what is roiling the system is the paucity of excess reserves in the banking system (now down to $1.4 Trillion) due to QT maneuvers, then lowering/cutting rates won’t directly address that shortfall.

    Lowering the cost of money is not the same as creating additional reserves through the magic/conjuring of the “printing press”.
    That printing press is called QE.

    Yet, Powell cannot simply skip over rate cuts and go straight to QE without freaking out the markets.

    Yet, cutting rates now-ish could be a repeat of late 1928/early 1929 when the Fed cuts just added rocket fuel to the stock market.

    Same could happen again. If Fed cuts rate soon-ish, stocks could
    have their final launch into hyper drive.

    At this point, I think a bet on Red EDs is better value than going long gold…..If/when stocks ultimately crack big time and the Fed truly panics, that is when gold is likely to begin a big time rally.



    • yraharris Says:

      Mike—I have been long both but sold the Eurodollars in the face no a no action by the FED—I remain Long Gold versus versus currencies –not yet dollars but I agree with your view on Powell

  11. Chicken Says:

    Wonder if the FED might begin paying banks IOER denominated in UST’s in lieu of cash?

    • yraharris Says:

      Chicken –a basic approach to a debt plagued company using PIK–payment in kind to meet coupon payments with more bond issuance which is why you must read your Bond covenants—see the recent work by poolside maven—Lloyd B

      • Chicken Says:

        I should stick to trading what I see and not what I think. The issue with these concepts I conjure is the FED’s masters are calling the shots.

  12. RoiMidas Says:

    The Chinese are the largest producers of gold, and not an ounce leaves the country. The volumes of gold trading on the Shanghai exchange are giving some to believe that China holds more than 4 times the official holdings.

    Will the paper game masters continue to hold markets and price discovery hostage? Can China commit the absolute sin and back the Yuan with gold without a major war starting?

  13. Michael Temple Says:

    I continue to be long Red EDs. The weight of the signals emanating from the UST curve and the strength of the USD suggest to me that Powell remains too tight, as hard as that seems to be.

    Also, the economic data is spotty. I simply believe that the megaphone earnings disasters of such REAL ECONOMY companies as UPS/FDX/Intel/3M matters. Also, the continued slowdown in key regions such as SKorea adds to my suspicions.

    Gold, unfortunately, may continue to serve as a source of collateral/margin call if something goes bump in the night. Any such “bump” would redound to the benefit of Red EDs while not doing much for gold immediately.

    Also, I think Powell could surprise us with even more dovishness. I think it is 50/50 (again, just my opinion) that Powell pulls forward the end of QT to Now-ish from the original September date.

    He will NOT cut rates today. But, a cut in IOER might be another
    “signaling” strategy to assuage any market concerns about tightness in the banking system.

    As Jeffrey Snider has highlighted, USD strength seems to be moving in lockstep with the EFF/IOER spread. Fed KNOWS (or should KNOW) that a strong USD is de facto tightening and is NOT what they expected or desired when they started to go dovish, especially with the pronouncement that QT would end.

    So, I also believe IOER rate will be lowered today.

    Again, I think it is frightening to see negative swap rates and this EFF/IOER anomaly, especially when we can see DAILY many signs of global weakness/slowdown.



    • yraharris Says:

      Mike–well stated and you are point onas Powell showed—these press conferences have become painful–there is nothing to say and the questions become inane

  14. Chicken Says:

    Didn’t Powell just expound the FED expects recent disinflation is transitory and emerging nation economies are beginning to exhibit positive indicators? That’s what I thought I heard…..

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