Why a Strong USD Policy is a far more potent geopolitical lever against China rather than traditional sanctions. Beware the BALL in a China Shop — specifically a USD Wrecking Ball.
Fair points, but it was a choice for them to 1. Not hedge their rate exposures, 2. Allow for an uninsured deposit base of over 90%. Imho, THAT was the forcing function that led to the run.
Thanks so much for the kind words, Norman! I try to always include attribution, and while I might not go through the agony of footnoting every blog post like I did with my West Point paper, I will definitely try to include bibliographical data whenever appropriate.
Not only a dynamite Substack post, but all the references to boot. A true professional.
The ‘China Story’ rhymes so well with my experience of the days when Japan was about to own the whole world. Ponzi is as Ponzi does, and the come-uppance may only be a couple of years away.
I am wondering about SIVB ramifications. As understand it, the loans/deposits weren’t the problem. It was the “safe” securities they owned that weren’t marked to market and were underwater with rising rates. That has nothing to do with the business itself. I’m uninformed on this issue but seems like there will be lots of other smaller banks with the same issue. My guess is the fed will prioritize those banks (which aren’t going to be the big money center ones) and create facilities to bail them out but keep rates high. Where I think the real losses will be is in the private credit/leveraged loan space. They have to be way exposed to tech and venture. How long can they hold out with mark to myth.
Even though it sounds speculative, I would say that China's triangle: high indebtedness, closed capital account and dependence on trade surplus, will end up with a depreciating Yuan. There is no other way out.
I think there were a few great opportunities for China to overtake the USD but China didn't do anything about it. For example, in the early days of the pandemic when Trump administration got totally lost, China may have issued offshore treasury in Hong Kong and demanded all exporters to settle in Yuan and recycle Yuan into offshore treasury. However, China didn't do so. China voluntarily continued to rely on the US Fed to drive the monetary policy. In other words, china chose to stick with the dollar hegemony, as its economy and policies were built around the dollar hegemony, not because the US does not want to share the hegemony with China.
US's dollar is the anchor of the globalization. The US uses trade deficit to absorb other countries' overcapacity and savings. Now, as the US-China relation soured, the world economy needs to be restructured and the USD will automatically lose its global reserve currency status, maybe not good for Wall Street, but definitely good for the US domestic economy.
Besides, I think HKD's de-pegging becomes, again, an interesting topic. As the total assets of HK banks are multiple-times of its GDP, every rational analyst would worry about a capital flight induced de-pegging. I have seen the CEO of Hong Kong doing his best to convince the Saudi to list Aramco in Hong Kong to draw capital inflows. Some people told us that almost $76B came to Hong Kong after the CS turnmoil, but the FX fluctuation didn't prove that.
In my calculation, if people continue to emigrate (even if only 5% of its indigenous population) and sell their apartments in Hong Kong upon departure, de-pegging will become a real threat.
“The China ‘revenge spending’ that nearly every economist forecasted at the beginning of the year hasn’t happened. In Shanghai, the general feeling is people are downspending. Subways, not Ubers. Fast food, not fine dining, etc.”
I think what everyone got wrong here about the “China Reopening” was to view it through a U.S. lens. The Covid responses could not have been more different. US stimulated like crazy and really focused on cushioning the consumer — fiscally. China’s zero-Covid policies and now tepid stimulus have eviscerated the consumer.
To me that leaves GDP growth entirely in the hands of export growth, which means CNY needs to continue to weaken — what I’ve been saying since March.
From Nicholas Glinsman of Malmgren-Glinsman Partners today:
"Despite a broad range of policies last year, a mountain of developer debt — equal to about 12% of China’s GDP — is at risk of default and poses a threat to financial stability, according to Bloomberg Economics."
Eventually, everything will have to go onto the PBOC's facade of a balance sheet (which I write about in detail in the referenced post).
How many grenades can they China/PBOC jump on before blowing themselves up?
I said over a month ago that CHINA would be the big story.
Still early, but CNH approaching 7 again despite DXY weakness and OIL completely retracing the OPEC+ surprise cut price action makes me worried that my thesis might be on the right track.
While I completely agree with your views on china's problems, you (we) are certainly in the minority as you cannot listen to a macro podcast these days that explains China is going to create a gold-backed digital yuan and then the dollar is going to become irrelevant in the world. while perhaps an exaggeration, it is the direction many are thinking. personally, I find it remarkable to believe that anybody in the world would trust their reserves to China, a capricious, lawless nation with an egomaniacal dictator, and a major debt problem, as you highlight. it doesn't seem hard to believe that President Xi would simply decide that China would be better off keeping other people's money than living up to any alleged promises he made at some point in the future. @halsrethink is absolutely correct!
Re: Geopolitics/Inflation/USD-Ball In A China Shop.
Fair points, but it was a choice for them to 1. Not hedge their rate exposures, 2. Allow for an uninsured deposit base of over 90%. Imho, THAT was the forcing function that led to the run.
Thanks for this article.
I felt able to absorb this content, even though I am a macro economics neophyte.
Thanks so much for the kind words, Norman! I try to always include attribution, and while I might not go through the agony of footnoting every blog post like I did with my West Point paper, I will definitely try to include bibliographical data whenever appropriate.
Kaoboy Sensei, I tip my 10 gallon to you, Sir!
Not only a dynamite Substack post, but all the references to boot. A true professional.
The ‘China Story’ rhymes so well with my experience of the days when Japan was about to own the whole world. Ponzi is as Ponzi does, and the come-uppance may only be a couple of years away.
I am wondering about SIVB ramifications. As understand it, the loans/deposits weren’t the problem. It was the “safe” securities they owned that weren’t marked to market and were underwater with rising rates. That has nothing to do with the business itself. I’m uninformed on this issue but seems like there will be lots of other smaller banks with the same issue. My guess is the fed will prioritize those banks (which aren’t going to be the big money center ones) and create facilities to bail them out but keep rates high. Where I think the real losses will be is in the private credit/leveraged loan space. They have to be way exposed to tech and venture. How long can they hold out with mark to myth.
Even though it sounds speculative, I would say that China's triangle: high indebtedness, closed capital account and dependence on trade surplus, will end up with a depreciating Yuan. There is no other way out.
I think there were a few great opportunities for China to overtake the USD but China didn't do anything about it. For example, in the early days of the pandemic when Trump administration got totally lost, China may have issued offshore treasury in Hong Kong and demanded all exporters to settle in Yuan and recycle Yuan into offshore treasury. However, China didn't do so. China voluntarily continued to rely on the US Fed to drive the monetary policy. In other words, china chose to stick with the dollar hegemony, as its economy and policies were built around the dollar hegemony, not because the US does not want to share the hegemony with China.
US's dollar is the anchor of the globalization. The US uses trade deficit to absorb other countries' overcapacity and savings. Now, as the US-China relation soured, the world economy needs to be restructured and the USD will automatically lose its global reserve currency status, maybe not good for Wall Street, but definitely good for the US domestic economy.
Hi Michael - great article as always
I'm just curious, would you happen to have any thoughts on the ramifications of a HKD:USD depeg on the Hong Kong stock and properties market?
Thanks for your time in advance!
Besides, I think HKD's de-pegging becomes, again, an interesting topic. As the total assets of HK banks are multiple-times of its GDP, every rational analyst would worry about a capital flight induced de-pegging. I have seen the CEO of Hong Kong doing his best to convince the Saudi to list Aramco in Hong Kong to draw capital inflows. Some people told us that almost $76B came to Hong Kong after the CS turnmoil, but the FX fluctuation didn't prove that.
In my calculation, if people continue to emigrate (even if only 5% of its indigenous population) and sell their apartments in Hong Kong upon departure, de-pegging will become a real threat.
About 70% of household wealth in China is tied up in Real Estate.
Seems to me that the Scylla of Weak CNY accomplishes multiple objectives now:
1. Supports consumer balance sheets
2. Helps Exports
https://asia.nikkei.com/Business/Markets/Property/China-s-existing-home-prices-back-in-free-fall-as-sellers-rush-in
Read about today’s “news” 4 months ago in this piece, where I explained the exact Scylla/Charybdis quandary the PBOC finds itself in today.👆
https://www.wsj.com/articles/chinas-weakening-currency-is-becoming-a-headache-for-its-central-bank-372ec31d
From a smart friend on the ground in China:
“The China ‘revenge spending’ that nearly every economist forecasted at the beginning of the year hasn’t happened. In Shanghai, the general feeling is people are downspending. Subways, not Ubers. Fast food, not fine dining, etc.”
I think what everyone got wrong here about the “China Reopening” was to view it through a U.S. lens. The Covid responses could not have been more different. US stimulated like crazy and really focused on cushioning the consumer — fiscally. China’s zero-Covid policies and now tepid stimulus have eviscerated the consumer.
To me that leaves GDP growth entirely in the hands of export growth, which means CNY needs to continue to weaken — what I’ve been saying since March.
From Nicholas Glinsman of Malmgren-Glinsman Partners today:
"Despite a broad range of policies last year, a mountain of developer debt — equal to about 12% of China’s GDP — is at risk of default and poses a threat to financial stability, according to Bloomberg Economics."
Eventually, everything will have to go onto the PBOC's facade of a balance sheet (which I write about in detail in the referenced post).
How many grenades can they China/PBOC jump on before blowing themselves up?
Here is the China playbook on how to deal with bad debts:
Sweep under rug. Poof! It no longer exists!
EXCEPT...at some point, that bulge under the rug gets a little too big and someone lifts it up to see what's underneath.
"China Considers Moving Stakes In Bad Banks To Sovereign Wealth Fund - BBG"
I said over a month ago that CHINA would be the big story.
Still early, but CNH approaching 7 again despite DXY weakness and OIL completely retracing the OPEC+ surprise cut price action makes me worried that my thesis might be on the right track.
While I completely agree with your views on china's problems, you (we) are certainly in the minority as you cannot listen to a macro podcast these days that explains China is going to create a gold-backed digital yuan and then the dollar is going to become irrelevant in the world. while perhaps an exaggeration, it is the direction many are thinking. personally, I find it remarkable to believe that anybody in the world would trust their reserves to China, a capricious, lawless nation with an egomaniacal dictator, and a major debt problem, as you highlight. it doesn't seem hard to believe that President Xi would simply decide that China would be better off keeping other people's money than living up to any alleged promises he made at some point in the future. @halsrethink is absolutely correct!
Short, sharp, and punchy. You’ve outdone yourself here. Exceptional piece mate.