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China Seems to Be Following US Game Strategy of 'Benign Neglect'

China Seems to Be Following US Game Strategy of 'Benign Neglect'

Monday, 11 January 2016 10:52 AM Current | Bio | Archive

The Chinese equity markets started the week, once again, deep in the red with declines going from -5 percent to about -8 percent.

The Chinese media reported Premier Li Keqiang as saying: “Policy makers wouldn’t seek strong stimulus or flood the economy with too much investment to boost demand.”

Markets tanked because the authorities seem this time around not to be inclined to open their well-known money floodgates — or is it the Chinese have lost their faith in the strength of their currency?

The Chinese investors seem to have lost confidence the Chinese authorities will be able to prevent the bottom falling out of their equity markets and to calm down substantially the ongoing capital flight and to manage a gradual and acceptable weakening of their currency, the renminbi or yuan (CNY).

Talking about the yuan for a moment, as I have learned during my professional life it’s better not believing too much of what authorities want you to believe, I’m convinced the Chinese authorities have already set the stage, of course not openly, to do exactly the same what the U.S. Treasury has done for years with its currency policy of  “benign neglect.”

That said — and also because the Chinese economy is slowing down at a much faster rate than the official numbers tell us — it would not be unreasonable the Chinese authorities would prefer a somewhat weaker currency, especially when we look back to its rise since 2010 as a consequence of its peg to the dollar.

In this context, I wouldn’t be surprised at all if we would see a yuan 7-handle against the dollar by the end of 2016, but which could open the doors to currency wars in different places of the world. We aren’t there yet, but we are on our way…

Now, I don’t think the Chinese another choice than to devalue their currency. When we just look at what amounts the Chinese have spent to defend their currency it becomes immediately obvious this can’t go on forever.

We know China has been burning through its FX reserves stockpile at an astonishing rate.

Last year, their reserves fell by about half of a trillion dollars to $3.33 trillion, hereby coming down from close to $4 trillion at the beginning of 2014 while the declines accelerated to $107.9 billion in December 2015 alone, which was a record monthly decline.

It’s relatively simple and therefore really alarming. When we see China’s currency reserves melting away by about $100 billion per month while we know the IMF requires China to keep a prudent reserve threshold of about $2.6 trillion in function of its liabilities, the blind can see we are only about half a year away from a “troubling” Chinese situation.

As investors we should better not forget the massive capital outflows out of China have been triggered by its “unexpected” shift to a trade weighted basket as reference for the daily fixing of the yuan, which has damaged enormously confidence, and with good reason, the Chinese had in their Central Bank (PBoC).

Besides that, it’s also a fact a weaker Chinese currency can only amplify the clear risks that stem from the well-known Chinese structural flaws and imbalances.

And all this is extremely important also to investors who are U.S.-based or/and have U.S. dollars because as we have learned from the past the Chinese have been buying enormous amounts of U.S. Treasurys and that has kept Treasury yields down and prices high.

I think these times are coming to an end because of China’s ongoing needs for mobilizing “cash,” that by itself could cause, when the actual trends continue, Treasury yields to rise, which is an equivalent to tightening even without the Fed raising rates, with which the U.S. economy could live, at least for a moment and under condition it doesn’t get out of hand, but with which the Emerging Economies and all those trillions in private debt that has been issued in U.S. dollars, will find it extremely hard to cope with.

No, this is not a pretty picture.

I always must think back to what then in 2013 Dallas Fed President Richard Fisher said in the Financial Times, “We’ve had a 30-year bond market rally. These things do not go on forever."

Believe me, this is serious food for thought, which all investors should better put on their radar screens.

Etienne "Hans" Parisis is a bank economist who has advised global billionaires and governments on the financial markets and international investments. To read more of his articles, GO HERE NOW.

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Believe me, this is serious food for thought, which all investors should better put on their radar screens.
investors, stock market, economy, serious
Monday, 11 January 2016 10:52 AM
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