Albert Edwards Calls For The Next Black Swan: Expect Yuan Devaluation Following Deep 2010 Downturn
With everyone and their grandmother screeching that it is about time for China to inflate the renminbi, despite that such an action would be economic and social suicide for the world's most populous country, SocGen's Albert Edwards once again stalks out the Black Swan in left field and posits the contrarian view de jour: China will aggressively devalue the yuan following a deep 2010 downturn coupled with escalating trade wars. As Edwards says: "I think the next 18 months will see major ructions in the financial markets. The consequences of a double-dip back into recession next year require some lateral thinking. If the carry trade unwind results in a turbo-charged dollar, any collapse in the China economic bubble will be doubly destructive to commodity prices. A surging dollar, coupled with China moving into sustained trade deficit through 2010, could prompt the Chinese authorities to acquiesce to US pressure for a more flexible exchange rate. But why does no-one expect a yuan devaluation?"
The critical observations from Edwards that may end up being spot on, courtesy of everyone with an FX account being short the dollar:
Investors seem to have spotted that the global economic cycle may be on the wane. The ECRI leading indicator for US activity has now slid for five weeks in a row. Recent data such as the slumping October US housing starts are causing very valid jitters of what will occur as the turbo-charged fiscal stimulus now starts to abate.
Having been in Asia for the last two weeks on business my thoughts turned to China. President Obama'?s recent visit there re-opened some uncomfortable issues about increasing trade frictions in the context of a Chinese currency which most commentators believe to be hugely undervalued and the US authorities believe to be ?manipulated?.
If we do indeed see the sort of unexpected 2010 synchronised global downturn I envisage, geo-political tensions are likely to increase sharply. And with trade barriers already beginning to be erected in a recovery, investors should be really concerned about what might unfold in any renewed global recession. Aggressive competitive devaluation and a proliferation of trade barriers would become an increasing prospect in 2010.
I show below one of my favourite charts of what world trade did in the 1930?s. Politicians reassure us that they have learnt the lessons from that period. Unfortunately, all I see are more and more protectionist measures being implemented, belying the soothing rhetoric.
First, here is why 2010 will be anything but what the Fed and the administration's puppets want everyone to believe:
Some serious concerns are emerging in the US about the sustainability of this recovery. And so they should! The jump in unemployment rate above 10% was entirely consistent with what is occurring in some of the other labour market surveys. The Conference Board Survey, for example, shows no abatement in the gloom about job availability (see the chart below). In addition, the moderation in job losses in the payroll data to its 188,000 average over the last three months vastly overstates the improvement. The Household Survey measure of jobs typically leads the payroll measure because it includes a better snapshot of what is going on with smaller companies. And this series shows a renewed downturn with job losses averaging a worrying 588,000 over the last three months (see chart below). Double-dip here we come.
Second, scrap all pre-existing expectations about China's traditionally burgeoning trade surplus. On deck: Chinese trade deficits!
Our Asian Economist Glenn Maguire has been very right on China this year. I was chatting to him on my recent visit to the region and he re-emphasised his call that China will be heading into trade DEFICIT (!) throughout 2010. This is a mega-call and will have major implications for the global financial markets. First and most obviously is that China will not be accumulating FX reserves at anywhere near its recent pace. This has implications not just for US treasuries etc., but also for the pace of Chinese growth itself, as the rise in reserves has previously been a major stimulus to domestic monetary growth and activity (see chart below).
Third - combining one and two would result in a major international capital flow revolution.
The fear of a cessation of flows of funds out of China in the event of a shift into trade deficit might also combine with similar worries about Japan. I, like many others, am increasingly concerned that the Japanese authorities may be nearing the end of the road in their ability to fund the out-of-control public sector deficit. Japan has been a major source of flows of funds for the global economy over the years as a direct mirror image of its massive trade and current account surpluses. Currently Japan is seeing huge long-term outflows (see chart below). A spike higher in JGB yields could seriously impair these capital outflows. Watch this space.
And the conclusion could very well be the harbinger of a major 2010 black swan (together with who knows what else courtesy of the Fed's central planning policy).
Imagine we are in the middle of 2010. Imagine the western economies (plus Japan) are sliding back into recession as the lack of additional fiscal stimulus reduces 2010 GDP growth back to its weak underlying rate (deficits need to widen to boost the economy). Imagine also that in 2010 the Chinese economy is beginning to roll over. China'?s vulnerability is perhaps far higher than the bulls suppose, having engaged in the same sort of recession defying stimulus as the US in 2003. The US authorities in no way thought gently tapping the monetary brakes in 2005/6 would end in the biggest economic and market crashes since the Great Depression. Personally, I see the Chinese conjuncture as little different ?- in particular, the market's? confidence that the authorities are in control of events opens the possibility of a rude shock.
I am reassured that my views are not totally bananas when two of the deepest thinkers in the markets are also concerned about a Chinese economic crash. Edward Chancellor thinks China is a bubble waiting to burst (link - he is one of the worlds? leading thinkers on bubbles and the author of the seminal book on the history of bubbles ? The Devil Take the Hindmost). I was also reading a news report on the views of Jim Chanos at Kynikos Associates -? link. Amid all the bullish hype on China, it is well worth taking some time to read these men'?s views.
Any synchronized end in Chinese and US recovery will undoubtedly heighten geo-political tensions and accelerate the inevitable trend towards protectionism. The trend towards competitive devaluation will also increase. And in the case of China, if its economy founders unexpectedly and unemployment soars, no lever to restore growth should be ruled out, including devaluation. With the potential for the dollar to soar, in the same way the yen did in 2008 as risk carry trades unwound, this may be all too much for a beleaguered Chinese economy. With a Chinese trade deficit and a loss of confidence in the growth miracle, China?'s reserves will in all probability be in decline. What better way of meeting the American?s call for greater flexibility than to give them what they want? The Chinese may yet respond to the new market pressures and devalue. 2010 could be a very lively year indeed.
A devaluation in the renminbi relative to the dollar will likely short-circuit all the millions of FX algos that expect a perpetual peg if not outright Chinese currency appreciation. This solidifies our view that the US Dollar is poised to become the next iteration of the Volkswagen short squeeze in the near- to medium-turn.