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Albert Edwards Vindicated: Discusses China's Upcoming Trade Deficit, And Why CNY DEVALUATION Is Now Increasingly Likely

Tyler Durden's picture




 

As we pointed out a few days ago when we noted that China is about to disclose a March trade deficit, Soc Gen's Albert Edwards was right on the dot, and has been since November. Sure enough, today he (rightfully so) revels in his vindication:

Many clients have congratulated us for flagging up this outturn back in November last year ?- see Global Strategy Weekly 23 November -? link. We said back in November that ?China will be heading into a trade DEFICIT (!) throughout 2010. This is a mega-call and will have major financial market implications?. Unfortunately I have not pushed this call hard enough. Why not? Well, because as the implications are so very non-consensus, I knew noone would take it seriously. With the  pre-announcement of March?s deficit, investors are now more willing to listen.

To be sure, only economists who still reference 1984 textbooks and write uninspired columns could not see this coming. Shockingly, this was indeed the dominant view. And inevitably it will take a long time before the ramifications of what a Chinese deficit means, finally sink in.

Edwards attempts to make llife for those whose world is about to be turned upside down, a little easier.

In part, the timing of such an announcement is political, ahead of moves in the US to label China a ?currency manipulator?. Chen said, "China's trade surplus with the US has been turned into a key excuse by American economists to pressurize the Chinese government to revalue the yuan," but, ironically, the calls have been growing stronger even as the "surplus keeps falling". Although the timing of the announcement may be political, the trend towards a sustained trade deficit is very real. It comes on the back of an aggressive stimulus package focused on infrastructure spending which has sucked in massive imports of commodities. The import of these dollar-denominated assets has additionally meant the need for official purchases of dollar-dominated Treasuries has lessened.

Edwards, unlike Stephen Roach, is a little more polite when it comes to Nobel-prize winner extraordinaire, Paul Krugman:

The debate on whether or not China should be revaluing its currency is heating up, not just between the two governments, but also between leading market economists. Stephen Roach, Chair of Morgan Stanley Asia, went so far as to say in a recent Bloomberg interview that ?we should take out the baseball bat on Paul Krugman? -? Roach Spars With Krugman Over Call to Pressure China -? Bloomberg.com. Krugman who has been calling for yuan revaluation responded in his NY Times blog that Roach had gone ?"batty?" -? link. With brick-bats and baseball bats being wheeled around I enter this debate with some trepidation. But I don?t want to get into what China should, or should not do, I want to focus on what I think will happen.

Credit for originating the call that China would move into trade deficit goes to our Asian Economist, Glenn Maguire. I reproduced the front cover chart of his a couple of weeks back with his projections for a trade deficit emerging from March onwards. Glenn doesn?t yet share my conclusions which I believe are likely to flow from this seismic shift in trade imbalances, but I?m still working on him (hmmm, maybe that?s why he avoids me when he visits London).

One of the key changes over the last year is the rate at which Chinese import growth now outstrips export growth (see left hand chart below). It is clear much of this is down to the rapid pace of commodity imports, associated with a step-up in infrastructure projects due to the fiscal stimulus programme, but also with stockbuilding. Hence we see total imports handsomely outstripping imports from countries that are not big commodity producers, such as the US and Europe (see right hand chart below).

Aluminum, Copper and Gold are now the new 10 Year, at least for China. This was substantially proven by the just passed miserable 5- and 7-Year auctions.

Now there are a couple of things I have been mulling over in my mind about these developments. It is well known that China has been buying commodities in excess of its needs for final consumption and stockpiling them. This seems sensible. If you have a pegged exchange rate and have to buy dollar assets, why just pile up mountains of US Treasuries when you can pile up mountains of copper and iron ore that can be usefully consumed at some point in the future? This change in policy also has the added advantage of engaging in FX intervention on the trade account rather than the capital account, thereby relieving intensifying political pressure for a yuan revaluation. Indeed I would suggest that the preannouncement of the March trade deficit is the latest salvo in the ongoing war of words. China can quite reasonably point at its trade deficit and respond to the US that its criticism that the yuan should be revalued is totally invalid if it is running a trade deficit. Some might argue that instead of "?manipulating?" its currency, it is trying to head off pressure to revalue by manipulating its trade balance.

If China is running a trade deficit, it is clear that it will be buying a lot fewer US Treasuries. We find it is widely assumed that this will result in a noticeable rise in US bond yields. But it may not. If China now has a trade deficit, someone else must be running either reduced deficits (the US?) or bigger trade surpluses (commodity producing countries?).

What does this mean for global trade balances:

To the extent that China?s trade surplus is ?'shifted'? elsewhere (e.g. Canada), these countries may be larger consumers of US goods and hence the US may see a quicker reduction of its own trade deficit. If that is the case, the US could become more like Japan, funding purchases of Treasuries out of domestic savings. Or to the extent the commodity nations see  larger trade surpluses and do not peg their currencies in the same way as China, they will see intensifying upward pressure on their own currencies, helping to clear recent extreme global imbalances which were at the heart of the recent credit crisis.

Ultimately, though, as EU trade commissioner Karel De Gucht pointed out recently in an FT interview, ?the dispute between the US and China [currently] is part of a bigger issue? (EU?s De Gucht airs concern on US trade stance - FT.com). Tensions have been rising on a number of separate fronts. And as such the US may still name China as a ?currency manipulator? despite a move into trade deficit.

I still make the very simple point I made back in November; a collapse of the current recovery seems extremely plausible in both the US and China in the not too distant future. This will only intensify the mutual belligerence seen in both nations. And despite the recent downturn last year, the yuan has strengthened decisively over the last four years.

I think the emergence of a persistent Chinese trade deficit would fundamentally change the political dynamics between the US and China. If political tensions continue to mount and the US begins to erect trade barriers after naming China as a "?currency manipulator?", at some point China may indeed do exactly as the US authorities wish and stop ?manipulating? its currency. And if it is running large trade deficits, investors should consider the very realistic outcome that China does indeed devalue the yuan.

And another observation: with FX intervention out of the way, the only way to stall an overheating economy (that is merely stockpiling UST alternatives, yet flooding the economy with free money), is to hike rates. The elimination of currency mechanisms to moderate overheating means that monetary policy is the only way, which means that the Bank of China is likely ever so closer to notjust removing excess liquidity, which it has been doing in overnight operations for the past two weeks, but raising the interest rate outright.

 

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Thu, 03/25/2010 - 14:03 | 275837 sheeple
sheeple's picture

"... the US could become more like Japan, funding purchases of Treasuries out of domestic savings."

Do you smell what the DIRECT BIDDERS are cooking?

Thu, 03/25/2010 - 17:53 | 276170 Buck Johnson
Buck Johnson's picture

Thats exactly what they have been moving in the shadows and wanting to do.  Remember getting Pensions to invest in bad banks assets.  Also the two times they tested the water to see if people will be okay to have their 401k's invested entirely in Social Security (A year ago), then coming back a few month ago and saying how about 401k's having 20% of their investment in annuities (which you can bet your last dollar they will be in UST).  The govt. see's this large pool of money that is left in 401k's and pensions and they want it.  If you don't think that govt. can't or will take pensions, google Argentinian president wants access to Argentinas pensions.

Thu, 03/25/2010 - 14:12 | 275854 43 Steelie
43 Steelie's picture

CADs bitches...assuming their Fed doesn't go the way of ours in responding to their housing bubble.

 

Thu, 03/25/2010 - 14:28 | 275877 wang
wang's picture

"Canada's housing bubble" ... hardly. Housing bubbles like the one in some markets in FLA (and other US regions) saw prices quadruple in a three or four year period. Free money, liar loans etc.,  none of those dynamics exist(ed) in Canada. Will there be a correction, perhaps but to call it a bubble is tantamount to David Rosenberg calling the rally from last years March lows to SPX 800 a suckers rally.  The only suckers were those who gave merit to his musings.

 

Garth Turner ( http://www.greaterfool.ca/ ) has been on the Canadian Real Estate bubble bandwagon for a couple of years. So far his track record rivals Rosies'.

Thu, 03/25/2010 - 17:39 | 276152 asteroids
asteroids's picture

The average Canadian is spending more than 50% of his income on his mortage. When interest rates go up, they'll all go bankrupt and housing will implode. But fear not, the banks have most of this junk insured by the CMHC. They learned quik.

Thu, 03/25/2010 - 14:18 | 275855 Mako
Mako's picture

Love all this talk of Yuan going up, the global economy is shrinking not expanding.  Eventually they will have to devalue to keep the game going.   It's a slow race to the bottom guys.

Helicopter Ben is not going to save you nor is Bruce Lee. 

 

Thu, 03/25/2010 - 14:50 | 275914 carbonmutant
carbonmutant's picture

 Sounds like the squid and their gang of banking mollusks needs to stop buying equities and start taking over the slack from the Indirects.

I wonder how Bernanke will convince them to do that...

Thu, 03/25/2010 - 15:26 | 275955 JW n FL
JW n FL's picture

Let them borrow at 0% from the Fed Window?

Pay the Taxes on the earnings?

Show the share holders a positive of Wall Street?

Did you want to know the mechanics or the politics... I covered both. ITS CALLED "GOD's" WORK!!!

To be clear, the last part... that was sarcasm...

Why do you think we can not look at the FED's books? Normal peoples heads would explode.

Thu, 03/25/2010 - 15:06 | 275930 Rick64
Rick64's picture

Excellent article. IMO I think the anti-China campaign (bubble,currency manipulator)has a bigger agenda of eventually getting them to float their currency which will allow the financial elite to manipulate their economy. Right now its very hard for them to control the Chinese government without any financial control over it.

Thu, 03/25/2010 - 22:25 | 276441 moneymutt
moneymutt's picture

Agreed, but I see China regime as a competing tyranny to other elite tyrannies, but they do still have their sovereignty, they just won't use it for their peoples own good, just as US regimes does not

Fri, 03/26/2010 - 04:51 | 276640 AnAnonymous
AnAnonymous's picture

And what should the plan for China be?

Thu, 03/25/2010 - 15:07 | 275931 mbasham
mbasham's picture

I would like to hear more, now that it appears every country in the world is racing to devalue faster than the Ben can print new crap dollars, about what the implications of perhaps a yuan devaluation, euro/dollar parity, and yen at 150 to the greenback, etc. etc. etc. are for US trade and the current account. I suppose in addition to export collapsing, it would sink the domestic hotel industry, while any American left with a job could vacation in Europe for 33% less than currently...

Thu, 03/25/2010 - 15:54 | 275992 TraderMark
TraderMark's picture

Doug Kass - 20 Signs that could mark a top in the markets

http://www.fundmymutualfund.com/2010/03/doug-kass-20-signs-that-could-ma...

#1 Anti Sign?

Ben Bernanke

Thu, 03/25/2010 - 18:05 | 276184 tmosley
tmosley's picture

My God what a dumb article.  

They are manipulating their currency by PRINTING Yuan to buy dollars and dollar denominated debt.  If they stop "manipulating", by definition, this means they stop printing, which is by definition bullish for Yuan.  QED.

How anyone can misunderstand something so simple is beyond me.  Sure, there are other reasons to be bearish on China with varying levels of merit, but to claim that halting QE operations will count as a devaluation just don't make no sense.

The trade deficit can probably be explained almost 100% in terms of fulfilling contracts for raw material imports.  Those raw materials don't disappear or get consumed, they get value added to them through manufacturing processes.  This is a more complex concept, and the author can be forgiven for failing to understand.  It is analogous to having commercial debt rather than consumer debt.  With commercial debt, you are going into debt in order to make things.  You can cash flow that debt from your increased production.  This is what China has (probably).  On the other hand you have consumer debt, which is put toward non-productive uses like kitchen renovation, plasma screen TVs, and big gulp grande macchiato enemas.  This is what the US has.  It is indicative of a society in decline that they import finished goods.  It is indicative of a society that is growing to import raw materials.

Tmosley's investing rule number 1: figure out what China is going to do, and do it first.  In this case, it looks an awful lot to me like they are accumulating capital goods, perhaps in preparation for *something*.  Perhaps a malodorous bit of slightly used organic material impacting a rapidly rotating blade?

Thu, 03/25/2010 - 23:14 | 276482 A Broken Bear
A Broken Bear's picture

Interestingly looking at Bloomberg figures indicates that from Dec to Feb Chinese Exports are down 35b USD and imports are down 25b over the same period.

If China runs a trade deficit, wouldnt that be as a result of a lack of export demand, which if that is the case may suggest the Chinese will be buying less commodities to make goods with in turn causing commodity prices to fall in turn impacting Nations like Canada and Australia. Weaker commodity prices = weaker CAD & AUD? 

Fri, 03/26/2010 - 01:02 | 276572 aus_punter
aus_punter's picture

NONE of this is bearish USD thats for sure

Tue, 04/13/2010 - 06:25 | 297789 mark456
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