The US-China-Australia love triangle

naufalsanaullah's picture

First of all, just a notification: our Trades tab page has been updated with new trades, closed/stopped-out positions, and updated PnL's.

Now to the post...

The pre-crisis status quo in regards to US-China economic relations involved the United States exporting USDs to China via consumption for Chinese exports. China recycled these USDs into Tsys, which fueled further consumption and increasing imbalances. With the crisis at hand, however, China is now forced to choose between continuining its bid for quickly-debasing UST's or rethinking its investment strategy.

With its announcement of a record trade deficit for March, China seems to be posturing for reallocating its surpluses away from US exposure. Falling exports surely impacted China's trade balance but the bigger issue is China's new appetite for commodities, importing hoards of them from places like Australia. This is confirmed by the fact that China's Bills exposure has declined more than 67% in just one year! It is evident China is not rolling its Bills held and instead is bidding for commodities (its imports are up over 60% YoY).

The reallocation away from US short-term debt into hard assets is clearly an inflation hedge play. Commodities (particularly copper) have surged, as have risk assets as a whole, while Tsy rates have been spiking and are in fact approaching breakout.

The US Treasury needs a bid for Bills to keep interest expense at reasonable levels or it will go the way of Greece. Record deficit spending and debt issuance, coupled with spiking CDS and a lack of Bills rolling from China, means the Tsy is incentivized for a risk asset selloff to spur demand into liquid safe havens, in which the USD/Bills still hold the crown, on a relative basis.

Without a surge in organic Bills demand, the USA will have a funding crisis and very bad inflation. This is not only bearish for the US, but for the entire world, because of the USD's role as the international reserve currency, the US's political and militaristic positions, and the massive foreign holdings of USD and UST's. More Fed demand via QE also would spike rates, as 10yr yields went up 25% in just the first (and thus far only) iteration of QE, in less than a year.

As per trading, the key will be the AUD. It seems to be topping and a 200DMA break signals a great short opportunity and more importantly signals an end to the China-fueled commodities imports demand (at least temporarily). Given the game theory behind the US Tsy's relations with the rest of the world, we also believe this would signal a risk asset sell-off for capital reallocation into Tsys, at the front end of the curve. The deleveraging and fundamentals on the real economy support this, but timing is key. An AUD/USD breakdown should signal a breakdown in risk assets across the board, and commodities indeed are already topping and beginning new downtrends (energy is the weakest sector in equity at the moment). We will be shorting in size the S&P and the AUD/USD on a 200DMA breakdown. A breakout through 0.935 invalidates this thesis and would lead to us stalking a long position (if there is sufficient follow-through to define it as a breakout), but would also presumably lead to plunging Tsys (yields are already on the verge of breakout, especially in the 10 and 30yr arena). Considering the inverted swap spreads anywhre from 7yr to 30yr bases and the unique position America is in politically and economically, we believe short-term deflation risk and an "engineered" reallocation from risk assets into Bills is the more likely scenario.


Below are charts showing the AUD's overvaluation, courtesy of Citi.

--Original post.

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Ivanovich's picture

This is a great analysis, and I'm not sure you'll find too many folks that disagree with your hypothesis that the AUD is overvalued at this juncture, but long and many are the graves that have been dug by those shorting this pig throughout the last year.  Extreme caution should be used as this is the fulcrum for the risk orgy that has persisted throughout the Fed induced rally of 09.


gilligan's picture

Just a note.  Reserve Bank Governor of Australia today flagged further interest rate rises for Oz, in part to try and cool the wildly overheating housing bubble (you gotta live here to believe it):


This will support the current strength of the AUD, yes?  Not so sure a fall is on the cards just yet. I'm expecting something like a 1% rise in interest rates across 2010 (unless the new downward leg begins and we reverse back to 'emergency' rates).


Also Chinese-Australian Rio Tinto exec was jailed for 10 years today in China for "bribes" and "stealing state secrets".


All those doing business in China be warned.  They don't like it when there plans are thwarted.  Payback can be a bitch.  Feel very sorry for this guy. His situation is a timely reminder that as flawed as our western countries are, China is a different ball game. Of course we can be sure that the Aussie govt won't let this little issue interfere with the relationship with our new best friend...

SteveNYC's picture

Especially given the fact we just invited them whole-heartedly to participate in the domestic housing market. Given the level of local anger this can and has produced due to the continued unafordability for the average Aussie, this could only have been done for one reason:


The government's greatest fear is not just a collapse, but even a mild downturn in the local housing market. The banks are so extremely leveraged, a 10% - 20% move down in house prices, and a corresponding move up in unemployment, could potentially render each and every "big 4" member insolvent.

I can't believe they have continued to encourage this, it can only end one way. BADLY.

gilligan's picture

Yeah SteveNYC, spot on. 

The Aussie domestic housing market is one massive TBTF situation.  The bubble has being going for a decade now and combined with real estate speculation becoming the national sport (seems like every basic salary earner now views themselves as a property investor/tycoon), we have a situation where massive numbers of the population are massively indebted through their mortgages.  A downturn in house prices is simply not acceptable as the collateral damage to the nation will be enormous, hence opening up the market to foreign (read Chinese) buyers.

The divergence between the govt's words on fixing housing affordability and the housing shortage while simultaneously selling off houses to non-resident foreigners is scandalous and a betrayal of the younger generation.  And yes, local anger towards this policy is rapidly rising and I think it will hurt the incumbent govt at the next election. 

But in the end, all they care about is not having it collapse on their watch, and they will do this at any cost, regardless of future consequences.  Any.


SteveNYC's picture

Exactly, kind of like a big game of "hot potato". It is actually more affordable for me to live in NYC than it is in any top-4 Australian city. So, I think I'll stay put for the time being! Haha!

As for the government, I have always been a proponent of "watch what they do, not what they say". K-Rudd is a classic example.

SteveNYC's picture

Especially given the fact we just invited them whole-heartedly to participate in the domestic housing market. Given the level of local anger this can and has produced due to the continued unafordability for the average Aussie, this could only have been done for one reason:


The government's greatest fear is not just a collapse, but even a mild downturn in the local housing market. The banks are so extremely leveraged, a 10% - 20% move down in house prices, and a corresponding move up in unemployment, could potentially render each and every "big 4" member insolvent.

I can't believe they have continued to encourage this, it can only end one way. BADLY.

ozziindaus's picture

And it's not just housing. As part of an accelerated citizenship program, Chinese are invited to buy up businesses and franchises. I believe the condition is that they must own them for three years.

I was priced out of the Melbourne RE market back in 2004 when prices well exceeded my gain in salary. For the same money (US pays a lot more in my field), my standard of living has more than doubled in the US.

My $10,000 car is $70,000 in Oz. My 3X salary house here is 10-15x salary in an comparable suburb and my $1 double cheeseburger is $2.50 (single only in Oz.) 

Matto's picture

Spot on boys, our whole economy flows through the 'big 4 banks' and they inturn are neck deep in the housing market. My only query over this is Stevens continuing to raise interest rates, seems to fly agaisnt the Govts agenda of importing property support though the Chinese. We'll see if he keeps talking but stops raising, he'd want to be sure he doesnt overdo it with the risks at hand.

SteveNYC's picture

Raising domestic rates simply allows the Chinese less competition at auctions. They are importing their cash.

Matto's picture

Yes but wouldnt the Federal Govt. prefer to have a more broad based house price appreciation then just the Chinese effect?


Perhaps our CB is more independant then most but id hazzard a guess that they slow their target rate increases from this more 'normalized' position despite the rhetoric.


SteveNYC's picture

Yes, I agree. However, if you've lived down there long enough you'll see the crazy price increases in food, gas, utilities etc etc. Keeping rates low will not help this situation, and gradual raises will lead to "some" levelling in the housing market.

A collapse is inevitable however, they have already sewn the seeds. It can't be undone, it is just a matter of time. It all hinges on jobs, especially mining jobs.

Mining and related jobs are often low-education (no offense, just a fact), low-skill, high pay, and these guys leverage their asses to the wall to get the nice house and all the shit that goes with it. Can't last, never has never will.

Matto's picture

Im on the Southern Gold Coast and its pretty flat here at the moment, no flow on form the Melbourne/Sydney property markets but i think Bris has started to feel it so we should normally be next in line. Brisbane economy is going very strong on resource HQ money but i understand Perth is off the richter scale right now. The Melb/Syd good news stories seem to be property specific for the most part and seem to be the focus of most of the attention from Asian buyers (Melb first, now Sydney).

I have to agree that a collapse now is almost assured and its going to take much of our little fiefdom by surprise. Theres an article in contrarian investors journal on this today, CBA would have its equity wiped out in the event of 6.6% of its loans (any type) becoming non-performing. A big increase in bond yields or a sharp slowdown in the rock market could spill a lot of bood.

Is it just me or is there an inverse relationship between mining industry pay and skill level?

Re price inflation: i look forward to Costco smashing the CML/WOW nice little business models.





SteveNYC's picture

Thanks for the insight and link mate.


And yes, there is no doubt that in the mining business pay and skill level are completely inverse.

Yardfarmer's picture

interesting the execs were arrested after the collapse of iron ore talks and were accused of cutting secret deals with bribes and kickbacks to "private" non state owned steel companies. In addition just weeks after Rio Tinto reportedly snubbed major investment by state run Chinalco. after being turned away repeatedly from investment deals in West, China is now playing hardball with western investors trying to circumvent PRC with back door deals. Mid- april U.S. foreign currency manipulation release will brand China as such opening up trade war unless Big Brother IMF intervention proceeds. Schumer and Graham are resurrecting 2005 tariff and sanction bill in Congress. somebody has to take the blame for impending bond market blowup and bleeding job losses, nearly 3 million "to China" in last seven years. 

ZeroPower's picture

Id say the $CAD is doing a bit too well also. Adjusted with PPP, the same grocery cart i buy weekly would cost me about 30% cheaper just 50km South of me in Vermont... 

London Banker's picture

Is it just me, or does anyone else think that the massive rise in copper and other commodities stockpiling in China is a backdoor carry trade.  Reminbi is not convertible, but imports of commodities can be dollar financed.  With the biggest stimulus in global history in China last year, many must have been tempted to get their Reminbi paper billions out the country through commodities finance deals with partners abroad.

Anyone else think this is what has been going on? 

AUD's picture

This guy has been short the AUD & commodities etc for months; Is he still wearing a wearing a shirt?

He could be right (eventually) but wtf does the US Treasury care about interest rates? It only 'pays' back with the same obligations which it creates through its check kiting scheme with the Fed, which by the way, like any other central bank, is not some nefarious cabal of private bankers.

I think the gi-normous issuance of government debt worldwide is in fact to stop  benchmark interest rates from falling. Falling gov bond yields is signalling a breakdown in the money market - depression - something governments are desperate to avoid.

Benchmark rates can only fall so far before they move into backwardation against the only true currency - gold. It's not called the noble metal for nothing. I posit that interest rates rising is not necessarily a bad thing, as far as governments are concerned.

Gold interest rates may also be rising, hence the recent 'sales' of 'IMF' gold. Possibly scraping the bottom of the barrel?

TooBearish's picture

Low probability event, in fact his senario would be crash material and not sure we're in that window until 10yr yields are well above 4% and they aren't threatening that yet....

abalone's picture

Australia is full of credit junkies. One has to only visit any of the myriad shopping complexes being built faster than houses all over the East coast to understand the moves are designed for the Banks & not the economy. I like this kids analysis as his trading plan has conviction. The AUD will eventually crack & when it does it will slide quickly as per usual.

Matto's picture

true true. not much upside left in this paso and plenty of risk exposure in the current economic model

fxrxexexdxoxmx's picture

Has anyone in Australia read about the housing bubble in America?

I am a layman on this topic. I believe credit was given to a large segment of the population for investment into real estate. After the credit dried up a bunch of people owe more money on their investments than the investments will ever be worth again.

Real estate bubbles are caused by credit bubbles which the Fed or any CB have never seen before they bubble.

BTW apparently employment, outside of government careers, is difficult after " Bubbles"

Matto's picture


Have heard and read as much as i can get my hands on. a few different factors factors have meant the prolonging of the Aussie bubble beyond every other developed nations.

1. Supply side inhibitors in Aus, there wasnt an abundance of new estates springing up due to tough development regulation and redtape (this wasnt a problem in the UK mind you).

2. Our bubble seemed to start off slower, around 2001/early 2002 and grew steadily ever since while the US bubble seemed to go exponetial from about 2004.

3. There werent strong incentives to write mortgages, repackage them and float them. standard mortgage writing fees prevailed throughout so there wasnt an abundance of crap shoved written and shoved onto the market. Non-performing loans have remained fairly low % wise comparatively. ie. we didnt have wall street scale fraud & manipulation, just normal small country town scale fraud.

4. China swang through the GFC with massive stimulus programs keeping Aus's income up (main factor!)

5. our interest rates were considerably higher (about 9% at the peak in 2008) leaving a lot of room to cut and minimal govt debt allowed for a big govt stimulus spend (highest per capita in the developed world... and we didnt even have a reccession!) - our debt problems were on the private side going into this.

6. Going forward we've had a plan to get back on track (sell more rocks to chinese people) while the US has seemed to go further into the abyss so the global debt markets werent to worried about refinancing us.


Our real estate market seems to be moving in lockstep with the boom in china and we're leveraged to their outcome. if they falter, we swandive.










aus_punter's picture

commodities indeed are already topping and beginning new downtrends


Which ones ? I don't disagree the thesis of the analysis but this is just wrong

Squid-puppets a-go-go's picture

I thought that the big 4 were relatively well capitalised because the regulators didnt bow to US pressure and allow a rise in the 12-1 traditional leverage limit  (that saw Lehman and Bear sterns blow out to 30-1 before collapsing)

aint that the case? (still , 12 to 1 can still get you in plenty of hot water in dire economic times, such is the folly of fractional reserve banking)

Matto's picture

Big 4 aussie banks? i was just reading an article that CBA is at 20:1 now but ultimately you're right on that either way. leverage limits never hit the US/Wall Street stratosphere and there was never a commercial push to blow it out to those levels (these arent investment banks btw). Didnt Lehman hit 42:1 right before implosion? that could have as much to do with carrying shit assets as a plan to expand to that level, the ratio would be dynamic on the quality of the assets which is the main risk for the aussie banks going forward. Property prices and loan delinquencies have a long way down from here if things start to go peary.

Squid-puppets a-go-go's picture

20:1 really?  maybe we are getting media BS about the health of aussie banks. One things for sure, im certain that they arent as healthy as the media/govt says they are because every time the reserve bank of australia raises rates .25bp, the banks raise their own by .5bp

they wouldnt need to do this if they were on solid ground.

Incidentally i posed the question when the repo 105 stuff came out but it wasnt answered - Has anyone recalibrated Lehman's true leverage when repo 105's are put back on the balance sheet ??

Matto's picture

I think there's a lot of different banking ratios at work here and it could be quite easy to mix them up, tier 1 capital ratios etc. and i really dont know the ins and outs of the semantics but our big 4 arent investment banks so should have held tighter ratios.

We also have a very tight regulatory framework in regard to banking and i cant imagine any of them considerting systematic use of ''repo 105" type transactions and expecting to get away with it. certainly there'd be serious gaol time to pay if they did and a lehman type wipe out ensued.

point #..?.. on my list: no non-recourse loans. simply doesnt happen.

TruthHunter's picture

No non-recourse loans?  What are you bankruptcy

laws like?

 So what's the plan? Repo all the houses and sell

them to the Chinese?  When they do that, they'll

be glad they took all your guns away!