When no lesser establishmentarian than Obama's former chief economist Jared Bernstein called for an end to the US Dollar's reserve status, it raised a few eyebrows, but as the WSJ recently noted, the voices discussing how the burden of being the world's reserve currency harms America, more than just Vladimir Putin is paying attention. While some argue that “no other global currency is ready to replace the U.S. dollar.” That is true of other paper and credit currencies, but the world’s monetary authorities still hold nearly 900 million ounces of gold, which is enough to restore, at the appropriate parity, the classical gold standard: the least imperfect monetary system of history.
Having told the world that it will not be undertaking system-wide rate cuts or stimulus - focusing more on idiosyncratic safety nets - last night's data from China is likely to have the PBOC frowning. Fixed Asset Investment (lowest growth since Dec 2001) and Retail Sales (lowest growth since Feb 2006) missed expectations, but it was the re-slump in Industrial Production (after a small 'huge-credit-injection-driven' bounce in September) that is most worrisome as China's 2014 output is growing at its slowest since at least 2005. As Michael Pettis previously noted "China will be no different... growth miracles have always been the relatively easy part; it is the subsequent adjustment that has been the tough part." Of course, this is not the 'soft-landing' so many bulls have expected, which, if enabled by moar credit, as Pettis warned "will inevitably lead to a very brutal hard landing."
Following the release of the quarterly monetary policy report from the People’s Bank of China, it is becoming clear, as Goldman Sachs notes, that stimulus - via cuts to system-wide RRR and/or benchmark interest rates - is becoming less and less likely. The PBOC's introduction of a new facility called the medium-term lending facility (MLF) allows 'targeted' easing, and as one local economist noted, "it shows the central bank is very reluctant to loosen monetary policy." The PBOC has broadened its toolkit to arrest an economic slowdown, while seeking to avoid adding financial risks, as The PBOC said it would "continue to implement a 'prudent' monetary policy and use various tools to manage liquidity." Not the exuberant stimulus-fest the talking-heads are calling for reminding us, as Pettis previously concluded, "In China, it will be no different. Growth miracles have always been the relatively easy part; it is the subsequent adjustment that has been the tough part."
When Chinese property developer Agile Property Holdings Ltd. said this month that its chairman was taken into custody by authorities, the disclosure was a shock to Western banks that lent the company money, according to China Spectator as the fog of ever-rising asset values suddenly evaporates into the reality of an opaque real estate credit market slap them in the face. The simple fact is "it is very difficult to get a handle on the financials of a Chinese company," as a local investigative consulting firm warns "in China, nothing is what it appears to be."
Globalization continually creates imbalances that fuel a perpetual instability that gradually impoverishes every sector other than global capital.
"If we have what everyone would hail as a soft landing, with growth remaining above 6-7% for another two years, it would just mean that credit was still growing too quickly. And once we reach debt capacity constraints, the so-called soft landing would be followed by a very brutal hard landing... Growth miracles have always been the relatively easy part; it is the subsequent adjustment that has been the tough part."
With global growth concerns on the rise, whether a bust in the Chinese housing sector could threaten the economic activity and financial stability of the world’s largest contributor to growth is top of mind for Goldman Sachs. As Michael Pettis warns, "this story only has a few possible endings, all of which imply a significant reduction in economic growth as debt problems are addressed." The following 3 charts suggest Pettis is right...
Following investors who came to prominence together with Kyle Bass after shorting the sub-prime market in 2007
This may be excessively optimistic on my part, but there seems to be a slow change in the way the world thinks about reserve currencies. For a long time it was widely accepted that reserve currency status granted the provider of the currency substantial economic benefits. For much of my career I pretty much accepted the consensus, but as one starts to think more seriously about the components of the balance of payments, it is clear Keynes wad right in his call for a hybrid currency when he recognized that once the reserve currency was no longer constrained by gold convertibility, the world needed an alternative way to prevent destabilizing imbalances from developing. On the heels of Treasury Economist Kenneth Austin and former-Obama chief economist Jared Bernstein discussing the end of the USD as a reserve currency, Michael Pettis summarizes 10 reasons the USD's reserve status has become an 'exorbitant burden'.
"...what was once a privilege is now a burden, undermining job growth, pumping up budget and trade deficits and inflating financial bubbles. To get the American economy on track, the government needs to drop its commitment to maintaining the dollar’s reserve-currency status...The privilege of having the world’s reserve currency is one America can no longer afford."
- former Chief Economist and Economic Adviser to Vice President Joe Biden, executive director of the White House Task Force on the Middle Class, and a member of President Obama’s economic team.
"Washington is absolutely correct, in my opinion, to want to boost American consumption, but the Fed seems to be trying to boost consumption by igniting another asset bubble in the hopes that, like before 2007, Americans will feel “richer” and so will consume more. This isn't sustainable, however, and will leave us, as Paul and Druckenmiller fear, even more heavily indebted and more dangerously exposed to the underlying weakness in demand."
Even if the economy were growing at a faster pace, it wouldn't come close to offsetting the interest payments on our ever-expanding debt. If you want to know why the Status Quo is unsustainable, just look at interest and debt.
"Excess credit creation is at the heart of much of China’s GDP growth, and why this means that China must choose between a sharp slowdown in GDP growth as credit is constrained, or a continued unsustainable increase in debt. The key point is that we cannot simply put the bad debt behind us once the economy is “reformed” and project growth as if nothing happened. Earlier losses are still unrecognized and hidden in the country’s various balance sheets."
China May Actually Have Surpassed U.S. in 2010 or 2011
While Emerging Market debt has recovered somewhat from the January turmoil, EM FX remains under significant pressure, and as Michael Pettis notes in a recent note, any rebound will face the same ugly arithmetic. Ordinary households in too many countries have seen their share of total GDP plunge. Until it rebounds, the global imbalances will only remain in place, and without a global New Deal, the only alternative to weak demand will be soaring debt. Add to this continued political uncertainty, not just in the developing world but also in peripheral Europe, and it is clear that we should expect developing country woes only to get worse over the next two to three years.