Renminbi

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• U.S. Examines Goldman Sachs Role in 1MDB Transactions (WSJ)
• JPMorgan Says Trading Pain Isn't Over After Third-Quarter Slump (BBG)
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News That Matters

The US is in decline. The US government is overloaded with debt. The US financial system is losing is dominance. And even the banking institutions themselves are losing relevance. This isn’t bad news. It’s tremendously exciting.

Having government control over the levers of the economy can have advantages. For example, by taking prompt action, the Chinese government was able to pull the economy out of the recession remarkably fast, basically by fire-housing the stimulus package that was equivalent to 12% GDP. That’s the advantage. The only problem is that these kinds of short-term advantages come with long-term, painful consequences.

"The data are positive for the probability of the yuan getting into the SDR basket. It shows that the so-called devaluation in August, which wasn’t massive in value, hasn’t driven people away from using the yuan."

From time to time, the data (from economic activity, inflationary pressure, risk appetite and asset valuations) points unambiguously in a single direction and experience tells us that such confluences are worth watching. We are today at such a point, and the worry is that each indicator is flashing red.

As documented here and elsewhere, in addition to the Pope and Putin, the third world leader US president Obama is "historically" meeting this week is China's President, and General Secretary of the Chinese Communist party, Xi Jinping. But just like everywhere else, the president is mostly a figurehead for far greater political and primarily financial interests backing him. So who calls the shots in China? The following infographc lays out the key power divisions of political, economic and financial power in China at this moment.

After 35 years of falling and now zero rates, the direction is only up for the cost of money, as is the cost to service debt, along with the burden to those who are most indebted (i.e. the U.S.). What should no longer be unthinkable is that the clock is ticking on America’s status as the holder of the reserve currency. If you still doubt this proposition, consider that China is in the process of setting up a third benchmark for oil, along with Brent and West Texas Intermediate, for trading oil futures contracts. And unlike the existing contracts, these will be traded in Renminbi. Who needs the dollar?

According to TIC, China, between its mainland and Euroclear holdings, sold a record $83 billion in Treasurys in the month of July. It also means that China has liquidated a whopping $184 billion notional in US Treasurys in 2015. Finally, and here it the punchline: the sale of ~$83 billion took place in July. This is before China announced its devaluation on August 11 and before, as we also first reported, it sold another $100 billion in Treasurys in August.

So far, it’s a different type of crisis – market tumult in the face of global QE, in the face of ultra-low interest rates and the perception of a concerted global central bank liquidity backstop. It’s the kind of crisis that’s so far been able to achieve a decent head of steam without causing much angst. And it’s difficult to interpret this bullishly. If Brazil goes into a tailspin, it will likely pull down Latin American neighbors, along with vulnerable Indonesia, Malaysia, Turkey and others. And then a full-fledged “risk off” de-risking/de-leveraging would have far-reaching ramifications, perhaps even dislocation and a collapse of the currency peg in China. China does have a number of major trading partners in trouble. Hard for me to believe the sophisticated players aren’t planning on slashing risk.

"Being bearish on China for the last few years has reminded me of the 1987 action classic "Predator". For bears, much like the alien in Predator, the Chinese government has continually used special abilities that were previously unknown. Bearish investors in China had been picked off relentlessly and seemingly effortlessly by the government and the central bank. But then just as suddenly, the stock market started to sell off and the pressure on the currency began to build. This led to the small devaluation we saw in the Renminbi in August."

The world is in the waning days of a historic multi-decade experiment in unfettered finance. International finance has for too long been effectively operating without constraints on either the quantity or the quality of Credit issued. From the perspective of unsound finance on a globalized basis, this period has been unique. History, however, is replete with isolated episodes of booms fueled by bouts of unsound money and Credit – monetary fiascos inevitably ending in disaster. We see discomforting confirmation that the current historic global monetary fiasco’s disaster phase is now unfolding.

There is no doubt that the Chinese economy is in a material economic slowdown. Policy officials’ aggressive actions and scare tactics against equity short sellers could continue to cause capital flight. However, this does not mean that China is going to sell large quantities of Treasuries. There is too much co-dependency between the US consumer and Chinese exporter. Destabilizing the US Treasury market with large sales would be tantamount to shooting themselves in the foot.