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The World’s Biggest Asymmetric Trade Just Got Bigger
By: Brad at www.CapitalistExploits.at
Ten days ago China cut interest rates in an effort to free up credit and stimulate the economy. This is unlikely to have much of a positive effect on economic growth in China. Rather it is likely to compound the big problem that the Chinese currently face: exports becoming increasingly uncompetitive.
China's biggest problem is its strong currency, the renminbi, caused by a strong USD. As the USD rises its exports become less competitive. What if currently cheap Chinese products on the shop shelves worldwide become less cheap and outright expensive as the USD continues down the path of a multi-year bull market. Cutting interest rates in China won't have any affect on making Chinese exports more competitive.
I am not an economist. Rather I am a macro trader and I look for relationships in global financial markets on which to base my views and trades. There has been considerable talk about the Chinese economic miracle over the last few years, but I believe that much of that "miracle" or "economic growth" has occurred on the back of a weak USD and cheap credit. Note how Chinese GDP started to go parabolic from about 2002 onwards.
Also note how the USD (as per the US Dollar Index) went into a bear market at about that time:
Yes, this may be a little simplistic but - what if the USD continues to rise from here and it trades at a new high within 5 years (I'm trying to be conservative), and the renminbi doesn't depreciate against the USD in any material sense? I don't think it takes much to work out that the Chinese economy would be in a recession if that were to occur! Either way - if the USD continues to appreciate over the coming months then the renminbi has to depreciate!
So all we have to do is to get the direction of the USD right and everything else falls into place. I have talked at length about the USD on a previous occasion. Nothing has changed to my perspectives since then, so I won't badger on about it here.
What about interest rates? If interest rates eventually track what is happening in the economy then to me it is just a question of when, not if rates will rise in the US. Given the behavior of leading indicators, interest rates in the US are likely to rise much sooner than is generally expected. The up trend of leading economic indicators doesn't seem to be in any danger, rather momentum appears to be gaining to the upside.
While there is a lot of debate as to when interest rates will rise, there has been little debate as to the magnitude of rate rises. Below is the yield of the US 2 year treasury; it has been engaged in a relatively tight trading range for the last 4-5 years. Usually breakouts of sideways trading ranges are dramatic. So don't be surprised to see rates move materially higher very quickly once the US 2 year yield breaks above 1%.
So we have a situation in the US where rates are getting ever so close to rising due to economic growth picking up, whereas rates are being cut in China due to economic activity slowing down. Combine this with a rising USD and it will certainly lead to a continuation of the unwind of the carry trade.
Charles Hugh Smith published a great article on the USD - "Why the Rising US Dollar Could destabilize the Global Financial System". In the article he details the essence of the carry trade:
We might imagine that the Federal Reserve ending its vast money-issuance program of quantitative easing would lessen the global risk posed by the carry trade, as it reduces the flood of dollars seeking higher-yield homes outside the U.S.
But this tightening has actually increased the risk of carry trades blowing up and bringing down emerging-market economies, for it reduces the flow of fresh capital into emerging markets. As the supply of dollars dries up, demand for dollars rises as carry trades are unwound. Emerging-market currencies then weaken significantly, causing profitable carry trades to reverse into losing trades, which then causes those holding debt in dollars and assets in other currencies to dump the assets and pay off the dollar-denominated debts before the trade goes even more against them.
There is a positive feedback in play: the more the dollar rises, the greater the losses in carry trades denominated in the dollar, and the greater the incentive for those still in the trade to sell emerging market assets and currencies.
In response to these massive outflows of capital, emerging nations must raise interest rates quickly to offer incentives for capital to stay put, which then causes the cost of new loans (and doing business in general) to quickly rise to painful levels.
Although the renminbi isn't depreciating against the USD, cutting rates in China does reduce the attractiveness of the Chinese carry trade. If the renminbi did start to depreciate against the US dollar then it would likely depreciate very quickly given the amount of capital that is locked up in the Chinese carry trade. This would lead to massive inflationary pressures that would eventually force the PBOC to raise rates to defend the currency (in so doing killing economic growth) and then we have a fully-fledged renminbi crisis on our hands.
Perhaps this is what the Chinese authorities fear, but it is what ultimately will happen if the US dollar continues its upward trajectory. The crowd has placed a very low probability of this situation playing out which is why we have begun a program of buying extremely cheap long dated call options on the USD/renminbi. Now we sit back and watch the slow motion train wreck begin to unfold.
- Brad
"Let China sleep, for when she awakes, she will shake the world." - Napoleon Bonaparte
PS: Whether you’re an individual investor looking for high-quality research and information to help steer through increasingly treacherous markets, or an investment professional looking to provide clients with solid, expert analysis and ideas to do the same thing, this report on global debt will interest you.
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Brad is a litle bit off his mark. If the stock market is about to crash as Tyler predicts, then the USD will go down and gold will go up. So we do not have to worry about the USD for now.
why did business select china for manufacturing its useless shit and high tech items.... slave labor... forget the currencies, it is when educated chinese suddenly wake up and no longer work for slave wasges.... that is what will change the situtaion... then business can relocate to central and s. america and use its slave labor...but the real issuse for he ussa is what does it make or ahve that the world needs or wants... printing dollars eventually comes to an end with a drop in purchasing power and demand.. china and russia and iran and others are trying to break the petrodollar and china and russia are heading towards a partial gold backed reserve currency... china is financing the ussa until it can ignite its own consumer market... and once it does that is the end of the ussa dominance..
Demand will force up wages, not waking up. The choice is accept a "market wage" or go back to subsitance farming! Comrade!
the economy cannot respond to trillions in new debt? perhaps it's because all those off shore jobs benefit from the debt, but what co is stimulated here in usa? - this is a jobless economy - and no one will admit it.
I agree with your comment and think America is digging itself into a deeper hole. The long term implications of poor job creation are massive. We are seeing that a huge number of people have dropped out of the work force. Often these people have little in the way of savings, this means the burden of caring for them will be transferred to society. If to many people shift into this category we will slowly wear down through attrition.
Finding a fair way to share and balance the work load that goes on every day is one of the most important problems facing our modern world. Failure to discover a solution to this dilemma bodes poorly for our consumer driven economy and adds to the toxic problem of inequality. Many of the numbers and budget projections of the government have been based on far better employment numbers then we are currently facing or will be facing if this continues. The article below looks at the long-term implication of poor job creation and how it will drastically impact in a negative way both the wealth and future of America.
http://brucewilds.blogspot.com/2013/09/implications-of-poor-job-creation.html
Iraq denies Lebanon captured wife of ISIS Leader Baghdadi despite daughter's positive DNA test
http://wtfrly.com/2014/12/03/iraq-denies-lebanon-captured-wife-isis-lead...
IF YOU CAN'T SEE PAST THE DISINFORMATION YOU WILL JUST SPIN YOUR WHEELS. ATTACKING WINDMILLS WENT OUT A LONG TIME AGO.
Lowering interest rates, short term interest rates has no effect on anything. Low LOW LOW rates like 2% or 1% or zero or less percent are just Mother Bankster telling you your money is worth NOTHING. GET IT? LOW RATES reduce servicing costs of national debt issued in such environments if the rest of the rate curve goes along with the artifice and provides banks with capital to inflate the stock market. CHINA SCHMINA U.S.A. or PU. Stop rolling around in all this nonsense. Stop trying to rationalize what never worked in the first place. Move on with your life. Move on with your thinking. Try and have a new thought. Try to observe the phenomena of whats happening. CUT THE SHIT.
Currency jiggering, selling out U.S. production and career employment, selling U.S. real estate, Treasuries, and Visa's to Chinese "escapees", endless Ctrl+P, currency debasing, 0% on savings...this will end in a war one way or another - and a big one.
East Asia gives us an amazing amount of "stuff" so that they can have a food supply.
The soaring dollar is now threatening that...and obviously therefore they are buying the ultimate form of debt called "dollars" in order to secure that. Yet waves of unrest are now sweeping both the USA and even parts of China as well. Hang on to your land and your shovel. The farmers no longer care. The implications of this are truly profound indeed. Once people start "securing your land" you will have a supply shock.
"The crowd has placed a very low probability of this situation playing out"...
What 'crowd'...? All I see are the likes of this guy's comment, Marc-to-Market and his 'rising $DX for years to come', etc., ad-nauseam... What I Don't see mentioned (Ever) from the likes of the two aforementioned 'experts', but referenced quite succinctly in the comment section here is: How in the bloody hell is the U.S. supposed to shoulder rising rates and keep the 'recovery' rolling along swimmingly...? Why is this otherwise simply obvious part of the equation conveniently left out of the discussion when it comes to the $dollar bulls...?
The wild card being the amount of gold bullion being stored in China.When interest rates rise in the United States it will be for only one reason and that will be because of inflation.Some would say that I was mad for even thinking that the U.S. Dollar can rise at the same time Gold is rising.I still say it will.The other major factor is whether or not China,Russia,India and other countries in an alternate trading system outside the U.S. Dollar system will establish gold backed notes for trading purposes and outside of SWIFT.Considering the high debt levels in the U.S, though,I don't understand how the U.S. Government could actually afford the increased payments on its 18 trillion debt and expect to tax the hell out of Americans to pay for it?I can't see it if you do the math but I guess they can print to monetize the debt in order to continue the endless war scenario.They'd have to be generating a pretty big bubble in the economy in order to put up taxes and interest rates but anythings possible I guess.We already hear that in Europe it is not a monetary but structural problem.I would argue that the U.S. also has the demographic structural issues along with a crumbling infrastructure.Detroit is a good example of what's wrong in America and no help in sight.
Agreed Herdee, and the 'wild-er' card is U.S. foreign policy itself, specifically as it pertains to Russia vis-a-vis the Wolfowitz doctrine, and to a (presently) lesser degree, China and its coastal waters.
I vote...'destabilize the global financial system'..
This guy makes the assumption that there could be some kind of reversion to the mean...I don't think our current situation, globally, could tolerate any such thing. To me it looks like we are confined to an ever narrowing range of limits...limits on bond yields, on stocks and on gold prices...if anything moves out of range something else has to be manipulated back the other way. One day they'll have to do 2 things that are impossible to do at the same time and that's when we'll hear that 'snap'. The camel will need a wheelchair.
Brad posts, "I am not an economist", and I think that provides him a better education and ability for understanding the economy than the academic economists. Economics ranks up there as a pseudoscience with the likes of astrology.
I am aprehensive about the myopic view of the topic; however, sometimes the most simple explaination is more accurate than the complicated version.
Thanks for the insight and opinion. I will have to do some research now after reading the article.
You keep telling yourself that rates are going to rise. There's going to be a massive wave of deflation from the East next year and the Fed. will have to weaken the $usd again, probably by printing more of them.
The instant rates go up the economy goes to shit as debt repayment gets costlier for businesses, .gov and the consumer. Additionally it will choke U.S. exports even further as the money pours into U.S. bonds and as the $usd strengthens further for the carry.
If the Fed. raises rates Japan implodes as the $usd strengthens and blows the Yen back to the stone age. China can just widen their trading band if they have to.
Soon no currency except for precious metals will have strength.
I think, and most of the world except for chicken littles, think the word "soon" means b 4 the end of this week, month, year.
Throw in next year too.
Otherwise this guess becomes worth less and less until it means nothing.
No sentient human bean------ not even the masters of the multiverse like currency manipulator George Soros------foresees PMs wiping out fiats in the next decade let alone "soon".
All 8 of you need to get a grip and J B T F D!
you will see the Central Banks start to lose control in 2016 and it will take 3-5 years before currency's start to collapse or break up and be replaced.
Just read history and you will se how it will work. The difference is that in the past, it is usually ONE country and in this case, it is (confirmed) 5 of the largest central banks to include The Fed, EUCB, BoJ, BoE and the IMF. You could throw in Russia and China but with or withtout them, there is a change coming and within a couple of years it will begin....
Go and refresh yourself on how long it took the Wiemar Republc before it collapse and how it played out, what it looked like and eventually how a new currency was created backed by metal.
If 'reading history' is all that it takes to make accurate predictions about the future, that might make some sense.
But history is a poor metric to use when it comes to the intervention of human beans in colossal events.
There may be a time in the future that PMs are used as back up metal; 2016-2020 has likely a 1% chance that it will happen then.
If I was certain of a black swan event like that in the next 2-4 years I'd be making preparations that would maximize my wealth to take full advantage of the chaos to ensue.
If you've done that, what are those preparations?
Couldn't agree more.
Re: "China's biggest problem is its strong currency, the renminbi, caused by a strong USD. As the USD rises its exports become less competitive." Wouldn't loosening the renminbi/USD collar take care of this problem? Would there be any terribly adverse effects of loosening the collar?
If they fully float the currency then they lose control of its value and they don't want that at all.
The dollar is TP. This most here know.
Many over the last year or two have also pointed out that those affiliated with and/or connected to the banksters seem to be facilitating an exit from the DC US and Petrodollar. The cow is running out of milk, and they are preparing it for slaughter.
What better a time to flee with the loot to new environs, or home base, than when the dollar has been artificially pushed up in value against most other currencies. One can get more euros, pounds, shekels, etc. than just a few months ago. And the Saudis can also be brought in on the scam as payment for knocking the price of oil down for the Zionists' war against Russia.
Look out below, the sky over the DC US is about to fall in.
An American, not US subject.
Can my dollars really be used for Toilet Paper? Good, I feel better.
"The Chinese government kept the exchange rate of the country at a low level. Therefore, the Chinese products became cheap and flooded America. And to pay for them, the US dollars flooded China. But rather than spend this money for the population, the Chinese leaders loaned them immediately back to America by buying government bonds. It was a perfect system of cheap goods and cheap money inflow in the US, all controlled by the Chinese political power. And that’s what created stability. From this, came an orgy of lending from banks to even most unreliable borrowers in the US. Although this time, the deregulated market had been stabilized thanks to the political intervention of China, the bankers wanted to make more money."
http://failedevolution.blogspot.gr/2012/07/the-illusion-of-self-regulati...
One of the things peple haven't noticed is China has started building factories in places like Ethiopia due to rising labor costs in China and now Japan is screwing with money printing. This is going to be epic in an Armageddon sort of way.