Rickards Warns "Prepare For A Chinese Maxi-Devaluation"

Authored by James Rickards via The Daily Reckoning,

The news is being dominated by breathless headlines about the new trade war between the U.S. and China. But this trade war has been brewing for years and came as no surprise to readers of my newsletter, Project Prophesy. In fact, the new trade war is simply a continuation of the currency wars that began in 2010.

I’ve warned for over a year that President Trump’s threats of tariffs should be taken seriously, while most of Wall Street discounted Trump’s talk as mere bluster. Now the trade wars are here as we expected, and they will get much worse before they are resolved.

Currency wars arise in a condition of too much debt and too little growth. Economic powers try to steal growth from their trading partners by devaluing their currencies to promote exports and import inflation.

But China can’t keep going with tariffs.

They only import about $150 billion of U.S. exports. At the rate they’re going, they’ll run out of goods to impose tariffs on. Trump can keep going because the U.S. imports so much more from China than they buy from us.

But the Chinese are obsessed with not losing face. Chinese President Xi has just been named in effect dictator for life. He doesn’t want to start out his new dictatorial regime by backing down from a stare-fest with Donald Trump. So he needs another option.

For China to keep fighting, they need an asymmetric response; they need to fight the trade war with something other than tariffs.

China holds over $1.2 trillion of U.S. Treasury securities. Some analysts say China can dump those Treasuries on world markets and drive up U.S. interest rates. This will also drive up mortgage rates, damage the U.S. housing market, and possibly drive the U.S. economy into a recession. Analysts call this China’s “nuclear option” when it comes to fighting a financial war with Trump.

There’s only one problem.

The nuclear option is a dud. If China did sell some of their Treasuries, they would hurt themselves because any increase in interest rates would reduce the market value of what they have left.

Also, there are plenty of buyers around if China became a seller. Those Treasuries would be bought up by U.S. banks, or even the Fed itself. If China pursued an extreme version of this Treasury dumping, the U.S. President could stop it with a single phone call to the Treasury.

That’s because the U.S. controls the digital ledger that records ownership of all Treasury securities. We could simply freeze the Chinese bond accounts in place and that would be the end of that. So, don’t worry when you hear about China dumping U.S. Treasuries. China is stuck with them. It has no nuclear option in the Treasury market.

But if you can’t win a trade war, you can try winning a currency war instead…

I just argued that China’s “nuclear option” in the trade wars is a dud. But, that does not mean China is out of bullets in a financial war. China cannot impose as many tariffs as Trump because they don’t buy as much from us as we buy from them.

China cannot dump Treasuries because there are plenty of buyers and the president could stop the dumping by freezing China’s accounts if things got out of hand in the Treasury market. But China could use a real nuclear option to counteract the trade war by fighting a currency war.

If Trump imposes 25% tariffs on Chinese goods, China could simply devalue their currency by 25%. That would make Chinese goods cheaper for U.S. buyers by the same amount as the tariff. The net effect on price would be unchanged and Americans could keep buying Chinese goods at the same price in dollars.

The impact of such a massive devaluation would not be limited to the trade war. A cheaper yuan exports deflation from China to the U.S. and makes it harder for the Fed to meet its inflation target.

Also, the last two times China tried to devalue its currency, August 2015 and December 2015, U.S. stock markets crashed by over 11% in a matter of a few weeks. So, if the trade war escalates as I expect, don’t worry about China dumping Treasuries or imposing tariffs.

Watch the currency. That’s where China will strike back. When they do, U.S. stock markets will be the first victims.

Maybe you think that’s unlikely because it would be such an extreme reaction by China. But you have to put yourself in the shoes of China’s leadership.

These aren’t academic issues to China’s leaders. They go to the heart of the government’s very legitimacy.

China’s economy is not just about providing jobs, goods and services. It is about regime survival for a Chinese Communist Party that faces an existential crisis if it fails to deliver. The overriding imperative of the Chinese leadership is to avoid societal unrest.

If China encounters a financial crisis, Xi could quickly lose what the Chinese call, “The Mandate of Heaven.” That’s a term that describes the intangible goodwill and popular support needed by emperors to rule China for the past 3,000 years.

If The Mandate of Heaven is lost, a ruler can fall quickly.

Up to half of China’s investment is a complete waste. It does produce jobs and utilize inputs like cement, steel, copper and glass. But the finished product, whether a city, train station or sports arena, is often a white elephant that will remain unused.

Chinese growth has been reported in recent years as 6.5–10% but is actually closer to 5% or lower once an adjustment is made for the waste. The Chinese landscape is littered with “ghost cities” that have resulted from China’s wasted investment and flawed development model.

What’s worse is that these white elephants are being financed with debt that can never be repaid. And no allowance has been made for the maintenance that will be needed to keep these white elephants in usable form if demand does rise in the future, which is doubtful.

Essentially, China is on the horns of a dilemma with no good way out. On the one hand, China has driven growth for the past eight years with excessive credit, wasted infrastructure investment and Ponzi schemes.

The Chinese leadership knows this, but they had to keep the growth machine in high gear to create jobs for millions of migrants coming from the countryside to the city and to maintain jobs for the millions more already in the cities.

The two ways to get rid of debt are deflation (which results in write-offs, bankruptcies and unemployment) or inflation (which results in theft of purchasing power, similar to a tax increase).

Both alternatives are unacceptable to the Communists because they lack the political legitimacy to endure either unemployment or inflation. Either policy would cause social unrest and unleash revolutionary potential.

China’s internal contradictions are catching up with it. China has to confront an insolvent banking system, a real estate bubble, and a $1 trillion wealth management product Ponzi scheme that is starting to fall apart.

A much weaker yuan would give China some policy space in terms of using its reserves to paper over some of these problems.

A maxi-devaluation of their currency is probably the best way to avoid the social unrest that terrifies China.

When that happens, possibly later this year in response to Trump’s trade war, the effects will not be confined to China. A shock yuan maxi-devaluation will be the shot heard round the world as it was in August and December 2015 (both times, U.S. stocks fell over 10% in a matter of weeks).

China doesn’t have a trade war nuclear option. But it does have one very powerful weapon. And it looks like it could be getting ready to use it.

Comments

zaphod American Dissident Wed, 07/25/2018 - 21:35 Permalink

China has the largest debt hole in modern history (probably in human history), their debts dwarf Japan and the US at their peaks.

The result is China's currency was always going to be devalued Zimbabwe style, there is no other escape. The trade war is just their excuse to do so. But so what? If China does so the costs their imports skyrocket, and Trump declares them a currency manipulator adding even more tariffs and cuts in trade. The end effect is the same, China's lifeboat which is a massive trade surplus to support their very inefficient (and getting very elderly) system, is cut off.

Imagine if the US transferred all of our technology to Russia, "invested" $10T in Russia and then ran a massive $10T trade deficit with Russia to boot. Russia would be booming, not the mess it is today.

Well that is what we did in China, take it away and it all reverses.
 

In reply to by American Dissident

Dewey Cheatum … zaphod Wed, 07/25/2018 - 22:45 Permalink

Correct.

Just follow how quickly, the Chicoms went full deval on the Yuan, once Trump called them out as trade cheats..oh BTW, first time someone has done that in 10 years.

Their production lines are dead and massively over leveraged on the front and back end.

Toxic debt that will blow..and there ain't enough phony Dollar, Yen, Yuan nor Euros to cover it up.

Good Fuckin Luck. See you at the bottom.

In reply to by zaphod

Element Dewey Cheatum … Thu, 07/26/2018 - 03:31 Permalink

 

" ... If Trump imposes 25% tariffs on Chinese goods, China could simply devalue their currency by 25%. That would make Chinese goods cheaper for U.S. buyers by the same amount as the tariff. The net effect on price would be unchanged and Americans could keep buying Chinese goods at the same price in dollars. ... "

 

This article's asessment is not true and it's a poor and incomplete analysis of the dynamic outcomes.

 

If China devalues Yuan 25% then their imported industrial inputs to production, for both domestic or export products, must still rise steeply, because then they have to pay that much more just to buy the raw resources (from places like Australia et al), to keep manufacturing products, so actually would impart stiff inflation to their own domestic consumption, thus slowing Chinese aggregate demand, in the process.

 

This may take 3 to 6 months to occur but Chinese produced export goods must rise in price accordingly as well, and by similar amounts, as mineral stockpiles are being used, needing replacement at much higher prices.

 

So in fact China does not have an effective competitive-devaluation financial 'nuclear option' here, that will negate the effects of Trump's trade tarrif impositions. It would bleed them out over time.

 

i.e. China will still lose out if it uses a radical devaluation tactic, and probably put themselves into a recession, while losing their market share, and thus impairing their capacity to recover.

In reply to by Dewey Cheatum …

gdpetti Element Thu, 07/26/2018 - 14:10 Permalink

What is implied is other countries doing the same... the devaluation game... Japan's been doing it for decades now.

What Mr. Rick fails to mention is the easiest way around this supposed USTbill trap.... simply use them as payments to other countries in their OBOR initiative... Marshall Plan style of investment... simple transfer of ownership at the Fed from Chinese to 'other'... it allows the US to keep the farce going a little longer... until the crushed can starts showing signs of its imminent demise... Russia has been prepping.... China needs to do the same... allow more reality into its markets... as they've allowed this fall in the yuan... just by lack of supporting the previous price... most of this can be done by default... same with those transfers... and until the Chinese holdings drop enough at the Fed, no one will say anything... but the markets are already showing its 'gone about as fer as it can go'.

In reply to by Element

halcyon zaphod Thu, 07/26/2018 - 01:16 Permalink

No, no, no and no.

Read the actual stats

https://tradingeconomics.com/country-list/government-debt-to-gdp

Even if you double ot triple China's private, corporate and public debt and external liabilities, it still isn't the dirtiest shirt around.

China will go through a hard landing, sure, but so will many others.

China will however recover, which I cannot say for many other countries...

Btw, you cannot take away something that's not yours to give.

 

In reply to by zaphod

vato poco halcyon Thu, 07/26/2018 - 04:12 Permalink

since china is "obsessed with not losing face", they *really* shouldn't have gone to the mats with our beloved God-Emperor, Donald J. Trump.

and the more they squirm; the slyer and more chineseey they try to be .... it's just gonna hurt 'em worse. make 'em even BIGGER laughingstocks in the eyes of the entire world. 

pity

In reply to by halcyon

Baron von Bud Dickguzinya Wed, 07/25/2018 - 20:00 Permalink

I don't know if Jim is correct but I do know the game has changed. America's fiscal situation is a disaster and so is China's. Russia dumped its US bonds and has a hugely profitable energy business that will only get better. The bigger issue for ZH readers is what does this mean for us peons. It means you better diversify your liquid assets into some gold while its low. Trump may succeed but the net effect will be depressed world trade for a long time. Nations must adjust from a world where they all lived off the US and our deficits to a business model where the discount is gone. Uncertainty alone will cause a global slowdown or worse.

In reply to by Dickguzinya

Prosource Baron von Bud Wed, 07/25/2018 - 23:02 Permalink

I agree it's easier to sleep holding metals.

But in a significant deflation environment, everything/commodities will be much cheaper, no?

Of course, it will be great to have metals when the hyper-inflation results from the liquefaction necessary to keep the financial system from seizing up, but that is after a deflation of how long?

In reply to by Baron von Bud

rtb61 Baron von Bud Wed, 07/25/2018 - 23:14 Permalink

Do you know that the average IQ of the Chinese is higher than the average IQ of Americans. Why assume they are stupid and have not planned well ahead.

The government of China's chess move, advance Africa, accelerate their infrastructure development, employ lots of lots of Africans, accessing African primary resources across the board, as Africa develops so their demand for product from China grows. Not just starting but already well and truly under way.

The US deep state tried the fuck this up with a false North Korea narrative to trap China in the defence of North Korea, they knew and it failed utterly. Trade war a move of pure desperation, dumb and way too late.

So tarrif on China, a poor mans wallmart tax in the US, demand for product from China drops, which of course reduces the value of the yaun and trade increases and the poor in America still pay the Wallmart tax to fund tax cuts for the rich. Any decrease in the US is way, way, way, more than made up with developments not only in Africa but also South America. China invests in infrastructure in those countries (China - generates a profit), massively increases the productivity of the countries (China - gets cheaper primary product), greater employment leads to greater demand (China sells more tertiary product), now add much tighter ties with Russia in the mix, including a joint space program and of course India, which is not stupid and knows it is better partnering with Russia and China, than being DOMINATED, by the US.

In reply to by Baron von Bud

Brian Captain Nemo d… Wed, 07/25/2018 - 19:57 Permalink

China DOES have the nuclear option of dumping treasuries.

If you think that an order to the Fed to buy $1.2 trillion in treasuries would not crash bonds and delegitimize the US dollar well then, you're not thinking straight.  There are NO buyers for this much paper.

Similarly, if you think an order to freeze the bonds isn't a default that will impact every country's central bank and wealth management products forever, again, you aren't right.  Once this order took place, you'd have the entire world knowing that US bonds are not a safe investment and the dumping would be so catastrophic that the US would instantly be third-world.  It's not even a conceivable option.

I agree, currency war and devaluation is coming, but dumping treasuries is absolutely a nuclear option that is entirely viable.

In reply to by Captain Nemo d…

aspen1880 Brian Wed, 07/25/2018 - 22:15 Permalink

china dumping T's would cause dollar to devalue against everything, even the yuan - basically increasing the value of the yuan.  that shoots china in the foot from the perspective of them trying to devalue the yuan.  Its not likely that china would dump the T's.  I think they hold the T's and devalue the yuan instead.

In reply to by Brian

mailll Captain Nemo d… Wed, 07/25/2018 - 22:10 Permalink

The Yuan is currently going down not up.  And China said they will not weaponize the Yuan.  But the US dollar/Yuan is the same as it ever was.  

https://www.xe.com/currencycharts/?from=USD&to=CNY&view=10Y

It goes up, then it goes down, then it goes back up again...like a yo yo.  I agree what this article says about the treasuries (debt) but China has to be careful also because devaluing the Yuan will also cause inflation in China due to higher costs for the imports, including raw materials they need to produce domestically.  This world economy is so diversified, things line devaluing the Yuan or raising oil prices don't have the impact it used to have.  The only major impact on our economies is the actions of the international bankers due to their control over the world money.  2008, 1929, etc. They have the power to make or break the world economies, not petty stuff like raising or lowering oil prices or increasing or decreasing the value of the Yuan.  China would be hurting themselves more than they would be hurting us if they weaponize the Yuan.

 

In reply to by Captain Nemo d…

SoDamnMad mailll Thu, 07/26/2018 - 02:24 Permalink

China buys a hell of  a lot of oil products and a great deal of food.  They are not like Russia who now is the world's major exporter of wheat when in a decade ago they actually had to import some grains. What do they wind up paying with devalued yuan when they buy Brazilian soybeans now the the Brazilian government tacked on fuel subsidies to the cost of beans and bean meal?

In reply to by mailll

mickrussom Captain Nemo d… Wed, 07/25/2018 - 23:02 Permalink

I avoid buying anything from China / Chyna at this point. The chicoms are disgusting and vile. Never sell them property, dont do business with them - they are thieves and dishonest and steal and must be bribed and never , ever, buy their low quality garbage product. 

We dont need China in the USA. With robots and automation the reason for doing business in China , slave labor, is barely a cost factor these days.

In reply to by Captain Nemo d…

CogitoMan Captain Nemo d… Thu, 07/26/2018 - 02:57 Permalink

I dunno but to me solution to that dilemma is simple...

China devalues Yuan by 25 percent, US increases taxes on China goods by 25 percent.

Hence on balance equilibrium is saved and China gains nothing vs US. But all other countries trading with China will get in hot water but this is of no importance to US. Let other countries bitch and moan about China devaluation....

In reply to by Captain Nemo d…

DarkPurpleHaze Wed, 07/25/2018 - 19:53 Permalink

This is a Rickards meme I can get behind at this point in time.

China's "correction" will one day make The  Great U.S. depression look like a bad recession.

The old saying used to be that when the US sneezes the rest of the world catches a cold.

Fast forward to present...when China coughs up their hidden debt ball the rest of the world will suffer a prolonged Asian flu.

Yen Cross Wed, 07/25/2018 - 19:53 Permalink

 All China is going to succeed in is starting regional conflicts with its neighbors and causing massive hyperinflation for the people living in China.

 To the dipshit Chink downvoter, how long do you think Japan, Korea, and other Asian manufactures are going to put up with the Chinese undercutting their exports through devaluation?

  How long do you think the Chinese people are going to put up with skyrocketing import prices from devaluation, along massive spikes in credit costs.

Element Yen Cross Thu, 07/26/2018 - 07:13 Permalink

The Chinese commies have not changed a bit in 10 years Yen, remember the situation back in early 2009, when the annual RioTinto Oz iron contracts were set at $60aud/t for all of Asia, but Beijing repeatedly DEMANDED that it should only pay $35aud/t, but every other directly competing country in Asia must still pay $60aud/t?

 

The arrogance of the scumbags! But of course, we made them pay $120aud/t ... lol ... fuckwits. But those same CHICOM shitheads have not changed a bit, they're still trying to fuck everyone in Asia. Never to be trusted. They're finally running out of rope.

In reply to by Yen Cross