Category Archives: Currency

My Top 5 Biggest New Year Risks to the Global Economy

In order or scale, priority and impact, here are my picks for the five most critical trigger-points that may impact, negatively, a return to ‘old normal’. Currently we stand at the edifice of a new normal, the great stagflation, but the anti-establishment and populist changes taking place seem to suggest a knew-jerk reaction by nations fed up with socialist dressed-up-as-market politics that have led the West for 20 years.

  1. China’s economy stagnates or crashes. Debt levels are above EM levels and are now among the largest, approaching the incredulous Japanese levels. This dynamic is not sustainable for a nation whose currency is not a reserve currency. However the economy is the world second largest even without the development and emergence of whole swathes of other sectors such as healthcare and leisure, which may offset contracting first world growth over the next year or two. So the risk is there and there is no clear leaning one way or the other, yet. But debt is growing faster than these new sectors; exchange reserves at $3bn are limited (though huge), and currency value management is not market-bases. So greater risk is with the downside. China’s growth flags, currency sinks, counterbalancing US growth and confidence, creating a massive imbalance in the global economy. Europe watches on as global GDP sinks under its own debt weight. KPI’s to avoid/watch out for: China GDP falls to or below 4.5%; China’s debt load surpasses 300% of GDP.
  2. Trump quits after 18 months due to intractable political limitations that prevent policy changes he seeks related to healthcare, regulatory complexity, tax reform and trade. Trump’s political rhetoric is being replaced with solid business-based policy. However not all such policies have ever been tested at a national level and scale. Some efforts will fall foul to physical, social and political limitations. This may prove frustrating for Trump. As growth will return short term, such medium term frustration will lead Trump to claim, “My policies worked, see? But now the system has reached its limit and there is nothing I can do until the country agrees with me to shut down the whole government system! Since they are not ready, yet, I am ‘outa here’ until they are!” Markets crash, interest rates balloon, inflation rages all within a year. World economy sinks into the abyss. KPI’s to avoid/watch out for: US GDP 1H 2017 reaches 4.5% but Congressional conflict leads to policy deadlock ; vacancy in position at Whitehouse. 
  3. Emerging Marker currency crisis as massed capital investment is siphoned away towards a resurgent US economy and dominant dollar, as well as a stable and even growing China economy. This situation is already underway. The risk is that what is currently a reasonably ordered trend becomes a financial route. This is possible since the financial markets are starved of yield due to the collective policies of central banks to keep interest rates very low for too long and for the build up in their massive balance sheets. If the trend becomes a torrent, EM’s will have to yank up interest rates far beyond what their local economics can support and economic disaster will follow. This will ferment more political instability and drive increased destabilizing ebonies to ruin. Though the US may be growing well, compared to its peers, it’s the imbalance they tips the ship over. KPI’s to avoid/watch out for: dollar index, the weighted value against basket of currencies, surpasses 115. It is currently at 103.33, which is a 14 year high; EM interest rate differential balloons.
  4. Hard Brexit forced through by intransigent Europeans who think the EU experiment is more about political union than economic liberalism. A new trade deal, legal framework and social contract can be negotiated within a two year window. But only if politicians and civil servants want it too. Continental politicians however, under the strain from populist pressures, will equate intransigence over Brexit negotiations with an improved politicos standing with their electorates. Fool for them as this will actually create the opposite response for such behavior will simply worsen the economic climate. The lack of any sign of return to old normal will lead to political paralysis and the clock will time-out. Hard Brexit will be forced upon a supplicant Britian. Europe and UK economies will tank; currency wars will wage; global trade will collapse further. This will not sunk the global economy short term but will act as a dead weight slowing its resurgence down. KPI’s to avoid/watch out for: no agreement at end of two year period lost triggering of Article 50. 
  5. Latin or Indian debt or economic crisis. Much like with other EM’s, growing sectors of significant size around the world may blow up- India being the best example. India’s growth is different to China. It is more integrated socially and politically with the west, but it’s corruption levels are far greater than what one can see or observe in China. It is possible that local economic difficulties, hard to observe today, may trigger a collapse in confidence that leads to a destabilizing debt or currency crisis. Brazil’s economy is certainly in the dock currently; Argentina is struggling. India’s economy looks like paradise right now but the growth across the country is extremely uneven- you only have to look at public sector infrastructure investment. So should two such countries suffer local difficulties, the combination may result in significant risk to the global financial system. KPI’s to avoid/watch out for: two simultaneous financial/debt crisis afflicting EM or India.

These are my top 5 risks the global economy faces in 2017. I hope I am wide of the mark, in a positive way. I left Japan off the top 5 list yet their economy remains anathema to growth. The Japanese market invented the whole new normal cycle with a anaemic growth, massive debt, low inflation, and demographic contraction. And Japan has an amazing debt load that refuses to spook investors. Things may yet have a Japanese tinge before the year end. Does Japan, along with the US, lead the global economy back to the old normal!
What potential risks do you see?


China Shock: The Untold Story

Front one of the US print edition of the Wall Street Journal last Fridy: Deep, Swift China Shock Drove Trump’s Support. A fascinating article that suggest, despite its title, that the impacts of China as it joined the global trade game led to swift and irreparable damage to America’s workforce and so led to the swell of support for Trump and Saunders. It so happens that I am half way through reading China Shock, by  David Autor, David Dorn, and Gordon Hanson. The story in the paper and the WSJ article is referring to in its title.

There are are several things to note about this so called, “China Shock”. They are not all good news and hindsight helps (where doesn’t it?)

Firstly global trade is taking a bashing. This is unfortunate. It is unfortunate because economically global trade has been shown to balance out and help everyone, even if one nation is better than all others at everything. What the economists models thus far did not show, nor were they meant to, is what happens under extreme changes in the dynamics of global trade. That is the fact: China shock is not a weakness of global trade, it’s a lack of understanding of the dynamics underpinning it.

The WSJ journal and the paper demonstrate with examples where massive displacement of jobs took place, in a very quick period, over and over in related industries. The two factors that made the shock such a shock are:

  • Original employers (US, per WSJ article and including Europe per the paper) national institutions, job training, educational practices and industrial policy were focused on the wrong thing. Instead of being focused on rapid migration and support for global trade dynamics, they were more focused on slow and limited protection for targeted and said to be critical industries
  • Exporting nation (China) was exporting so much cheap Labour and products across a broad and often related swathe of markets and industries that had a multiplier effect I terms of displacement and elimination of ‘landing places’ for those initially displaced.

These two factors explain how it was that worker after worker listed in the article lost a job, gained a job, then lost it again. Then finally were not able to get a job.

Our economists did misunderstand some of the dynamics of global trade given the entrance of such a large supplier as China. But governments should have spent more time focused on policies related to growth and industrial migration, rather than pandering to selfish efforts protecting themselves.  

Now that China Shock has shocked, what do we do about it? Well, media and press are now gunning for global trade. This hype will damage global growth and crimp efforts to get past current anemic conditions. Capitalism is again under attack not due to a failure of the system but a failure of our own misunderstanding of the dynamics of the world around us.

Governments need to focus on building a resilient trade and industrial policy that responds to changing global dynamics. Industry and government need to work more closely together so that as global trade pressures alter the competing advantage of nations and firms, action can be taken to provide alternative safety nets.

Another article in the Business and Technology section of the WSJ demonstrates this: Coding Camps Attract Tech Firms. A small private educator runs 12 week courses for $15,000 that leads to no degree. But almost every attendee gets a job within 6 weeks of graduating with an average salary of over $74K. What is impressive is that the curriculum changes within weeks of any new demands from industry. Try doing this at more established educational establishments.

Governments also need to work on exchange rate policy and collaborative monetary policy. One aspect, not explored in detail here, relates to how currency value can have a big impact on comparative advantage. As such this policy effort needs to be reconciled to industrial policy.

If global trade gets bashed, and government policy targets protection of industries that are no longer competitive, we will just avoid paying the piper at the right time. The piper will be back but his tune will be louder and more deafening.

The Relentless Rise of the Dollar and Fall of the Yuan

With sentiment at the Fed shifting toward a rate rise in June, and news today in the Wall Street Journal (see China loses resolve to revamp Yuan) that China is again worried about the pressure on the Yuan, we can all predict what is about to happen. 

The low interest rate the Fed promotes has been described as a response by the Fed to the lack of active policy by the US government to drive economic growth. The market distortion as a result of the low interest rate are frightening. There was a piece, albeit an opinion, in yesterday’s Financial Tines that explained the impact on savings (negative), retirement planning (disastrous), and debt (growing toward all time highs again).   But we will not change the government’s actions overnight, not until November that is, and even that is not guaranteed. So we are stuck between a rock and a hard place. The Fed wants to raise rates but has to avoid chocking off the meager growth that is limping along.

China has its own economic challenges. As it wrestles with the gradual transition from a manufacturing based economy to a consumer and services based economy, it is using the exchange rate to control its export competitiveness. Note that in recent times, in studying the UK’s transition between late 1950’s to the 1990’s, this effort won’t be easy or quick. But China is trying to move quickly, perhaps too quickly.  And despite the IMF signaling it’s faith that China was going to let the market drive the Yuan’s exchange rate, the People’s Bank of China (PBOC) continues to take action to stabilize its currency. 

Assuming the Fed increase interest rates in June, we will all hear that big sucking sound again as capital flies from emerging markets including China back to American shores and the powering dollar. This will trigger a fall in the Yuan and the PBOC will again start to leverage its foreign exchange reserve to stem the losses. That reserve has fallen from an estimated $4th to about $3.2tn in the last year or so. The question is, how far can that reserve go in defending the Yuan?

Sterling was ‘broken’ in the 1970’s and the U.K. Government had to go to the IMF for a loan – check out “Decline to Fall: The Making of British Macro-Economic Policy and the 1976 IMF Crisis, Douglas Wass, 2008”.  That was a low point for the UK. The pound was again ‘broken’, perhaps more famously, by George Soros during ‘black Friday’ when the UK was forced to leave the Exchange Rate Mechanism (ERM), a pegged exchange-rate system that preceded the single currency, the euro. 

Clearly the PBOC won’t use up all its reserves. So the question becomes: what is the level at which the market expects massive red flags? Perhaps a leading indicator to watch are the monthly reported FX outflows from the PBOC. As that ramps up, the red flags will start to fly. And they won’t be the party flags of choice- they will be the economic panic flags that none of us want to see.

China’s Debt Binge Headed for the Rocks – and the Global Economy with it

Pictures are more powerful than words, in many cases.  The Economist this week had a graph that presented the cycle of private non-financial sector credit as a % of GDP for a number of countries.  The chart was in the article, Free Exchange: Red Ink Rising – China cannot escape the economic reckoning that a debt binge brings.  The article, and chart, highlight how for countries such as Japan, Thailand (and the Asian financial crisis of the late 1990s), US (sub-prime crisis of 2007) and Spain, all things that go up (such as debt) have to come down.  The chart worryingly shows how China’s debt binge has been in the making for a long time, and has accelerated since 2008.  The real issue is when and how to unwind the debt without unhinging the world economy and killing off growth.  Few countries have been able to do so at such high levels of debt – that’s the problem.

And as if that was not enough, last Wednesday’s US print edition of the Financial Times carried an article that again highlighted the IMF’s misplaced clarion calls for coordination.  The article, IMF calls for global action to lift demand as China exports fall, reports on the IMF’s number 2 (David Lipton) in a speech in which he called on global leaders to increase spending and investment in parts of their economies that would create growth.  This is of course a classic Keynsian drive for government spending, at a time when debt remains significant.  The IMF continues to ask the right question – we do need coordinated action.  But the IMF continues to conclude the wrong response – we don’t need more governance spending, at least overall.  We might leverage targeted spending in some Infrastructure areas.  But we need a lot more coordination in policy change and that takes time.  If the US elects an establishment favorite in its national elections this November, that country will not make the changes needed.  If Trump were to be elected, and the republicans stay in control of the House and Senate, there will be 2 or 3 years of the kind of disruption that would clear the house of cobwebs and overly complex tax and business and private regulation.  And large chunks of non-productive government spending should be cut back, leaving funds spare for real effective infrastructure spending.  

But what the IMF should be doing is helping the leading nations of the world cope with financial volatility.  It should require leading central bankers to form up and create a new currency exchange agreement to help manage the dynamics that are killing global trade and driving the beggar-the-neighbor devlations that are hiding under the rune of negative interest rates, and sometimes not hiding in terms of currency manipulation.   We don’t need fixed exchange rates – we need managed exchange rates – for a period that allows normal, private sector growth to return.  We need a new Bretton Woods agreement.  We need a new Plazza Accord.  We need the IMF to do it’s job, not shirk its responsibility and hand off that impossible task to individual governments.

The Fed’s Bark is Loud; the PBOC’s Bite will be much Worse

Andrew Browne’s article, from yesterday’s US print edition of the Wall Street Journal, (see Yuan’s Fall is Just Noise) nicely captures the current situation and market sentiment as it pertains to the confidence in the renminbi. Only the day before China warned off George Soros from attacking its currency. This sounds like red rag to a bull, if you ask me. But the real point is valid: if the market perceives an imbalance or a weakness in a currency it will take a position. In this I am betting that Soros would hedge for a fall in the Chinese currency. And the PBOC would be required to use interest rates and its diminishing currency reserves to defend and control the fall. It has already used close to $800m of what was a $4tn war chest.

Since the PBOC is not keen to use its powder – and since it had little experience in how to survive such a new phenomena as a free market driving its currency value – it will likely turn to capital controls to help stem the flow of currency leaving its shores.  As the Fed raises rates, more and more money is changing direction from emerging markets, including China, back to the US.  So even though the press and pundits in the west are looking at the bark that is the Fed with its meetings and minutes, and discussions about the odd quarter point rise in rates, the reality is that what China does, it’s bite, will be far more impactful on the global economy.  

I noted the other day that China will likely look to introduce capital controls since history books will have shown its economic guru’s that this helps control the flood. Well when you read your newspapers this morning you will note that it the process has begun, rather quietly too.  In the Financial Times you can see Capital Controls no longer taboo in fight against flight, and in the Wall Street Journal, Beijing Moves to Slow Money Outflow.  The next phase of the economic cycle is about to get started and it won’t be pretty.

The Three Key Leading Indicators that will Signal Global Economic Recovery

This week the mandarins and thought leaders of our leading economies and policy wonks are meeting in Davos.  They do this every year at the World Economic Forum.  In anticipation of this the IMF publishes before hand an update to its World Economic Outlook, and the Wall Street Journal publishes it’s, “Outlook” piece.  The IMF came out yesterday and reported more trouble ahead, worsening conditions, and slight reduction in global growth.  The Wall Street Journal piece is very good too – and is well worth reading.  It highlights several challenges we face.  However, it also exposes in my mind what ought to be thought of as leading indicators that tell us our global economy might be turning a corner.  Even if these analytics turn positive, there is ample room for our politicians, bent by political dogma, to make the wrong fiscal and regulatory decisions.  At this time in our economic history, we need to expunge socialist, modernist, post-capitalistic ideas about furthering social policy and equality through re-distribution.  Any and all such attempts, for the next two years, will actually make things worse for the poor and middle-class since such policy energy will detract from the energy needed to grow the same pie that such wonks need to share.  

So what are the three main metrics that express why we are in the mess we are?

 – Chinese debt

– Business Investment

 – New Business Start-ups

Martin Wolf’s Comment in today’s US print edition of the Financial Times (see China’s great economic shift needs to begin) explored China’s debt challenges.  Andrew Browne, of the Wall Street Journal, did the same in his article (see China’s Debt Binge Isn’t Over Yet, and That’s the Problem) in its Outlook 2016, did the same.  First is the scale of the problem. Mr. Wolf reports that China’s debt to GDP was 157% at the end of 2007, 250% at the end of 2013, and 29% at the end of the second quarter in 2015. Mr Browne calls out that it was due to the launch of China’s debt binge in 2008 and 2009 that helped the global economy stave off depression, after the collapse of Lehman Brothers. The problem is that this debt mountain has been the main driver of growth in China, and China has become the second largest economy in the world and, with anemic growth in the US, the biggest single driver of global growth.  Now that debt-driven demand cannot be maintained for ever and with no natural consumer demand to replace it, over capacity is driving down commodity prices around the globe.  This continues to weaken growth further, and contributes to deflation.  So the cycle is complete and we need to break it.  We need to watch Chinese debt and debt to GDP and look for a change in behavior.

In Greg Ip’s piece in Outlook 2016 (see Dear Business Leaders: Invest in Optimism, Not Buybacks), the challenge related to the lack of business investment in productivity improving efforts are exposed.  He reports that since 2009, US businesses has boosted capital investment by 43%, dividends by 67%, and stock Buybacks by 194%.  Record levels of Mergers and Acquisitions are being made year over year.  Record levels of debt are being taken out to fund these acquisitions, and Buybacks.  And the phenomena is global, according to Mr. Ip.  The press (as reported by Mr. Ip) tells us that increased government regulation and persisting trauma from the financial crisis are behind this behavior.  The Fed has used this lack of investment and spending as reason to justify its entire QE program (the world over, too) and the unprecedented expansion of the Fed’s balance sheet.  But if you ask business treasury leaders, you get a very different perspective.  Business do not, on the whole, change investment strategies based on interest rates.  They base their main investment strategies based on business goals, opportunities and strategies.  It seems the M&A spurt is about the only aspect of this that has reacted to policy changes, specifically interest rates at historic low levels.  The challenge remains – irrespective of the trauma, regulation, or indifference to interest rates, firms are not investing for productivity growth.  Until they do, we cannot magic such growth out of the air and we cannot mandate such growth through political edict.

In the same article by Grep Ip there is a related data point: “Since 2009, annual new businesses started have run 18% below the prior eight years, while business closures haven’t changed, according to the US Census data”.  Mr. Ip has been talking of this issue for some time.  I blogged on an article from him on the same topic in July 2015.  More telling is this quote from today’s article:  “For all the hoopla surrounding social media and smart phones, US business investment in high-technology equipment remains well below its pre-recession level as a share of gross domestic product.  BUsiness and individuals are taking longer to replace their computers and smart phones, since each upgrade adds fewer compelling features then the last.”  R&D is this not paying off as it used too and so money is finding new ways to generate a return, and that does not include productivity-inducing IT.  I have blogged on this issue too.

So I think these would be useful leading indicators.  Alone, neither will lead to growth but combined, they could signal a change in our furtunes.  If we could just get the politicians out of the way, we could take rational, economic decisions to help improve our chances.  As it stands, this is not going to happen so economic malaise is assured.  In fact it will get worse, before it gets better.  Since our leaders cannot bring themselves to agree global collaboration and alignment of goals and policy, the market may force their hand.  Ray Dallio, founder of Bridgwater Associates, agrees with my thoughts of the other day.  Today, on CNBC, while on site at Davos, he said that the Fed’s next move would be toward quantitative easing, not towards (quantitative) tightening.  This suggests that US interest rates may fall again.  So even as the US determines it is strong enough to ignore the world, it will be brought back to earth with a bang.

Release the Kraken: Free Capital Flows Will Transmit Chinese Economic Woes – Fast!

In 1979 Margeret Thatcher came to power in the UK and one of her first decisions as prime minister was to scrap capital controls.  It was the beginning of a new era and not just for Britain.  So says Wolfgang Munchau, in yesterday’s US print edition of the Financial Times in his Comment piece, Free Capital Flows can put Economies in a Bind.  He is totally correct of course.  Capital flows are one of the impossible trinity – the other two being exchange rates and sovereign monetary policy.  The theory has it that you can manage two at best, the third being a dynamic you can monitor and manage toward but not control directly.  More specifically, it is impossible to have all three at the same time:

  • Stable exchange rate
  • Free capital movement
  • An independent monetary policy

Thatcher wanted to control her country’s monetary policy and in time thus improve the exchange rate, so she had to get rid of capital controls put in place to defend sterling.  Now free capital movement is the stick that threatens to beat us all as the global market moves capital around the globe every day in response to policy changes in each sovereign nation.  With small changes here and there, an odd point change in interest rate etc, trillions of dollars move quietly and seamlessly around the world.  Thus small changes everywhere are amplified and the impact of such policy changes are hard to predict behind the obvious target of the policy.  This creates a very unstable global market for capital and it is capital that makes all things possible.

Very recently we have seen the US embark on its much publicized interest rate journey with the first rise in several years.  This is leading to a great sucking sound from emerging markets as investment is now diverted from lower yielding regimes to the US.  Chinese economic data triggered global turmoil in the markets last week and this.  The ability for the market as a whole to understand the global situation is very misleading – it simply reacts to what it sees.  Politicians will soon conclude that the market has too much power that is seemingly out of any one’s control, and it is very likely that before the current economic malaise is passed, capital controls will be reinstated.  This again is the conclusion of Mr. Muchau’s piece.  I agree 100%.

In today’s US print edition of the Financial Times there is an article in Markets and Investing by George Magnus, titled Credit Binge is the real concern as crisis shows little sign of abating.  Mr. Magnus reports the troubling situation that shows how non financial credit is ballooning in China and showing now signs of slowing down. It seems that much credit growth has gone to fuel the already highly leveraged real-estate sector, and not private sector growth.  So with manufacturing slowing down it seems that the ability to use credit to soften the landing will just result in an even bigger bubble.  The point being that the Chinese authorities may have money to burn (such as vast exchange reserves) but their options to control, or contain, the changing and complex economic situation are few and getting less flexible.  The market will of course react quickly and sizably to any sign of weakness or policy change it does not understand.  This will continue to add oil to the fire and the soon-to-emerging call for capital controls.  Just as soon as China percieves its reserves are a finite resource…