We’re Missing the Obvious
We have now sunk to a depth at which restatement of the obvious is the first duty of intelligent men – George Orwell
The rally in China portends its collapse, not its recovery. The Chinese Politburo is in a state of panic because the Chinese economy continues to revert to the mean. It’s why they have been able to push aside Xi in order to force changes at odds with Xi’s policies through the committee. The fact that these policies seem well-coordinated suggests that Western bankers are advising. I imagine Xi having the same expression as Alec Guinness in “Bridge over the River Kwai” as he left the Politburo meeting. What have I done?
This is obvious if you care to look and no amount of shock and awe in the markets will change things. The Chinese Communist Party, and Xi in particular, have made such an extraordinary mess of things the Potemkin façade of new buildings and railroads can’t obscure the fact that China is rapidly becoming Detroit.
“Shock and awe” is the only strategy Western leaders can use these days because they too have managed their economies badly for the past 30 years. For the past 15 years, they have turned to “shock and awe” in the markets and new debt to cover up the vast number of sins they’ve committed against Adam Smith instead of allowing the system to recalibrate to sustainable levels.
Whatever it Takes
Never think that lack of variability is stability. Don’t confuse lack of volatility with stability, ever – Nassim Nicholas Taleb
Black Swans may have been put on the endangered species list but the events that spawn those birds are multiplying like a colony of rabbits. Taleb is right because volatility is not a good measure of risk even though it’s the best we have.
In the aftermath of the GFC, or Great Financial Crisis, I believe that financial regulators took the giant step of controlling financial volatility initially as a means towards putting a floor under financial assets followed by creating the greatest financial bubble the world has ever seen. All done in the name of preventing global deflation. The Europeans jumped on the bandwagon in 2012 when Mario Draghi told us he would do “whatever it takes” to reverse the collapse of the European economy. This led to negative interest rates in Europe for 10 years.
Financial assets are all based on discounted cash flow, more specifically, the present value of discounted cash flow yet the move from a negative 0.6% to positive 3.9% didn’t negatively impact equity values in Europe or the US. Theoretically, that’s practically impossible in a true marketplace. It’s simple math. But that’s not what happened in Europe…
The war in Ukraine has hit Germany particularly hard. Their heavy industry used to rely heavily on cheap imports of Russian natural gas and petrochemical derivatives, not to mention cheap Russian, Ukrainian, and Belarussian minerals. Many of those companies are relocating to the US and other places to remain competitive. So why the pop in the stock market?
If you can view the chart of the Consumer Price Index in Germany and still believe in free markets, there is a Nigerian prince looking to transfer a million dollars to your personal account. Go for it.
The extraordinary moves in German CPI should have created equal moves in the volatility of German assets. Instead, like all Western stock markets, they kept moving higher in value.
Prices are starting to come down a little in Germany but the 1.5 years of 3rd world inflation is still in their cost structure, making Germany exceedingly uncompetitive in world markets. Just check out Volkswagens plan to slash 60,000 jobs in Germany, something that was virtually unheard of before this year.
This is what Mario Draghi meant by “whatever it takes.” It’s not a coincidence that the Chinese used the exact same western translation when they announced their new plan. It’s why Chinese stocks popped so much.
But China is not Europe. While European leaders have been collectively terrible for generations, the Chinese Communist Party has been many times worse. When the Eurodollars stopped flowing into China in 2014, we got to see the impact of their previous decisions – it’s been ugly.
The southern cities of the Pearl River Delta seem to have been hit the hardest and this is the region primarily responsible for bringing trade revenues and foreign capital into the country. This new tactic may bring some “hot money” into China long enough to squeeze short sellers, but it’s not going to attract foreign capital back to China. Foreign capital built China and now it’s going to starve China.
The US will not ease restrictions on technology transfer nor will Japan and Taiwan allow their multinationals to return. Nobody is going to commit serious resources to help a strategic competitor. Once this squeeze is finished, China’s markets will collapse once again.
Lastly, there is no money to support Chinese markets without printing that money. If money is printed, it will allow Chinese princelings to buy up depreciated assets, much like Russian oligarchs cornered the Russian markets in the 1990’s. It won’t help Chinese citizens which means that the Chinese Miracle is over. The CCP is and has always been about the CCP, not China.
Currency Markets
You cannot escape the responsibility of tomorrow by evading it today – Abraham Lincoln
You can manipulate asset prices for short to intermediate periods of time but not over the long-term. And artificial stability always leads to heightened instability – just look at the wars in Ukraine and the Middle East along with growing tensions in the South China Sea. Currency markets should be volatile right now, not complacent.
The problem for Western bankers is that they can’t allow the Chinese yuan to collapse without de-stabilizing their own banking systems which are already on the edge. This is why it appears as if they’ve been attempting to establish a floor of 7.25 yuan to the dollar (or 1/.138) since late 2022. If that floor breaks and the yuan devalues, I’m not sure global central banks will be able to hold back the tsunami of deflation that has been threatening for the past 15 years. Printing new money to support your capital markets tends to be bad for the value of your currency, unless your currency is the US dollar.
The chart of the Chinese yuan looks like someone drowning, trying desperately to keep his/her head above water.
The fact that China unveiled this plan at the 11th hour tells me that CCP leadership is in a panic and throwing a “Hail Mary”. We’ve known for years that they created a Frankenstein Monster of an economy but they seemed to believe they were on the correct path – mostly because they were personally making money. We know they are panicking because they imitated Draghi’s words, hoping their perceived intent will be enough to carry the battle.
But it’s not just China that is about to experience financial collapse, it’s also Europe. Let’s take a look at the chart of the euro. Most see a currency that is stabilizing; I see a currency that is being flat-lined to prevent a freefall. In my opinion, it represents artificial stability.
Europe is beating the war drums like they want to take a swing at Russia. I suppose Europe’s strategic position is untenable without Russia’s energy but I see nothing but trouble if NATO oversteps the boundaries of common sense. Russia is a broken, former military power that lacks the manpower, logistics, and offensive assets to seriously threaten NATO nations. They haven’t been a real threat in decades, apart from their nuclear arsenal.
Meanwhile, the broader European economy continues to weaken. Skilled workers are leaving the workforce for retirement while the flood of immigrants ostensibly brought in to replace the retirees are proving more trouble than they are worth. The electorate is angry as their standard of living declines while crime increases. Brussels is in the process of failing miserably – even the Netherlands is looking for the exit.
It's easy to attack the US dollar but what’s going to replace it? Bitcoin and other digital currencies would take decades to replace the dollar if allowed to do so yet they would effectively mimic the gold standard. A gold standard sounds nice in theory but it would result in a catastrophic drop in global living standards because credit expansion would be sharply curtailed. Like it or not, the dollar system still makes the most sense if only governments would stop behaving like governments.
The world may want to replace the dollar as the dominant reserve currency but nobody else offers a value proposition that matches the dollar. China and Europe are in decline while the International Monetary Fund and United Nations are dominated by Socialists/Marxists who are better at scheming than acting.
The US keeps printing additional dollars which the world gladly takes in trade. Unfortunately, those dollars have largely been destroyed by poor investment in emerging economies such as China, most of Africa, central Asia, the Middle East and many parts of South America. Bad investment leads to deflation which is what I expect from the Eurodollar market – scarcity which leads to write-downs and bankruptcy.
For this reason, and others, I view a spike in the US dollar as the most likely outcome. As I have written many times before, the global banking system is effectively short the US dollar which means that a spike in the value of the dollar would bankrupt most of the world.
US Election
The US is the biggest threat to the global economy because we don’t need the global economy like other nations do. We have food, oil, technology, capital, water, the most dominant military ever seen in the world, and under-utilized human capital. We’re the only nation that can effectively assimilate immigrants which means we can attract the world’s best and brightest.
The question before the American people is whether to maintain the global economic order put in place to buttress the world against the might of the old Soviet Union or turn inward to focus exclusively on the American people. It’s a question that has seismic ramifications for global markets, the global economy and the artificial stability in place since 2008. This is the real reason why it has been such a contentious race.
The US has the potential to destroy the global economy by simply competing against the world on a level playing field; such is the magnitude of our competitive advantages in energy, food, military, and technology. With the fall of the old Soviet Union, China became the choice as countervailing force but China is rapidly failing, thus the 11th hour attempt to save it. Other than nuclear war, which would destroy the world, there is no military that can challenge the might of the US.
When the decision is outlined in binary form, we can see the potential tectonic shift in front of us. It’s certainly not a decision to take lightly.
Conclusion
What information consumes is rather obvious; it consumes the attention of its recipients. Hence a wealth of information creates a poverty of attention, and a need to allocate that attention efficiently among the overabundance of information sources that might consume it – Herbert A. Simon
It’s easy to miss the forest through the trees these days yet I’m still kicking myself for not putting the above pieces together until just recently. Fortunately, it’s early enough to take advantage of the inevitable volatility that my analysis portends, assuming you agree with it – most won’t. I prefer it that way.
You don’t make money at turning points doing the same things as everyone else and this time will be no different. We have plans for both potential outcomes in November and creating the plans was made easier by the simplifying nature of the above analysis.