Monday, July 1, 2013

Back From The Desert

It has been so long since the last post that I might as well have been perambulating in the desert!  Which, in a way, I have.

But, no matter, dear readers and friends, here goes.

I have been trying to think how the current situation will play out.  Brief description of what's happening today:
  1. The US is stuck in Quantitative Easing (call me printing) to the tune of hundreds of billions yearly.
  2. Europe is mired in deflationary misery and recession, with Germany calling all the shots and everyone else hating them.
  3. China is the world's second largest economy, with serious contention for hegemony. 
There is an enormous imbalance in the global economy, and it needs to be corrected.

How will this be accomplished?  The key is China. After nearly two decades of massive growth, the country is no longer a bowl of rice a day economy. Far, far from it.  It is fast becoming wealthy, particularly in the major cities, and needs to protect and improve living standards for its burgeoning middle class. Up to now it has done so through being cheapest-to-produce in export goods, gutting the West's manufacturing base.  

 In my opinion, everyone understands that this game is over.  The current model of borrow-import-spend can't survive any longer and is in dire need of immediate replacement.  Something like a new Bretton Woods agreement is necessary to correct the imbalances, and recirculate China's vast reserves back into the global productive economy, and not as passive portfolio investments.

Chinese FX Reserves - $ Million

Here's a possible solution:
  • China will gradually shift from being export-driven, to investing its reserves in productive assets abroad.  It will generate jobs within its western customer base AND recirculate its reserves into the real economy, instead of letting it sit in Treasurys and Bunds.  The current "bubble" in low interest rates for AAA borrowers and the (previous) bubble in gold prices also stems from that condition.

 10-Year US Treasury Yield

  •  A significant revaluation of the yuan is probable in this scenario.
 Chinese Yuan per $US

  •  Europe will introduce its own version of QE, probably laced with heavy doses of Germanic rectitude and fiscal righteousness.  But it will ease.
Everyone benefits under this scenario: The west is lifted from recession, the US can ease off its own QE pedal, and China can invest its reserves more safely than risking bond defaults and haircuts.

I believe we are already observing early signs of such a move:
  1.  The US is hinting heavily of ending QE.
  2. China is clamping down on domestic credit expansion, and is looking to invest in infrastructure abroad.
  3. Europe realizes that deflationary politics are now fast becoming counterproductive, since they risk popular backlash.  Italy, in particular, could blow up without warning.
  4. Japan is now on the QE wagon.
Key date: the German elections in September.

1 comment:

  1. Nice to have you back.

    "The current model of borrow-import-spend can't survive any longer and is in dire need of immediate replacement."


    I have been on the gold-as-a-long-term-cash-investor because of this general situation (not because I love jewels or Rolex watch or a survivalist à la Rambo....).

    Do not be fooled on "gold-bugs". We would just agree with every word you put. Just that we wrote them a bit ahead of time (in my case late 2006 when I started to read Roubini and you on subprimes and a lot of others on the general framework starting with Mises that I missed during my 1970s studies).

    "Something like a new Bretton Woods agreement is necessary to correct the imbalances, and recirculate China's vast reserves back into the global productive economy"

    Do you believe there is a real chance of "recirculating China reserves" at the current junction? A peaceful output.

    I do not!

    That kind of arrangement could certainly happen with intra-Eurozone. The tensions generated by the financial in-balances are rough.

    Rough enough to hinder financial-and-monetary solutions and breaking the social and political patterns here? IMHO the risk is low.

    Can the overall post-Bretton-Woods system be mended and the so-called reserves peacefully "recirculated" as you said? Looks like a very tall order. IMHO the chances are extremely thin.

    Was that possible in 2008? Before the big investment leap forward Possibly, the Chinese financial picture was robust. Immensely so.

    The intra-China financial situation is has changed.

    Five years of over-investing-at-below-sealevel-rates, insane accounting practices and a high level re-socialization of the economy have destroyed too much of the balance sheets of bankers and households alike.

    Is this a situation that allows for quiet international monetary bargaining required for a global mending, some sort of Bretton Woods II.0?

    IMHO the chances are extremely thin... Even if the current political top leaders of China and the US are certainly great persons (I do really believe they are).

    The challenge is too high. Recirculating as you said requires a framework that bundled trust, a robust banking system, a financial capacity by lenders to wait for the payback.

    Can oil-producers wait? Most certainly so. Can reserve-rich Asian people continue to wait for OECD to pay-back the money lent? In view of their Gini coefficient, their average wealth and their demographic pattern, I reckon they do not.

    The situation is made even worse by the new geopolitical patterns in Asia.

    IMHO this system is now due for some kind break. Not a proper rewrite. Do not be fooled, I am not longing for it. Just anticipating it.

    IMHO an organized break into decent regional monetary arrangements and limited geopolitical frictions would be the best one could expect.

    So I am expecting it. No more.