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Three trends for the next decade

2012/03/20 in macro trends, political economy, Rebalancing Global Finance

We just finished reading one of the most thought-provoking and interesting articles related to Global Trends.  It was written by Louis Gave of @GaveKal Research titled “Weeks When Decades Happen“.   I originally found this article posted on John Mauldin’s Outside the Box newsletter.  We recommend taking a serious look at these predictions of future trends.  A brief summary of the main points are highlighted below…

The three big events of 2001 were:

  • The terrorist attacks of 9/11. This unleashed a decade of bi-partisan “guns and butter”policies in the US and produced a structurally weaker dollar.
  • China joined the WTO in December 2001. China’s full entry into the global trading system signaled a re-organization of global production lines and China’s emergence as a major exporter. Export earnings were recycled into the mother of all investment booms, which drove a surge in commodity demand and a wider boom in emerging markets.
  • The introduction of euro banknotes. The introduction of the common currency unleashed a decade of excess consumption in southern Europe, financed unwittingly by northern Europe through large bank and insurance purchases of government debt.

     

All three trends have ended.

For the future, he indicates the following three important trends:

Instead of lamenting over the past, investors should be coming to grips with the trends of the future: 

  1. the internationalization of the RMB, 
  2. the rise of cheaper and more flexible automation, 
  3. dramatically cheaper energy in the US.

Why these three trends are significant was very well presented in his article.  We suggest reading the article in full here:  ”Weeks When Decades Happen“.  Some interesting comments are highlighted here:

  • “the creation of the offshore RMB bond market in Hong Kong, a development which may go down as the most important financial event of 2011.”
  • “ yesterday China’s trade mostly took place with developed markets, was comprised of low-valued-added goods, and was priced in dollars. Tomorrow, China’s trade will be oriented towards emerging markets, focused on higher value-added goods, and priced in RMB.”
  • Over the coming decade, cheap labor may not be the comparative advantage it was in the previous decade, simply because the cost of automation is now falling fast “
  • “one aspect of policymaking which makes China unique: the country’s leaders wake up every morning pondering how to return China to being the world’s number one economy and a geopolitical superpower in its own right (few other world leaders harbor such thoughts).”
  • Hence we are convinced Beijing will eventually bite the financial reform bullet, and RMB internationalization is the leading edge of that reform. In that light, the creation of the RMB offshore bond market is an event of much greater significance than is currently acknowledged by the general consensus.”
  • “This does not make for a stable situation. And given that the RMB is unlikely to replace the dollar as the principal global trading currency for many years to come (see History Lessons and the Offshore RMB), the likely combination of expanding global trade and a shrinking US trade deficit should mean that either the dollar will have to rise, or US assets will outperform non-US assets to the point where valuation differnces make it attractive for US investors to deploy dollars abroad (since US consumers won’t). “
  • “The internationalization of the RMB and the birth of the RMB bond market is likely to be one of the most important developments of the decade. The closest analogy is the creation of the junk bond market by Michael Milken in the 1980s. Interestingly, just as in the early 1980s, few people are taking the time to work through the ramifications of this momentous event. Understanding this new market will prove essential to understanding the world of tomorrow.”
  • “The likely evolution of the US from record high twin deficits to much smaller budget and trade deficits should help push the dollar higher over the coming years. And this in turn will have broad ramifications for a number of asset prices.” 

 

 

Top trends for 2012 (economic, political)

2012/02/23 in Europe, Great Debate - Economics, macro trends, political economy, Rebalancing Global Finance

2012 Trends

In no particular order, here are the global macro trends that we think will be most significant in the current year (2012):

Continue reading here: Visit our Wiki to see the rest of this article.  Community involvement:  This document is dynamic, so any of our community is welcome to contribute, and to help shape our views of these important developments.  Please log in to our wiki, and feel free to comment…

See also: Top Trends for 2009

 

The “savings glut” that may be to blame…

2009/02/10 in credit crisis, macro trends

The “savings glut” theory is one of the two main competing theories to explain some of the bigger mysteries of global finance in recent years (including the credit crisis of 2007 ).  The basis of this theory is that there are underlying fundamental “global imbalances” which are causing all of the trouble (and which need to be fixed in order for the crises to stop).  In this blog post, Im going to quickly outline “savings glut” theory…

The other theory (money glut)

The more popular (and easier to understand) theory (which Im not going to cover in this blog) is called the “money glut” theory…which basically says that American Central Bank kept interest rates too low for too long, which led to too much money, too much credit and encouraged too much risk taking by banks and greedy people on wall street.  This is the popular version of the story that most people hear every night from their local news commentator.  This is NOT the theory that Im going to review in this blog posting.

Savings glut (summarized)

The less well known (and more difficult to understand) theory of what-went-wrong…is the  “savings glut theory”….which basically says that the root of the problem lies not within the US, but with the fundamental imbalance of international finance.

While finance is risky (borrow short, lend long), it is even more risky when it crosses borders.  Countries in Asia and Latin America learned the lesson not to accept deficits after punishing recessions in the 1990′s and early 2000′s.  Since then, nearly all emerging nations (and most developed ones, minus USA) have fought hard to keep current account surpluses.   In an effort to keep away from risky deficits, many central banks (especially in emerging Asia) have purposefully chosen to (a) keep their currencies undervalued, and (b) to accumulate foreign exchange reserves to buffer against potential shocks.  Note that the countries with large reserves in 2009 are the ones most likely to survive this latest crisis with their economies in tact.   After seeing the prescriptions given by the IMF after the last round of crises, most emerging countries said “no thanks” to foreign capital, and instead have chosen to run massive surpluses.

The key to understanding the “savings glut” theory is to first understand that the nations “balance of payments“, by definition, must BALANCE.  That means that if a country chooses not to accept foreign capital, and therefore if they choose to run a capital account deficit…then they must by definition also run a current account surplus (the current account is physical goods exports).  That means that in order to export capital, they must also export products (I know, it gets a bit confusing, sorry).  The net result = they must keep the currency undervalued for this to work.  And the currency of choice = the US dollar (as a target peg).

“Ok, so what is the problem?” you might ask…

Well, due to the rules of global accounting…if one country runs a current account surplus, then others must run a current account deficit.  That part is easy to understand….if one country exports, another must import.  Ok, but what is less obvious is that if one country runs a capital account surplus (think China), then another MUST run a capital account surplus (think USA).  This is the root of the “savings glut” theory…

The savings glut theory states that sometime in the late 1990′s to early 2000′s…there was a massive amount of countries that all decided “thats enough”…no more foreign capital can come in.  It was too risky, and led to too many crises.  As Martin Wolf says, they chose to “smoke, but not inhale” from international finance…and so began a massive financial recycling program, whereby money that came in quickly was sent back to sender.  Money no longer flowed from rich countries to poor ones…instead money was borrowed on a massive scale from poor ones to rich ones.

Why did this happen?  The theory is that international finance proved to be too risky, and so developing countries almost unanimously chose to reject international finance and send it back.   (the only emerging markets that did not follow this prescription seems to have been the emerging Eastern European nations, many of which are now facing crisis…on a much deeper scale than emerging Asia).

Enter the “borrower of last resort”

But, with all of these emerging countries sending money back, unfortunately, there was only ONE country on the planet that was willing and able to accept it:  the USA.  (note that economists that subscribe to this theory are extremely critical of Germany / Japan and other developed nations that did not take some of this capital that was flooding the USA).

The US, as the theory goes, was uniquely capable to absorb this flood of “savings” because the US dollar was the global reserve currency, and the US could borrow in its own currency on a massive scale (with no chance of foreign exchange crisis).

economist-image

Who Believes this theory?

Surprisingly, the “savings glut” theory has some pretty impressive followers…

  • the list goes on and on….

Who is to right?  Who is to blame?

The reality is that both “savings glut” theorists and “money glut” practitioners are probably each 1/2 right. I read somewhere…”the Chinese may have supplied the noose, but it was the US that strangled themselves”…Thats probably the most accurate way of reconciling the “savings glut” vs “money glut” theories…

More on the “Savings Glut”

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Are Asian currencies undervalued? maybe not (anymore)…

2009/02/03 in credit crisis, currency, macro trends

If someone tells you that “Asian countries artificially keep their currencies undervalued” (in order to boost exports to the US), you should probably challenge them… While that assertion might have been true in 2008, it may not be anymore.

All that you think you “know” about Asian currencies may be changing…

If you were like me, you probably assumed that  Asian currencies were undervalued (vs the dollar) and should rise (if only their central bankers would stop targeting a weak currency vs. the dollar).  But, is that still true?  Or, have the facts changed?…

How quickly the “facts” can change:

Remember, it wasn’t all that long ago that Vietnam was one of those “undervalued” countries that was facing pressure from trading partners to allow the currency to appreciate.  It was widely reported that the Vietnamese authorities sold local currency, bought dollars in an effort to stop appreciation of their currency (in an effort to keep their exports competitive with Chinese exports heading for the USA).  But then…common wisdom was proved wrong in the blink of an eye.

As we outlined here in GloboTrends, those factors can change suddenly….

In April / May of 2008 there was a sudden change, and investors no longer thought the Vietnamese currency (dong) was undervalued, but instead thought it was overvalued, and began to sell..and sell, and then sell some more.   The chart below has an inverted scale, so the sudden shift “upward” indicates a dollar strengthening, or Vietnam Dong weakening (ie. it took more Vietnamese currency to buy one US dollar).

vietnam-dong

Leading up to April ’08….there was increasing pressure on Vietnam to allow their currency to appreciate (become stronger vs the dollar).  But then…do you see the sudden change?

What was scary was just how quickly “common knowledge” could be turned upside down.  Overnight, the common wisdom changed from one in which “Vietnam was holding its currency down to boost exports”….and turned into a route with downward pressure on the currency (you could hear currency traders yelling “sell, sell, sell”)…Is there a lesson here for investors looking at China and other Asian currencies?  You had better believe it!

Are the Asian currencies still “undervalued”…maybe not

Recent data and analysis shows (many countries in) Asia to be suffering from two crises.  One is the a crisis of falling exports.  The other is of falling internal demand.  While this dynamic may be true in much of the world in 2009, it is magnified to a ‘whole-nother-level’ in Asia…

Read the rest of this entry →

Bill Gates and China…

2009/01/28 in BRIC - emerging markets, currency, macro trends

China’s wealth of reserves is massive, impressive.  Some analysts estimate the value of China’s foreign reserves to be in near $2 trillion (with about a trillion of that in US treasuries).  Yes, China has way more wealth than Bill Gates ….so where is the connection?   Hang on, I’ll get there, but first…lets look at the data from Brad Setser blog:

In 2008, my best estimate  is that China bought $374.6 billion of the $1684.8 billion increase in the outstanding stock of marketable Treasuries not held by the Fed.

China currently has — in my judgment — about $900 billion of Treasuries.

Wow!  That is an incredible amount of money…But its not money that China has…no,actually… its mostly money that is owed to China.   Money being lent from China to the United States.  In this upside-down world of international finance, we actually see money flowing from places like China on a massive scale to countries like the USA… (note that only in recent history is money borrowed by rich countries from developing ones!).

But, having a massive amount of “reserves” (on paper) makes China rich, no?

On paper, yes…But, remember…these reserves (in the form of US treasuries) are like I.O.U.’s from the US to China.   In other words, the US takes the money now, and issues I.O.U’s for future payments, which fill up the Chinese reserves… As a result, this massive “wealth” of foreign reserves is a bit illusionary…because it exists on paper, and not in physical wealth.  (the real wealth of China* lies in its stock of productive capacity and innovative people…. and not in its paper wealth of international reserves)….

There are three main problems with a “wealth” of reserves…

  • Much of it is paper wealth…. its like Bill Gates having been the richest man, but having had all of his wealth tied up in MS stock…if he had tried to cash out quickly, it would have driven the stock price down…eliminating much of his paper wealth. China is in a similar situation; having the wealth of reserves tied up in I.O.U’s (debt issued by the US)…if China were to suddenly try to sell their position in US treasuries, it would drive down the price and reduce their value.  So, much like Bill Gates, China would need to sell off its position gradually (or just slow down their pace of acquisition).
  • If the US dollar were to depreciate, the amount of “wealth” would simply disappear.
  • China cant spend that money internally without risking (a) inflation, and (b) currency appreciation. While inflation isn’t that big of a risk (now), the currency appreciation is. Remember…the only way china can run HUGE current account deficits is if they also simultaneously run capital account surpluses (the Balance of payments must balance). So, that surplus capital must exit the country, or else…if they spend it internally, the current account must shrink (What would be the mechanism by which this would happen?… currency appreciation to eliminate exports).

Can China spend this “wealth” on Fiscal Stimulus?

No, I dont think so.

Its not that they dont want to (I believe the Chinese would love to spend that money to stimulate internal demand and boost production / jobs).  It’s that they can’t (at least not easily, and not all at once).

But, you might wonder…didnt I just read about a massive fiscal stimulus package coming from China?  Yes, you probably did (we highlight this in our wiki).  But, much of $600 billion in fiscal stimulus that China announced in (late) 2008 was already-planned spending (see Heritage Foundation analysis here).

Foreign analysts that encourage China to spend that stockpile of “money” to stimulate the internal demand (and boost the world economy) are likely to be disappointed.

*The Chinese wealth ultimately lies not with stockpiles of foreign reserves but in developing and expanding their internal market.  Stimulating demand internally and becoming less reliant on export growth is the key to China’s bright future.

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credit crisis…a symptom, not the cause of global imbalances

2009/01/17 in BRIC - emerging markets, credit crisis, currency, macro trends

What is often considered to be an American-led banking crisis should really be considered just a symptom of global imbalances (and not the cause of them).   Rather than seeing this credit crisis (turned banking crisis, turned global economic crisis) as the result of US financial greed, innovation or stupidity…its more accurate to look at this recent crisis as just one of a string of bubbles that burst as a RESULT of global imbalances in international finance.

The global imbalance that I’m talking about is the role that the US has been forced to assume as the absorber of surpluses from many exporting countries (especially emerging economies of China, east Asian nations, and oil exporters).

Remember, if one country (or a bloc of nations) runs a current account surplus, then some other country by definition, must be running a deficit.  But when countries such as China, Japan, South Korea, Taiwan, etc make it their policy to control their exchange rates vs. the US dollar, and to drive their economies with export-driven growth, then by definition, there must be some other country running a surplus.

The lessons of the 80´s – 90´s taught most emerging nations the dangers of running current account deficits.  They learned mostly through experience the brutal dangers of accepting capital from foreigners (Mexico in 94, SE Asia in 97-98, Russia in 98, Brazil in 99, Argentina 2001-02).   So, as a result of learning these lessons the hard way, almost every emerging economy chose to build up `reserves´ of US dollars, and to run surpluses rather than deficits.

reserves

China and others purposely decided to ´smoke but not inhale` from global finance.  They would do everything in their power to recycle the incoming dollars, and send them back outside of the country.  This process of dollar recycling guaranteed that the money earned from exports would be sent back out of the country as US treasury purchases.

The more China exported, the more they were forced to purchase US treasuries to keep their undervalued currency undervalued, so that the machine could continue.  But, the more they exported capital, the more that global finance became flooded with cheap credit and easy money.  This should have fueled inflation, but cheap Chinese products and labor kept a lid consumer products and drove down labor costs around the globe.  In this new world, the central bankers in the US and Europe were able to keep interest  rates at all time lows without running the risk of inflation.

The only problem was the (string of) asset bubbles that followed…

A series of bubbles…

In response to a flood of cheap credit on tap from Asia, China, and oil exporters…we saw a series of bubbles build up in assets starting in the late 1990´s.  First was the internet bubble,then Telecom bubble, then real estate bubble, then commodities bubble…all the while there was a credit-bubble building and building and then finally popped.

Each of these asset bubbles built up as a direct result of cheap credit on tap from countries that were unwilling (or unable) to absorb incoming capital from global finance, and instead chose to force that capital back on the only country willing and able to absorb excess savings abroad: the USA.

The key question now that the credit bubble burst is:  what´s next?  If you assume that the credit bubble was just the result of American´s choosing to spend more than their income (and poor regulation in the USA), then you might be inclined to believe that this would be over once the credit crisis were over.  But, if you believe (like I do), that this credit crisis was just a symptom rather than the root cause of the recent pain…then you would have to wonder like I do: what´s next?

Note: Morgan Stanley highlights the fact that there will likely be another bubble in their recent article A New Global Liquidity Cycle, where they say `It’s time to get ready for the new global liquidity cycle.`

The only way that this series of crises will end is for the underlying imbalances in global finance to be corrected.  In order for this to happen, then countries like China (Japan, S Korea, Taiwan,etc) will need to stop targeting undervalued exchange rates by selling local currency and buying US dollars.  The only way out is for global finance to be restructured in a way that emerging markets would not be afraid of accepting capital from developed economies, and would be willing to run deficits without the fear of punishing deficit and currency crises.

In an ideal world (or one that makes sense), capital would flow from the rich developed nations to the rapidly developing ones (where opportunities to invest that capital was greater).

For now, we live in a strange world in which money flows on a massive scale from the worlds poor developing nations to the developed rich ones.  And, as a result of this perverse capial flow, we will continue witnessing bubbles that will continue bursting until we fix the underlying causes of these problems.

Please add your comments to our forum here:

Related blog posts:

  1. What is causing the commodities bubble?
  2. Series of bubbles
  3. USA credit crisis – what caused it to happen?

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