All that matters for 2018

Takeaway

China bought two years with its 2016 reflation, aborting a global slowdown stemming from its last decision to slow credit growth. This growth cycle has completed and is turning down again.

The fallout from the prior slowdown started showing up after Spring Festival in 2014. From February 23, 2014: China Real Estate Rage Is Back; Ghost Cities Everywhere; Offshore Yuan Plunges; Talk of Falling Real Estate Prices Across China.

Regarding the dip in the yuan, I wrote:

If this keeps up, we may soon hear about a dollar shortage in China, which happened last time the yuan spiked. Also, after the 2011 drop, forex reserves fell.

It will only take a small marginal change in the economic trends to create a hurricane force in the financial markets. Once the market moves the other way, the shift will be swift and brutal because everyone is on the other side of the trade. How many people out there have puts on the yuan and expect China’s reserves to start falling?

If history rhymes, there’s going to be some significant negative news out of China in March. If that happens, the clock will start ticking on the next global deflationary wave.

The conventional wisdom about equities, interest rates, inflation and emerging markets is wrong again, just as it was in 2011 and 2014.” [Link]

The emphasis in the first line is mine and I recall what I wrote in MINT in July 2017 querying whether the global economic recovery was statistical or real. It was yet another credit-led growth from China:

China was the main source of that credit growth for the 2016-2017 boomlet. If it is truly over, then global growth will go with it. [Link]

Elsewhere in that blog, the blogger writes this about the yuan:

The yuan is a problem at USDCNY 6.3 and USDCNY 6.9 because China has a massive credit bubble. At one end, the deflationary impact of a rising yuan and at the other, the risk of a major devaluation. In the middle is the Goldilocks exchange rate, not to strong to trigger debt default, not to weak to trigger outflows. USDCNY 6.3 in the current environment is too strong. The PBoC is also pinned in this range. Loosen capital controls to let the yuan weaken, exacerbate the liquidity crunch in the banking system and risk uncontrolled depreciation/capital flight. Let the yuan strengthen and risk a credit crisis. Further reverse yuan internationalization and set the yuan price, but risk an economic response from the United States.

He is quite spot-on. In fact, the paragraph above on the yuan rhymes with what ‘Houses and Holes’ wrote in http://www.macrobusiness.com.au on Trump’s policies towards China – that they are working.

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