Breaking: Chinese Goverment Weakens the Yuan Reference Rate by 1.9%!

The Chinese government has now resorted to the yuan's devaluation to bailout the besieged stock market and the economy

From Bloomberg:

China’s central bank weakened its daily reference rate for the yuan by a record 1.9 percent amid signs of a deepening slowdown in the world’s second-largest economy.

The currency tumbled 1 percent to 6.2770 per dollar as of 9:20 a.m. in Hong Kong’s offshore trading, the biggest decline since 2011. Onshore trading begins at 9:30 a.m. and the spot rate is kept within 2 percent of the reference rate.

While weakening of currencies of the other Asian economies have been due to the easing policies mainly designed to support unsustainable debt burdens, the PBoC's devaluation can be seen as a case of "currency war" or to deliberately weaken the currency as subsidy to exporters.

China's exports plunged 8.3% in July as shown above from investing.com and has been stagnating for most of 2015

The above chart represents the nominal dollar based export value from tradingeconomics.com

This may even be in response to the buildup of internal financial pressures as revealed by the recent surge in capital outflows  (FT Alphaville)

The Chinese government must be so distressed for them to adapt one desperate measure after another.

 

Abenomics: Has Blowing the World’s Biggest Bond Bubble been an Act of a Genius?

The mainstream apparently gets into the Abe-Kuroda pantomime.

At the Bloomberg, Asian columnist William Pesek asks whether BoJ’s inflation of the world’s greatest bond bubble is an act of a genius or a madman? (bold mine)

Ten years from now, will Bank of Japan Governor Haruhiko Kuroda be regarded as a genius or a madman?

Kuroda's shock-and-awe stimulus move on Oct. 31 delighted markets and won him plaudits as a monetary virtuoso. Japan, the conventional wisdom tells us, has finally gotten serious about ending deflation, and isn't it wonderful. But what happens when a central bank buys up an entire bond market? We're about to find out as Kuroda, like some feverish hedge fund manager, corners Japan's. Neglected in all the celebrating: To reach a 2 percent inflation goal that's both arbitrary and meaningless, the BOJ is destroying Japan's standing as a market economy.

Now to the world’s biggest bond bubble…

In announcing that it will boost purchases of government bonds to a record annual pace of $709 billion, the central bank has just added further fuel to the most obvious bond bubble in modern history -- and helped create a fresh one on stocks. Once the laws of finance, and gravity, reassert themselves, Japan's debt market could crash in ways that make the 2008 collapse of Lehman Brothers look like a warm-up. Worse, because Japan's interest-rate environment is so warped, investors won't have the usual warning signs of market distress. Even before Friday's bond-buying move, Japan had lost its last honest tool of price discovery. When a nation that needs 16 digits in yen terms to express its national debt (it reached 1,000,000,000,000,000 yen in August 2013) sees benchmark yields falling, you've entered the financial Twilight Zone. Good luck fairly pricing corporate, asset-backed or mortgage-backed securities.

Considered in relation to gross domestic product, Kuroda's purchases make the U.S. Federal Reserve's quantitative-easing program look quaint. The Fed, of course, is already ending its QE experiment, while Japan is doubling down on one that dates back to 2001. Kuroda's latest move means Japan's QE scheme could last forever. The BOJ has willingly become the Ministry of Finance's ATM; reversing the arrangement will be no small task.

The wish that Japan's QE scheme "could last forever" represents Kuroda’s Hail Mary Pass.

However as the April 2013 initial doubling of monetary base reveals, there is no such thing as a free lunch. The failure of the first phase (QE 1.0) thus leads to the second wave (QE 2.0)…

As I recently wrote

There you go: the BoJ’s ¥50 trillion a year down the drain. Now if one fails with ¥50 trillion, perhaps will 60% more or ¥80 trillion serve as a magic number and do the trick?

I believe that 2% inflation signifies as the headline objective presented by Mr. Kuroda, however the real goal must be to monetize Japan’s gargantuan unsustainable debt problems…

…and this includes the financing of the government’s reckless fiscal activities which has all been supported by debt (charts above from Zero Hedge). 

Runaway government spending can't be funded by stagnating tax revenues as the fiscal deficit gap continues to widen (top). This comes as the share of interest rate and debt servicing (bottom) continues to grab a bigger piece of the tax revenue pie. So there is no way Japan's economy can pay back all those loans under current political economic conditions except to monetize them (inflate the debt away!).

Again I as commented,

So the BoJ may have expanded her QE to accommodate more monetization of fiscal deficits aside from possibly including the possible shift by GPIF out of domestic bonds. Of course the latter could function as a decoy as to shield the Japanese government from revealing its anxieties.

Back to the money illusion…

All this liquidity has made for surreal events in Tokyo. Take the news that Japan's $1.2 trillion Government Pension Investment Fund will dramatically rebalance its portfolio away from bonds. Japan has enormous public debt and a fast-aging population, and now the world's biggest pension pool is shifting to stocks. Yet somehow, 10-year yields are just 0.43 percent. The explanation, of course, is that the parts of the market the BOJ doesn't already own are sedated by its overwhelming liquidity. The BOJ is now on a financial treadmill that's bound to accelerate, demanding ever more multi-trillion-dollar infusions to keep the market in line.

To Japan bulls, the end justifies the means. If Kuroda changes the deflationary mindset that's stalked Japan for 17 years now, then his gambit was worth it. One problem with this argument is that deflation isn't the cause of Japan's malaise, but a side-effect. Consumer prices rising at 2 percent or more will be a big problem if Prime Minister Shinzo Abe doesn’t push ahead with plans to deregulate the economy and prod companies to raise wages. That's doubly true as Tokyo mulls another growth-denting rise in the consumption tax.

Realize that the BoJ’s supposed goal to “reach a 2 percent inflation” is diametrically opposite to how inflation influences interest rates. So the BoJ’s incoherent act simply implies that their policies are self defeating; either this leads to boom-bust cycle or to hyperinflation. Kuroda's has adapted policies that has essentially boxed themselves into a corner, there is no middle ground.

In addition, by draining JGB liquidity from the marketplace this would magnify Japan’s risk of financial system’s instability 

Now, the BoJ overhauled into a hedge fund…

Another problem is that Kuroda is turning the BOJ into the world's biggest asset-management company. The BOJ won't admit it, but it's monetizing Japan's debt on a massive scale, and probably even retiring large blocks of it -- just as the government did in the 1930s. What happens when the BOJ decides Japan needs a credible and functioning bond market in the years ahead? Kuroda's successors face terrible odds disengaging from a market he's effectively nationalized.

Well, if we are to describe bubble as a product of unsustainable ‘something for nothing’ policies which leads asset pricing to vastly deviate from pricing of market activities outside such (political) interventions then creating the world’s biggest bond bubble isn’t likely a work of a 'genius'. 

And there won't be any orderly fixes because of the massive scale of imbalances that has already been built into the system. And this is why Abe-Kuroda has been doubling down in the hope to kick the proverbial can down the road. Hope is now Abe-Kuroda's ONLY strategy.

In addition, the sustained assault on the economy by the government will most likely lead to more disruption in economic activities.

And the path to hyperinflation is the overwhelming destruction of the economy's production capacity through the total distortion of price signals from sustained money printing. Such dynamic will be compounded by other interventions like price controls, raising taxes, currency controls, et. al., in response to the government's desperate recourse to the use of the printing/digital press to finance fiscal requirements or fiscal monetization that leads to a loss of confidence on the currency. 

There are real time examples of hyperinflationary governments: Venezuela, Argentina...previously Zimbabwe

Will Japan be next???

For now Japan’s advantage is that they are still open or still have access to the global markets. But this may change.

Media has already been already speculating that the Abe administration will squelch growing opposition to Abe-Kuroda policy in the BoJ by replacing dissidents with pro-administration henchmen. 

The next step may be to increase protectionism.

PM Abe’s reluctance to expand trade by the Trans Pacific Partnership as well as the promotion of other policies in favor of vested interest groups gives a hint on PM Abe’s proclivity for protectionism.

A full scale ‘beggar thy neighbor’ currency war would imply protectionism and could be reinforced by other economic warfare policies again through currency and trade controls or more.

For those who think today’s Nikkei ramp from BoJ-GPIF's direct intervention will be sustainable, history gives us a clue. 

The first wave of 50 trillion yen had a 7 month euphoric effect after which the Nikkei went rangebound. Yet much of the post 2013 QE 1.0 trading range support has been in anticipation of today’s QE. 

The 64 Quintillion Question is: will 80 trillion be the last or will there be more? 

If 80 trillion ends, the stock- (greatest) bond market bubble boom will turn out to be a colossal historical bust. 

However if 80 trillion will be added or if the "financial treadmill" is bound to accelerate, then the Nikkei, as Dylan Grice puts it, may hit 63,000,000 or may be alot higher than the current levels.

Realize too that all episodes of hyperinflation has been accompanied by soaring stocks which runs alongside domestic currency collapses. 

The unfortunate part is that any stock market gains from hyperinflation will have limited purchasing power. In the case of Zimbabwe, thousands of percentage stock market returns can only buy 3 eggs!!!

Yellenomics Pushes Japan’s Nikkei to Key Resistance Level

The bullish stock market sentiment from Yellenomics has been contagious. Japan’s Nikkei has now reached a critical juncture.

From Bloomberg:

The Nikkei 225 added 2.1 percent to 14,876.41 in Tokyo, its highest close since May 22. The broader Topix index climbed 1.2 percent to 1,218.55, with all but one of its 33 industry groups rising. Shares advanced in the morning as remarks by Janet Yellen, the nominee to lead the Federal Reserve, fueled optimism the U.S. will maintain stimulus. The yen slid 0.4 percent to 99.64 per dollar.

“Yellen’s speech is making the market buoyant as the view spreads that tapering will be delayed,” said Hiroaki Hiwada, a strategist at Toyo Securities Co. in Tokyo. Aso’s comments provide “verbal support. While it’s unlikely they’ll intervene with the currency at these levels, it’s positive as it means there’ll be pressure on the yen if it strengthens.”…

As with other nations, Japan needs to be able to intervene in currency markets if necessary, Aso said at a parliamentary committee today in response to a question about the government’s special foreign-exchange accounts law. The country must set aside a proper amount of money to fund such actions, he said.

The chart above of the Nikkei 225 from stockcharts.com has not been updated.

Nevertheless, today's big gains has pushed the Nikkei to test the resistance level (blue horizontal line).

Abenomics has brought about a seemingly symmetric correlation between the Nikkei and the Yen where both has moved in inverse directions (green trend lines). This relationship passed me by when I slipped “there has been little signs of symmetry in their (yen-nikkei) flows”. 

The yen has recently been weakening that has led to a re-energized Nikkei. Today's comments by incoming Fed chief Janet Yellen only bolstered the momentum.

Also, a similar dynamic “bad news is good news” applies to Japan’s financial markets.

Today’s disclosure of the halving of economic growth rate will likely put pressure on Japan’s policymakers to apply more stimulus.

From the Financial Times

The rate of growth in Japan’s economy roughly halved between the second and third quarters, the government reported on Thursday, as weaker consumption and exports offset big rises in public spending and property investment.

According to Cabinet Office estimates, the real value of goods and services produced by the world’s third-largest economy grew at an annualised rate of 1.9 per cent between July and September…

Nonetheless, the data will sustain pressure on Shinzo Abe to keep Japan’s growth trajectory intact. Since returning to power last December, the prime minister has moved to overturn more than a decade of deflation through the “three arrows” of aggressive monetary easing, a more flexible approach to fiscal spending, and a series of overlapping initiatives to lift the country’s longer-term growth potential.

As pointed in the chart above from zero hedge, aside from a slowing economic growth and despite higher cpi, Japan's wage growth has also turned lower. 

The momentum from Abenomics seem to be fading.

This implies that the markets expect the Abe administration via the BoJ to conduct more easing in the future, thus the lower yen.

For both the Yen and the US dollar, it has been a race to the bottom. Nevertheless lost purchasing power of the average citizenry would, for the meantime, extrapolate to a bonanza for banks, financial institutions, the Japanese government and to asset investors, should the Nikkei breakout to the upside. 

Updated to add: The futures markets appear to be pointing at a successful breach.

Bank of Israel Buys Equities and Foreign Currencies

As I have been pointing out, inflationism has now become a central banking standard.

The Bank of Israel has reportedly bought $200 million of foreign currencies

From Ynet News.com

The Bank of Israel bought an estimated $200 million of foreign currency on Tuesday in a bid to weaken the shekel after it hit a 19-month high, although the move had little effect.

With exports comprising 40% of Israeli economic activity, the central bank has made it clear it will not allow a steep rise in the shekel.

So nearly every country have been attempting to “devalue” against another, which should provoke a competition or a race to the bottom. Some call this the currency wars.

This also shows how global central bankers will put to test the current paper money standard to the limits. Current developments have made them believe that they have attained a policymaking nirvana or where money printing bears no consequences to the real economy.

Also Bank of Israel is one example of countries supposedly diversifying into equities.

From Bloomberg:

The Bank of Israel plans to almost double equity holdings by the end of the year after falling bond yields prompted the central bank to invest in European shares for the first time.

The bank will increase its stock holdings to as much as 6 percent of foreign-exchange reserves, or about $4.5 billion, from 3 percent at the end of 2012, according to Yossi Saadon, a Bank of Israel spokesman. Investments in shares rose to about 4.5 percent of assets in the first four months of 2013 as the institution made a “small allocation” to European equities in addition to its U.S. funds, he said.

Aside from the political motive, central bank operations seem to have transitioned into hedge fund operations but underpinned by the “guns and badges” institutions.

Bank of Israel’s equity exposure on the European and US equities could be interpreted as providing support on the equity markets of the US and Eurozone.

Ironically, this comes as the shekel is deliberately being devalued by them.

Bank of Israel’s actions thus appears to be tweaking profits via foreing currency-foreign equity arbitrages through policies. 

Are these not insider trading or manipulations? At whose expense? Market players and the economy?

I am not sure whether Bank of Israel’s equity purchases has been entirely foreign.

Nonetheless Israel’s TA-25 appears to be on mends following a downdraft in 2011. (chart from tradingeconomics.com)

Bank of Israel’s recent actions are examples of implicit guarantees on asset prices that only balloons the global pandemic of asset bubbles.

BRICs Mull Bank to Bypass World Bank and IMF

Developing economies represented by the BRICs or Brazil Russia India and China, a popular acronym coined by Goldman Sach analyst Jim O’Neill, have been reported as intending to establish their own multilateral bank to bypass or breakout from the clutches of the influences of the US and the World Bank-IMF cabal. 

From Bloomberg:

The biggest emerging markets are uniting to tackle under-development and currency volatility with plans to set up institutions that encroach on the roles of the World Bank and International Monetary Fund.

The leaders of the so-called BRICS nations -- Brazil, Russia, India, China and South Africa -- are set to approve the establishment of a new development bank during an annual summit that starts today in the eastern South African city of Durban, officials from all five nations say. They will also discuss pooling foreign-currency reserves to ward off balance of payments or currency crises.

“The deepest rationale for the BRICS is almost certainly the creation of new Bretton Woods-type institutions that are inclined toward the developing world,” Martyn Davies, chief executive officer of Johannesburg-based Frontier Advisory, which provides research on emerging markets, said in a phone interview. “There’s a shift in power from the traditional to the emerging world. There is a lot of geo-political concern about this shift in the western world.”

The growing role of emerging markets suggests of a commensurate expansion in geopolitical clout. From the same article:

The BRICS nations, which have combined foreign-currency reserves of $4.4 trillion and account for 43 percent of the world’s population, are seeking greater sway in global finance to match their rising economic power. They have called for an overhaul of management of the World Bank and IMF, which were created in Bretton Woods, New Hampshire, in 1944, and oppose the practice of their respective presidents being drawn from the U.S. and Europe…

Trade within the group surged to $282 billion last year from $27 billion in 2002 and may reach $500 billion by 2015, according to data from Brazil’s government. 

But such plans are still on the drawing board…

While BRICS leaders may approve the creation of a development bank in principle at the summit, there’s still disagreement on how it should be funded and operated.

There is more than meets the eye from this development.

 

The BRICs has been expressing apprehension over central bank 'credit easing policies' adapted or imbued by developed economies led by the US Federal Reserve. 

Russia’s Putin calls Bernanke’s QEs as “hooliganism”. Brazil has blamed the Fed for inciting a currency war, and so with China’s censure of QE. 

And partly in response and also in part to promote advancing her geopolitical role, China has been promoting the yuan, via bilateral trade arrangements to the BRICs and the ASEAN.

BRICs along with other emerging markets have been major buyers of gold

Emerging markets led by the BRICs dominated buying in 2012 according to the Bullion Street:

Central bank buying lifted gold last year and is likely to do so this year as more and more emerging market central banks have become first time buyers in recent years.

Observers said central banks across the globe collectively bought more gold than they had previously over 40 years. The buyers were not the usual central bank suspects among the old world European nations, but emerging economies.

And also in 2011 (chart from Reuters)

And recent events in Cyprus only exhibits of the rapidly deteriorating state of the current central bank based fiat money system. 

As Tim Price at the Sovereign Man aptly commented

It matters because the inept handling of its crisis last week threw one facet of modern banking into sharp relief: if a deposit guarantee is seen to be fraudulent or sufficiently fragile to be easily smashed by politicians, then confidence in banks, and in unbacked paper currency itself, will be vulnerable to an unpredictable run.

So the BRICs dissension over the current system has been prompting them to "diversify" (euphemism for acquiring insurance through gold purchases), as well as, to work on creating an alternative system that would circumvent the US dollar standard, possibly with their own bank. 

Perhaps BRICs officials are becoming more aware of the warning given by the French historian and philosopher François-Marie Arouet, popularly known by his nom de plume Voltaire: Paper money eventually returns to its intrinsic value--zero.

Are Expanding Deals in Currency Swaps Signs of Currency Wars?

Lately I questioned the popular wisdom promoted by politicians and by media as “currency wars”

Reports say that the Bank of England (BoE) may seal a deal with the People’s Bank of China (PBoC) for currency swap lines.

From Reuters

Britain said on Friday it hopes to set up a currency swap line with China soon to help finance trade, a move that will enhance London's drive to become a leading offshore centre for yuan trade.

China, in an effort to internationalize the yuan and eventually make it a world reserve currency, has already agreed swap lines with more than 15 other countries, mostly emerging markets.

The Bank of England said on Friday it would work with China's central bank to sign a final agreement shortly on a reciprocal three-year yuan-sterling swap, building on its statement last month that it was ready "in principle" to adopt the swap line.

Last December global central banks went on to renew arrangements for forex swap lines

From Reuters

The U.S. Federal Reserve said it had extended for another year the dollar swaps with the European Central Bank, Bank of Canada, Bank of England and Swiss National Bank. The announcement was released at the same time by the other central banks.

These provisions were an important part of the powerful response launched by monetary authorities during the crisis to keep global financial markets open, curbing lofty dollar funding costs which had spiraled due to fear over counter-party risk.

Swap arrangements were revised and extended in November, 2011 as the euro zone debt crisis intensified, to ease the dollar funding pressure being experienced by some European banks.

China has said to have closed 18 swap arrangements worth a total of 1.6 trillion yuan involving different nations since 2009 (China Daily).

So essentially as these governments embark on their respective domestic money expansion programs, what they do to “hedge” against potential “shocks” (implicitly caused by such programs) has been to accommodate each other currencies through swap line deals.

Some currency war eh?

Quote of the Day: Deficit Without Tears

For its part, the United States finds congenial a world in which a dollar sent to China for cheap goods comes back overnight in the form of a near-zero interest loan, which can then be recycled through the U.S. financial system to create yet more cheap credit.

Neither partner in this monetary marriage is, therefore, likely to file for divorce any time soon.

This is from the highly influential political think tank the Council of Foreign Relations CFR via Benn Steil and Dinah Walker.

I say “deficit without tears” because the above resonates with the unsustainable free lunch system from the de facto world monetary standard, the US dollar system, aptly described by Jacques Rueff. 

"Deficit without tears" has widespread global economic and financial repercussions (e.g. financialization and global boom bust cycles), as well as, geopolitical ones (think Scarborough-Spratlys dispute).

The Political Pretense called Currency War

A geneticist recently claimed that human intelligence has been on a gradual decline due to the extensive use of fluorides in the water supply, pesticides, high fructose corn syrup and processed foods. 

I have a different opinion. If true, then I would say that the main culprit has been the public’s worship of state, from which untruths, as conveyed by media, politicians and their apologists, envelops its essence. Blind belief in political falsehood makes people lose their intellectual bearings.

Just recently the Japanese government has been blamed by her counterparts as Russia, South Korea and the Bundesbank for inciting, if not escalating, a “currency war” via open ended bond buying program to devalue the yen. The implication is that Japan’s “currency manipulation” polices signifies as “beggar thy neighbor” policies that have been implicitly designed to hurt other nations.

A “currency war” is another term for competitive devaluation which according to Wikipedia.org represents “a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency” where “states engaging in competitive devaluation since 2010 have used a mix of policy tools, including direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing.”

Yet one would notice that the balance sheets of major central banks, all of which have been skyrocketing, and which allegedly reflects on “direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing”, currency wars in the light of competitive devaluation has been an ongoing event since 2008 as shown in the chart above. 

In short, neither has this been an exclusive Japan event nor has been a fresh development.

And this has also not been limited to major central banks but extends all the way to emerging Asia and to China as well, the Philippines included. (chart from the Bank of International Settlements)

In short, global central banks have been in a state of “currency war” or “currency manipulation” since 2008.

This article is not meant to absolve Japan's policies but to expose on what seems as political canard.

In reality “currency war” or “currency manipulation” or competitive devaluation is simply nothing more than inflationism. The great Ludwig von Mises defined inflation as

if the quantity of money is increased, the purchasing power of the monetary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also.

While there may be technical difference on what a central bank buys to expand her assets through a corresponding expansion of currency liabilities, the fact is that “quantity of money is increased”.

The assets of Swiss National Bank have mostly been in foreign currency reserves (as of November 2012) while the Bank of Japan has mostly been in JGBs (as of September 30, 2012). Table from (SNBCHF.com)

American neo-mercantilists have labeled “currency manipulation” on nations, who allegedly use of accumulation of currency reserves as exchange rate policy, from which they call their government to impose protectionist countermeasures such as China.

As I wrote previously this represents naïve thinking.

While the technical reasons why countries accumulate foreign currency reserves are mainly for self-insurance (for instance Asia reserve accumulation has partly been due to the stigma of the Asian Crisis) and from trade, financial and capital flows (NY FED), the real “behind the curtain” reason has been the US dollar standard system. Such system allows for a “deficit without tears”, or unsustainable free lunch by the use of the US dollar seingorage to acquire global goods and services that results to seemingly perpetual trade deficits. 

Deficit without tears, as the late French economist and adviser to the French government Jacques Rueff wrote in the Monetary Sin of the West (p.23), “allowed the countries in possession of a currency benefiting from international prestige to give without taking, to lend without borrowing, and to acquire without paying.” 

And this has been the main reason for America’s “financialization” and the recurring policy induced boom bust cycles around the world, which essentially has been transmitted via the Triffin dilemma or “the conflict of interest between short-term domestic and long-term international economic objectives” of an international reserve currency

Thus blaming China or even the Philippines for reserve currency accumulation seems plain preposterous and only represents political lobotomy.

Currency war or currency manipulations serves no less than to “cloak the plea for inflation and credit expansion in the sophisticated terminology of mathematical economics”, to quote anew the great professor Ludwig von Mises from which “to advance plausible arguments in favor of the policy of reckless spending; they simply could not find a case against the economic theorem concerning institutional unemployment.”

And may I add that pretentious public censures account for as ploys to divert public’s attention or serve as smokescreens from homegrown government “inflationist” policy failures.

Since major central bank represented by the G-20 knows that by labeling Japan as instigator of currency wars would be similar to the proverbial pot calling the kettle black, they went about fudging with semantics to exonerate Japan’s political authorities.

From Bloomberg,

Global finance chiefs signaled Japan has scope to keep stimulating its stagnant economy as long as policy makers cease publicly advocating a sliding yen.

The message was delivered at weekend talks of finance ministers and central bankers from the Group of 20 in Moscow. While they pledged not “to target our exchange rates for competitive purposes,” Japan wasn’t singled out for allowing the yen to drop and won backing for its push to beat deflation.

This doesn’t look like a “war”, does it?

At the end of the day, currency war, or perhaps, stealth collaborative currency devaluation (perhaps a modern day Plaza-Louvre Accord) maneuvering means that central bank shindig will go on; publicity sensationalism notwithstanding.

PBOC Sets Another Record Weekly Liquidity Injection

I pointed out in last week that media, backed by the consensus, have been saying that China’s economy has been “recovering”.  Such  has been linked to the resurgent stock market as reflected by the Shanghai index

On the other hand, I have been pointing out that China’s government has been engaged in stealth stimulus via State Owned Enterprises (SoE) and from the PBoC which has been artificially boosting statistical recovery and has prompted for asset inflation.

Ironically the so-called recovering China has been reported to require another bout of record interventions from China’s central bank, the People’s Bank of China (PBOC) which has been slated for this week.

From the NASDAQ

China's central bank is set to pump a net 662 billion yuan ($106.3 billion) into the banking system this week through regular open-market operations, marking a record weekly liquidity injection in a bid to meet surging cash demand ahead of the Lunar New Year holiday, traders said Thursday.

The People's Bank of China is offering CNY410 billion worth of 14-day reverse repurchase agreements, a short-term lending facility, they said.

It injected a net CNY59 billion last week via its regular open-market operations after draining a net CNY49 billion the week before.

China’s government recently has been pinning the blame of easing policies, as well as currency wars, on developed economies that has led to domestic “imported inflation”. The reality is that there is no such thing as imported inflation. China’s concern over the growing risk of price inflation is a function of domestic policies.

As Kel Kelly at the Mises Institute explains

When the PBOC creates yuan, it expands the money supply. It is therefore this expansion in the money supply, not an artificially low currency per se that is creating price inflation in China.

China’s economy has swimming in debt with the recent property bubble leading to record inventory levels (Wall Street Journal Blog).

Perhaps the real reason the why such record liquidity injection has been put in place has been about the tenuous state of the banking system. 

According to Tim Staermose of the Sovereign Man:

That’s because, just as in the West, the Chinese government is engaging in a giant game of “extend and pretend.” Chinese banks have just rolled over 75% of all loans to local governments, which were supposed to have been repaid by the end of 2012.

We’re talking about at least 3 trillion Chinese Yuan, or nearly half a TRILLION dollars worth of debt. It’s an enormous burden.

Global asset bubbles are about illusions based on policies of "extend and pretend". And China plays an important role in it. 

Or perhaps an added reason could be that the PBoC's recent interventions in the currency markets could mean that China may have joined the currency war which she has been lamenting about. As an old saw goes, "If you can't beat them join them"

Asian and Emerging Market Currencies Confronts the US ‘Our Currency, Your Problem’ Dilemma

Former US Treasury Secretary’s John Connally’s famous comment about the US dollar where he said was “our currency, but your problem” seems very pertinent today.

Governments of Asian and emerging economies whose currencies have been linked to the US dollar have been feeling frictions or pressures from the US Fed’s credit easing policies (as well as from the other developed economies).

From Bloomberg,

Hong Kong’s de facto central bank stepped in for the first time since 2009 to prevent the city’s currency from rising against the U.S. dollar after it touched the upper limit of a range that triggers an intervention.

The Hong Kong Monetary Authority said it bought $603 million at HK$7.75 per dollar, which is the so-called strong side of the permitted convertibility range of HK$7.75 to HK$7.85 that obligates intervention. The move, announced in an e-mailed statement yesterday, was confirmed by spokeswoman Rhonda Lam who said the HKMA acted during New York trading hours.

“Funds continue to flow into Hong Kong given the monetary easing in the U.S. and Europe,” said Kenix Lai, a currency analyst at Bank of East Asia Ltd. in Hong Kong. “That’s evident by the rising stock market and property prices. I expect HKMA will still have to intervene in the near term as capital inflows continue.”

Policy makers from around the world have bemoaned the economic threat of stronger exchange rates from the U.S. Federal Reserve’s monetary easing. At International Monetary Fund meetings in Tokyo this month, Brazil’s Finance Minister Guido Mantega vowed to shield his country from the “selfish” monetary policies of some developed nations, while Philippine central bank Governor Amando Tetangco said the Fed was causing “challenges to monetary policy in emerging markets.”

Each government have their own idiosyncratic political agenda, where the supposed lumping of threat of a “stronger exchange rate” is in truth signifies a dubious, if not devious, propositions.

The fact is that all central banks have been doing the same thing, except the difference lies on the degree or scale of inflationism and interventions. The above shows Hong Kong as no different.

The world operates in uncharted territory when it comes to government's aggressive use of monetary tools spearheaded by developed economies (chart from Zero Hedge)

Yet for some governments, the apparent passing the blame on others serve as convenient smokescreens to impose domestic social controls and to implement policies which benefits the incumbent political leaders.

As I pointed out in the past 

In a world where central banks compete to destroy their currencies through devaluation, rising currencies may signify as symptoms of relative devaluation and they could also mask the bubble policies that underpins the statistical economic growth.

Maybe emerging market or Asian central bankers would like to try a shock therapy: Link their currencies to gold and simultaneously liberalize their economies.  However, this would go against the interests of those in power or the political class, as well as, those connected to or dependent on them.

Besides, these would vastly reduce the ability for politicians to make political promises that would jeopardize their hold on power.

At the end of the day, currency wars or the dilemma of "our currency, your problem" through the threat of "stronger exchange rates" makes for great soundbites.

Currency Manipulation and the Politics of Neo-Mercantilism

At the local stock market forum, the Stock Market Pilipinas I had been asked to comment about the currency manipulation charges hurled against China.

For starters, as per Wikipedia’s definition of currency intervention, otherwise known as exchange rate intervention or foreign exchange market intervention, is the purchase or the sale of the currency on the exchange market by the fiscal authority or the monetary authority, in order to influence the value of the domestic currency. (bold emphasis mine)

In brief, the employment of currency/foreign exchange/exchange rate interventions implies that both monetary and fiscal authorities of ALL nations are currency manipulators.

(chart from Bloomberg)

As evidence, considering that international reserves assets (excluding gold) are at record highs mainly through the expansion of central bank balance sheets (via unsterilized interventions) these means that all central banks have been manipulating their respective currencies.

The growth of central bank balance sheets includes Asia and the Philippines. (Bank of International Settlements)

Such concerted balance sheet expansions has also been reflected on the state of money supply growth. (chart from Mao Money, Mao Problems)

Fund manager David R. Kotok of Cumberland Advisors has a good narrative of why the growing concerns over dollar debasement are valid.

Mr. Kotok writes, (bold emphasis mine)

The dollar maintains its reserve currency status because it is the least worst of the major four currencies – the US dollar, the British pound, the Japanese yen, and the euro.  All four of these currencies are now suffering the effects of a stimulative, expansive, and QE-oriented monetary policy.

We must now add the Swiss franc as a major currency, since Switzerland and its central bank are embarked on a policy course of fixing the exchange rate between the franc and the euro at 1.2 to 1.  Hence the Swiss National Bank becomes an extension of the European Central Bank, and therefore its monetary policy is necessarily linked to that of the eurozone… 

When you add up these currencies and the others that are linked to them, you conclude that about 80% of the world’s capital markets are tied to one of them.  All of the major four are in QE of one sort or another.  All four are maintaining a shorter-term interest rate near zero, which explains the reduction of volatility in the shorter-term rate structure.  If all currencies yield about the same and are likely to continue doing so for a while, it becomes hard to distinguish a relative value among them; hence, volatility falls.

The other currencies of the world may have value-adding characteristics.  We see that in places like Canada, Sweden, and New Zealand.  But the capital-market size of those currencies, or even of a basket of them, is not sufficient to replace the dollar as the major reserve currency.  Thus the dollar wins as the least worst of the big guys.

Fear of dollar debasement is, however, well-founded.  The United States continues to run federal budget deficits at high percentages of GDP.  The US central bank has a policy of QE and has committed itself to an extension of the period during which it will preserve this expansive policy.  That timeframe is now estimated to be at least three years.  The central bank has specifically said it wants more inflation.  The real interest rates in US-dollar-denominated Treasury debt are negative.  This is a recipe for a weaker dollar.  The only reason that the dollar is not much weaker is that the other major central banks are engaged in similar policies.

Given the high concentration of exposure by the world’s banking system on these four major international reserves currencies (US dollar, British pound, Japanese Yen, and the euro), this means that policies of ancillary central banks has to adjust in accordance to the policies of these major international reserve currencies.

In short, policies by the US mostly dominate on the policies of global central banks. Alternatively this suggest that the US has been the world’s biggest 'currency manipulator'.

While it is also true that some peripheral currencies has differentiating factors as pointed above, the point is that these currencies don’t have enough market depth to replace the incumbent international reserve currencies.

As caveat, such premises remain conditional on the absence of a currency crisis. Abrupt changes to the current setting should be expected if or once a currency crisis should occur.

Yet the fundamental issue is to understand the role of role of central banks. As Mises Institute founder Llewellyn Rockwell Jr. recently wrote, (lewRockwell.com):

First, they serve as lenders of last resort, which in practice means bailouts for the big financial firms. Second, they coordinate the inflation of the money supply by establishing a uniform rate at which the banks inflate, thereby making the fractional-reserve banking system less unstable and more consistently profitable than it would be without a central bank (which, by the way, is why the banks themselves always clamor for a central bank). Finally, they allow governments, via inflation, to finance their operations far more cheaply and surreptitiously than they otherwise could.

The bottom line is that currency manipulation, through inflationism, is the essence of the paper money legal tender based central banking.

So what’s the hullabaloo over China as "currency manipulator"?

Well, “currency manipulation” has been no less than a popular sloganeering of “us against them” politics meant to attain political goals.

Such political goal has been subtly designed for the protection of the privileged business interests allied with the political class through trade restrictions or through the transformation “of the economy from roughly laissez-faire to centralized, coordinated statism” as the great dean of Austrian school of economics Murray N. Rothbard pointed out.

This is called neo-mercantilism.

In the 80s, rising Japan had been painted as a threat to American economic standings, such that hate and envy based politics echoed the call for neo-mercantilist protectionism, again from Professor Rothbard,

Protectionism, often refuted and seemingly abandoned, has returned, and with a vengeance. The Japanese, who bounced back from grievous losses in World War II to astound the world by producing innovative, high-quality products at low prices, are serving as the convenient butt of protectionist propaganda. Memories of wartime myths prove a heady brew, as protectionists warn about this new "Japanese imperialism," even "worse than Pearl Harbor." This "imperialism" turns out to consist of selling Americans wonderful TV sets, autos, microchips, etc., at prices more than competitive with American firms.

Is this "flood" of Japanese products really a menace, to be combated by the U.S. government? Or is the new Japan a godsend to American consumers? In taking our stand on this issue, we should recognize that all government action means coercion, so that calling upon the U.S. government to intervene means urging it to use force and violence to restrain peaceful trade. One trusts that the protectionists are not willing to pursue their logic of force to the ultimate in the form of another Hiroshima and Nagasaki.

With Japan suffering from a humongous bubble bust that has led to a lost decade, today such political bogeyman has shifted to China.

The mainstream (mostly representing captured interests) has used all sorts of highly flawed and deceptive technically based assumptions and theories as cheap labor theory, cheap currencies, global savings glut, global imbalances and others to divert or camouflage the public’s attention from the unintended consequences from serial interventionist domestic policies and bubble monetary policies by riling up or conjuring emotive nationalist or xenophobic sentiment.

Gullible public opinion are easily swayed due to either the dearth of economic understanding or because they are blinded from the obsession to politics.

As the great Ludwig von Mises pointed out (OMNIPOTENT GOVERNMENT p.183)

People favor discrimination and privileges because they do not realize that they themselves are consumers and as such must foot the bill. In the case of protectionism, for example, they believe that only the foreigners against whom the import duties discriminate are hurt. It is true the foreigners are hurt, but not they alone: the consumers who must pay higher prices suffer with them.

And part of that reality has not entirely been about achieving some dubious trading objectives but to expand credit, again for political goals.

Again the Professor von Mises, (Human Action)

While the size of the credit expansion that private banks and bankers are able to engineer on an unhampered market is strictly limited, the governments aim at the greatest possible amount of credit expansion. Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.

The politics of neomercantilism exploits economic patsies and the politically blind in the name of nationalism for the benefit of political class, vested interest groups and or their cronies at the expense of society.