'..Japanification, to use a word, is going to make income and wealth inequality worse, not better.''Public pension funds will get hammered in the bear market and many will have difficulty meeting their obligations. Governments will be forced to either cut benefits, raise taxes, or both. That is not going to make for a happy citizenry. It will play out in different manners all across the world, but the resulting frustration will be the same. And to put it very bluntly, “frustration” is inadequate to describe the result of underfunded pensions. Retirees made plans for their futures based upon receiving those pensions. And taxpayers likewise make plans.
All of this will have significant investment implications, which we will visit below and in great detail in the coming weeks and months. But Japanification, to use a word, is going to make income and wealth inequality worse, not better.'
- John Mauldin,
Time to Change Strategy, May 3, 2019
'..Hong Kong .. Neither central bank presidents, monetary authority heads, currency board architects, treasury officials, nor the IMF will ever explain the potential risks of default or currency board/peg failure until it’s too late. Doing so is antithetical to their mission to promote and maintain stability.''The HKMA has spent 80% of their reserves over the past year or so. If the aggregate balance goes to zero, we expect Hong Kong rates will spike (as you see we are in the convex portion of the scatterplot today) and their banking system could collapse. Hong Kong currently sits atop one of the largest financial time bombs in history.
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In September of 1983, the South China Morning Post declared that the currency was in “free-fall” and that Hong Kong was becoming a banana republic. Then, after denying the plans in the press on multiple occasions, the Hong Kong government pegged the local currency to the USD. The peg was entered into hastily to calm investors’ minds and restore some sense of order and confidence. The day after the handover from the British to the Chinese happened to be the day the Thai Bhat broke its peg to the USD and began a tumultuous 53% devaluation. Investors in various Asian nations were actively selling domestic investments and currencies to move to the safe haven of US Dollars (they had also borrowed heavily in US dollars which intensified the situation). The Asian Financial Crisis of 1997 was in part sparked by the lack of trust in the Chinese as they took over control of Hong Kong.
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Currency pegs and currency boards are rigid financial ideas that are an attempt to bring confidence and fiscal discipline into an emerging economy. Some say they are a substitute for a disciplined monetary policy rule for undisciplined monetary policy. The funny thing about the history of such relationships is that they almost exclusively assume and rely on the discipline on the anchor’s side. Historically, the anchor currency (predominantly the USD) has been the regime with policy stability and relative fiscal discipline. The Global Financial Crisis forced the United States to take interest rates to zero for the first time in its history. All prior studies on currency boards, inflation, and the relationships between the pegged economy and the anchor economy need to be tabled for this discussion. The inmate (the anchored currency) is now running the asylum.
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Investors must pay keen attention to the balances and imbalances that matter and avoid listening to “others” telling them that everything is going to be fine. One only needs to look back at major dislocations in history to learn that the architects and keepers of the sovereign have no incentive to warn investors of the risks. In early 2015, European Commission President Jean-Claude Juncker said, “There will be no default.” He was referring to Greece’s acute debt management problems. When rumors of a secret meeting between Euro area finance ministers were confirmed immediately after Juncker denied the meeting even happened, he was quoted saying something profound for a public official to admit to. When confronted by the same reporters he had just lied to, he said, “when it becomes serious, you have to lie.” Greece went on to default on its sovereign debt later in 2015. Private sector bondholders lost 80% of their money. Neither central bank presidents, monetary authority heads, currency board architects, treasury officials, nor the IMF will ever explain the potential risks of default or currency board/peg failure until it’s too late. Doing so is antithetical to their mission to promote and maintain stability.
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US Congressman James McGovern (D-Mass) said in a statement this month that “the people of Hong Kong and foreigners residing in Hong Kong – including 85,000 Americans – must be protected from a criminal justice system in mainland China that is regularly employed as a tool of repression.” The Hong Kong autonomy issue is one of the rare places where both sides of the United States political spectrum are in agreement. The United States will not stand silent while this new proposal becomes law. This has major implications for the 1992 Policy Act continuing to stand and US-Hong Kong trading relations remaining unobstructed.
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These shifts have just begun. Investors, Hong Kong depositors, and policy makers alike need to pay strict attention to the outcome of this legislative dance between China and Hong Kong. Hong Kong is currently the center of China’s ability to raise US Dollars in Asia. China is desperately short of US dollars and, therefore, needs Hong Kong to remain a non-tariffed most-favored-nation trader with the United States and the United Kingdom.'
- Kyle Bass (
On My Radar: Parkinson’s, Stock Buybacks and the Hong Kong Short, May 3, 2019)
'In my 30 years of studying Bubbles, a few things have become clear – I would argue indisputable: They always burst. During the Bubble, virtually everyone dismisses Bubble analysis, instead believing the boom is well-founded and sustainable. The pain on the downside is proportional to the excesses during the preceding boom. Tremendous damage is inflicted during the final “Terminal Phase” of excess.''We live in an era where unstable global financial markets dictate financial conditions and economic performance like never before. Moreover, the world is in the throes of history’s greatest financial and market Bubbles. So discard any fanciful notion of “equilibrium.” At this point, the Bubble either inflates or falters – and the longer it inflates the more acutely vulnerable everything becomes. The global Bubble was in jeopardy in December, with ill-prepared central bankers coming feverishly to the markets’ rescue. Their next rescue attempt will come with greater challenges.
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My fascination with Bubbles goes back more than 30 years (Japan in 1986). There have been so many – seemingly an endless stream of Bubbles: Japan, U.S. equities, junk bonds and leveraged buyouts, the S&Ls, and coastal real estate Bubbles from the second-half of the eighties. Bonds, mortgage derivatives, Mexico from the early nineties. SE Asia, Russia and EM from the mid-nineties. A major U.S. Bubble in technology, telecommunications and corporate Credit more generally. Argentina. Iceland. The historic U.S. mortgage finance Bubble. Europe, especially Greece and the European periphery. Dubai and so on – to mention only the first that come to mind.
In my 30 years of studying Bubbles, a few things have become clear – I would argue indisputable: They always burst. During the Bubble, virtually everyone dismisses Bubble analysis, instead believing the boom is well-founded and sustainable. The pain on the downside is proportional to the excesses during the preceding boom. Tremendous damage is inflicted during the final “Terminal Phase” of excess.
There’s no sound reason to believe China has discovered some magic formula for escaping the downside. These days there’s every reason to contemplate what a bursting Chinese Bubble will mean to China and the rest of the world. And I find it very intriguing that there is absolutely no mention of China in all the discussion of inflation and Fed policy. I actually believe that acute Chinese fragilities go a long way towards explaining (the latest “conundrum” of) depressed global sovereign yields (especially Treasuries, bunds and JGBs) in the face of surging risk markets.
Sure, China’s boom has been inflating for so long that the naysayers (arguing the view of an unsustainable Bubble) have been long discredited. I would strongly argue that the historic Chinese Bubble has been the most perilous consequence of Bernanke’s zero rates/QE, Draghi’s “whatever it takes,” Kuroda’s “QE infinity,” and, more generally, the most aggressive and protracted synchronized global monetary stimulus imaginable. In many respects, China has become the epicenter of the now decadelong global government finance Bubble. Today, no market – sovereign debt, equities, corporate credit, commodities, currencies and derivatives – is immune to the Virulent China Syndrome.
The upshot to the most globally accommodated Bubble ever has been history’s greatest credit excesses; unprecedented domestic over/mal-investment; unparalleled inflations in bank Credit and apartment finance; a massive pool of Chinese global spending and investment; and the most dangerous distortions in global trade, financial flows, and structural imbalances the world has ever experienced.
The China Bubble has altered global inflation dynamics – it has fundamentally changed geopolitics and the world order. It has certainly played a prevailing role in a global backdrop promoting asset inflation at the expense of wages – in the process exacerbating inequality. And, increasingly, China’s ascendency on the world stage has spurred an extraordinary Arms Race in everything technology, industrial, military and geopolitical. In short, China has become the Global Poster Child for Unsound “Money” - with incredibly far-reaching consequences.
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Beijing’s huge horde of international reserve assets created the capacity for sustaining its Bubble beyond that of all previous developing economies. While down from the $4.0 TN peak back in mid-2014, China’s $3.1 TN of reserves has been sufficient to maintain confidence in the Chinese currency and hold market crisis fears at bay. There was a scare in late 2015. Fears subsided when China pushed through aggressive stimulus while global central banks adopted only greater QE and monetary stimulus. And when currency weakness again posed risk to the Chinese Bubble late last year, Beijing pivots to yet another round of stimulus.
While conventional thinking holds that Beijing can stimulate Chinese Credit and economic output at its discretion indefinitely, such optimism is at this point misguided. A large and growing portion of the recent Credit expansion has flowed into non-productive purposes – including inflated apartment markets, hopelessly insolvent corporate borrowers and egregiously overleveraged local government entities. Stimulus operations are losing the battle of diminishing marginal returns. Meanwhile, “Terminal” excess continues to ensure systemic risk rises exponentially – the apartment Bubble, the ballooning banking sector, resource misallocation and deep structural impairment. And let’s throw in unquantifiable “carry trade” speculative leveraging that has surely ballooned precariously.
It’s worth pondering that China’s international reserve holdings have not expanded in eight years. Over this period, Chinese banking system assets have inflated 165% (to $39TN). Chinese GDP has inflated 113% ($13.6TN). System Credit has easily more than doubled. And let’s not forget that there is little transparency as to the composition of China’s $3.1 TN of reserves. Much has been committed to China’s fledgling international lending programs.
While global risk markets have grown complacent with regard to China, the scope of myriad China-related latent risks should have alarm bells ringing. Yet I’ll be the first to admit that such risks can remain largely masked so long as Chinese Bubble inflation is uninterrupted. For this, Credit growth must accelerate.
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Meanwhile, reminiscent of the second-half of 2007, collapsing market yields and anticipation of another round of Fed stimulus throw gas on the speculative mania burning white-hot in the risk markets. Why fret some potentially lurking Chinese developments months (or years) into the future with such easy “money” to be made in the risk markets in the here and now? If I were Chairman Powell, I certainly wouldn’t be interested in stoking that fire either.'
- Doug Noland,
Transitory Histrionics, May 4, 2019
Context'..if we’re now at an inflection point for global market liquidity..''..the “middle class” suffering disproportionately from inflation and Bubbles..''..things continue to follow the worst-case scenario .. It was another blunder for the global central bank community..'