'I’ll stick with the analysis that global markets are moving toward a very problematic scenario. Having witnessed previous EM crises (i.e. Mexico in ‘94/’95, Southeast Asian in ’97, Russia in ’98 and Brazil in ‘01/’02), it’s worth recalling how currency market dislocations become instrumental in systemic crises. Rapid drawdowns in international reserve holdings stoke fears of illiquidity, leading to a destabilizing “hot money” exodus. Rapidly shrinking reserve holdings force central banks to raise interest rates to support domestic currencies, with the resulting rapidly tightened financial conditions bursting fragile financial and economic Bubbles.''Italy, the U.K., China, India, Brazil and others… Global central bank-induced liquidity excess has kept numerous remarkably leaky boats afloat in recent years. There will be systemic hell to pay when the dam finally breaks.
I’ll assume Monday’s global market convulsions will have the U.S. administration and Beijing treading cautiously next week. Yet I expect it will prove more difficult this time to squeeze the genie back into the bottle. To see such high cross asset correlations around the globe is disconcerting. And we saw Monday how critical a stable renminbi has become to global finance. It’s not a stretch to say this global party comes to rapid conclusion the moment markets fear a disorderly Chinese currency devaluation.
..
..My sense is analysts have little grasp of potential capital flight risk, for China or EM more generally. How much “carry trade” leverage (borrow in low-yielding currencies to fund purchases in higher-yielding instruments) has accumulated during this most-protracted of speculative cycles? What other “hot money” vulnerability lurks (i.e. ETF flows, derivatives…). Such issues garner little notice when “risk on” is bubbling and liquidity is flowing abundantly. But we were reminded Monday how abruptly “risk off” deleveraging/de-risking can erupt – and how quickly fears of illiquidity and dislocation can take hold.
I’ll stick with the analysis that global markets are moving toward a very problematic scenario. Having witnessed previous EM crises (i.e. Mexico in ‘94/’95, Southeast Asian in ’97, Russia in ’98 and Brazil in ‘01/’02), it’s worth recalling how currency market dislocations become instrumental in systemic crises. Rapid drawdowns in international reserve holdings stoke fears of illiquidity, leading to a destabilizing “hot money” exodus. Rapidly shrinking reserve holdings force central banks to raise interest rates to support domestic currencies, with the resulting rapidly tightened financial conditions bursting fragile financial and economic Bubbles.
..
China’s major state-owned backs can support the renminbi through clandestine derivatives trading, while supporting the faltering small bank sector with liquidity and capital injections along with bolstering the faltering Chinese Bubble with aggressive Credit growth. This, as well, is an ostensible miracle – until it all blows up. To repeat: How large is the “carry trade” in higher-yielding Chinese securities? Add to this: How large are the big Chinese banks’ derivatives positions in support of the renminbi?
I am clearly not alone in the view that Beijing took a huge gamble in moving to devalue the Chinese currency this week. They today have a large international reserve position. Over the coming weeks and months, I expect analysts to increasingly question the adequacy of these reserves in light of extraordinary financial and economic vulnerabilities.
The key take-away from another critical week: As the marginal provider of global liquidity and economic growth, Chinese finance has become the epicenter of crisis dynamics. Global markets are highly correlated; speculative dynamics remain extraordinarily synchronized. At this point, a bet on global risk markets is a bet on China – a bet on the ongoing inflation of China’s historic Bubble. Developments – market, policy, economic and geopolitical - are corroborating the analysis that it’s very late in the game. I’ll assume the flow of “hot money” away from global risk markets has commenced.'
- Doug Noland,
"Hot Money" Watch, August 20, 2019
Context'..a world of debt, a historic global securities Bubble..'