It has always sounded archaic, at best. Most think “lunatic fringe.” Yet, there is nothing as fundamental, vital, as urgent as Sound Money. Stable money and Credit that we can trust; that doesn’t inherently cause trouble; that doesn’t unleash the Scourge of Inflation.
How many crises – how much mayhem, monetary disorder and human hardship – until we finally learn? Serial economic booms and busts; market Bubbles, manias and collapses; inequality and inflation; insecurity, fragmentation and conflict – both domestically and internationally. And the process is so incredibly insidious, as unsound money and attendant monetary disorder surreptitiously operate as a wrecking ball – methodically chipping away, bit by bit by bit, over decades. Chipping away at financial, economic, social, political and geopolitical stability. Chipping away at our faith in the markets, policymaking, our institutions, the future. And the costs are unfathomable. Even war.
The S&P500’s 4.6% rally notwithstanding, it was another in a series of distressing weeks. The world is changing, and sometimes there’s an almost slow-motion element that offers a particularly coherent view of what the future holds. The UK, one of our closest allies, has succumbed to financial, economic and political crisis – with strong, effective leadership seemingly a pipedream. Chairman Mao – I mean Xi – spewing ideology from an era the world thought had been relegated to a less enlightened period of history. The war in Ukraine, which becomes more reminiscent of World War II savagery by the week.
And it’s one of the great ironies: After inundating the world with Trillions of surplus dollar balances, “king dollar” nonetheless reigns supreme. But that doesn’t alter the fact that the U.S. has arguably been the world’s most consequential perpetrator of unsound money. Where might energy prices trade today if not for multi-Trillions of global QE? The size of Russia’s international reserve position and Putin’s ambitions? And then there’s China’s $4.0 TN (now closer to $3TN) of international reserves, having inflated perilous delusions of grandeur (among other things).
October 16 – Bloomberg (Rebecca Choong Wilkins and Kari Soo Lindberg): “President Xi Jinping had a clear message to those who want to thwart China’s rise: You will fail… Xi let the world know that China wouldn’t change course even as it faces ‘dangerous storms’ in a more hostile world. Instead, he declared the ‘rejuvenation of the Chinese nation is now on an irreversible historical course’ and more forcefully offered China up as an alternative to the US and its allies. ‘China’s international influence, appeal and power to shape the world has significantly increased,’ Xi said… ‘Chinese modernization offers humanity a new choice for achieving modernization,’ he added. Xi’s remarks indicate that China is ready to stare down a growing challenge from the US under President Joe Biden, who has moved to hinder Beijing’s ability to access advanced technology and sought to deter any military action against Taiwan — the biggest flash point between the world’s biggest economies. The Chinese leader hailed the nation’s ‘fighting spirit’ and said the country was ‘well-positioned for pursuing development and ensuring security.’”
I remember back in the eighties, when Japanese manufacturing and finance appeared poised to take over the world. It was all a fantastic Bubble illusion. And when their Bubble burst, Japanese policymakers were completely absorbed by domestic issues. There was recognition that serious mismanagement was responsible for the nation’s predicament. I was always intrigued that more blame wasn’t directed at U.S. pressure on Japan to further stimulate throughout the Bubble period. The Japanese weren’t out to settle scores, forge enemies or remake the world order. And perhaps the ballot box provides (provided) democracies more of a release valve and levelheaded political disposition than is generally appreciated.
I worry about China. I have deep sympathy for the Chinese people. They’ve worked incredibly hard – endured so much. They had dreams and expectations inflated by historic Bubble excess. Of course, they were willing to tolerate Beijing’s heavy hand – that didn’t seem such a hefty price to pay when wages were surging and apartment prices skyrocketing. It was nothing short of truly unimaginable (perceived) wealth-creation. Confidence grew that the Chinese growth model was both clearly superior and sustainable. It was easy to ignore a lot, while hailing the great Beijing meritocracy. Bubbles create genius.
October 18 – New York Times (Keith Bradsher): “For the past quarter-century, China was run by a well-oiled government bureaucracy that predictably focused on the economy as its top priority. That may no longer be the case. Xi Jinping, China’s top leader, made clear… that politics and national security were paramount. That point was reinforced the next day when Beijing made the unusual move of delaying what should have been a routine, closely stage-managed release of data on how the economy fared in the past three months. ‘It does show the primacy of politics in influencing the very competent, institutional technocracy that China has,’ said Victor Shih, a specialist in Chinese elite politics and finance at the University of California, San Diego.”
Make no mistake, China’s historic Bubble is deflating. And nary a ballot box to be found anywhere. Expect no humility out of Beijing – no self-reflection or adjustment. Who’s willing to take responsibility for mistakes? The communist party totally bought into the Bubble Illusion: China finally overcoming centuries of foreign deprivation to assume its destiny as a (the) world superpower. How things play out over the coming decades is unknown. For now and the foreseeable future, China faces arduous post-Bubble financial and economic adjustment.
October 16 – Bloomberg: “Chinese President Xi Jinping reiterated that economic development is the Communist Party’s ‘top priority,’ a signal that Beijing will continue to emphasize growth despite some analysts expecting a shift toward greater focus on national security. At the opening of the 20th party congress… he echoed development-first phrasing used in congress addresses by every party leader since Jiang Zemin in 2002. ‘Development is the party’s top priority in governance,’ he said. Xi has increasingly been highlighting the need to balance security concerns with economic growth since 2020, prompting some analysts to suggest Xi would drop the development-first slogan… At the same time, the president warned of the security risks China faces when pursing its ambitions, and twice mentioned in his speech the need to ‘balance development with security.’”
Some analysts took comfort from Xi signaling no change in priority for maintaining China’s economic growth model. Yet Beijing should today be keenly focused on post-Bubble structural adjustment, willing to tolerate a period of economic contraction necessary to purge uneconomic enterprises while reallocating resources. Fundamental to this readjustment is a focus on stabilizing a perilously dysfunctional Credit system. Finance should be redirected to sound enterprises, while significantly reducing system Credit growth. In short, Beijing must radically change the trajectory of monetary inflation to avert financial collapse.
Xi’s and the communist party’s priorities are elsewhere – so-called “security.” Beijing will use company/industry collapses as proof of Capitalism’s lawlessness and fragility, while absorbing more and more of the economy into the state apparatus. They remain determined to push hard for GDP growth, downplaying the risk of acute financial crisis, with the overarching objective of bolstering global standing, influence and raw power. Geopolitics – their dangerous obsession – is now driving Beijing policymaking. Serious policy mistakes will continue to pile up. There will be accidents, and the miscreants responsible are all preplanned: the U.S., Japan and the West.
October 16 – Bloomberg: “President Xi Jinping declared China’s global power had increased while warning of ‘dangerous storms’ ahead, striking a defiant tone to kick off a twice-a-decade Communist Party meeting… ‘China’s international influence, appeal and power to shape the world has significantly increased,’ Xi said… Still, he warned of a more unstable international environment, saying China must be prepared for ‘strong winds and high waves and even dangerous storms.’ ‘Confronted with drastic changes in the international landscape, we have maintained a firm strategic resolve and shown a fighting spirit,’ Xi, 69, said… ‘Throughout these endeavors, we have safeguarded China’s dignity and core interests and kept ourselves well-positioned for pursuing development and ensuring security.’”
I was holding out for a little positive surprise. I hoped Xi might inject a sliver of caution regarding his “partner without limits” – Putin’s Russia. None. If there were any lingering doubts, it’s now obvious that the objective of the China/Russia axis is to forge a new world order to counter U.S. power and influence. The quagmire Russia is creating does not alter China’s overarching goal. Xi is clearly more determined than ever, and his speech likely marks a critical historical juncture.
October 16 – Financial Times (Edward White): “China’s president Xi Jinping has signalled his intention to steer the foreign policy of the world’s most populous country and rising military superpower away from reconciliation with the west as he warned of ‘grave international developments’ not seen in the past 100 years… Xi touted his administration’s success in countering foreign interference and safeguarding China’s ‘dignity’ and ‘core interests’. Xi also issued thinly veiled criticism of the US and its allies, boasting that China under his leadership had taken a ‘clear-cut stance’ against hegemonism and stood unwavering in the face of ‘bullying’. China’s most powerful leader since Mao Zedong reiterated his commitment to taking control of Taiwan, potentially by military force.”
October 17 – Politico (Phelim Kine): “Chinese President Xi Jinping’s speech… charts a course for ongoing tense relations with the U.S. hinged to a dark vision of a China beset by ‘external attempts to suppress and contain’ it. Xi outlined an aggressive foreign policy on Sunday as he detailed his ‘work report,’ a document that sets out domestic and foreign policy priorities for the Chinese Communist Party for the next five years. ‘We will resolutely safeguard the security of China’s state power, systems and ideology — and build up security capacity in key areas,’ Xi said. ‘We will crack down hard on infiltration, sabotage, subversion, and separatist activities by hostile forces.’”
Xi’s speech widens the global chasm – hardens the new “iron curtain.” “China’s international influence, appeal and power to shape the world has significantly increased.” “Chinese modernization offers humanity a new choice for achieving modernization.” “China stands firmly against all forms of hegemonism and power politics, the Cold War mentality, interference in other countries’ internal affairs, and double standards.”
At a minimum, China will move aggressively toward self-sufficiency, certainly in the areas of semiconductors and high-technology generally. I would also now expect a more hostile approach with retaliatory trade measures. Restricting U.S. high-tech exports to China surely hit a nerve in Beijing. Retaliating with a ban on areas of importance to the U.S. economy would elevate this unfolding economic war to a more threatening level. I’ll also assume more overt support for Russia over the coming months, with the U.S. and Europe potentially adopting tougher attitudes toward sanctioning China.
The nurturing of a cult of personality is another ominous facet of Xi and the communist party. There’s too much narrative that would appear to be preparing the Chinese people for military confrontation.
October 19 – Bloomberg: “President Xi Jinping has accumulated so many titles he’s been called the Chairman of Everything. But one gaining traction among Communist Party elites is raising concerns of a Mao Zedong-style personality cult. Lingxiu, or ‘leader,’ is a revered title of praise previously reserved for Mao, the founder of the People’s Republic, who was referred to as ‘the great leader’ when the Cultural Revolution started in 1966. While party officials and state media have occasionally bestowed the title on Xi in the past few years — in the form of renmin lingxiu, or ‘people’s leader’ — this week has seen more cadres using the term, including at least two Politburo members.”
October 15 – Financial Times (Tom Mitchell and Primrose Riordan): “President Xi Jinping has called on the Chinese Communist party’s 97mn members to steel themselves for a ‘critical time’ in the country’s history, as he opened a congress that will solidify his status as its most powerful ruler since revolutionary hero Mao Zedong. In an almost two-hour speech…, Xi said the party’s ‘mission is glorious beyond compare’ as he outlined goals ranging from an ‘all-out people’s war’ against the Covid-19 pandemic to realising the unification of China and Taiwan. In one of the speech’s biggest applause lines, Xi pledged that the party, which celebrated its centennial last year and has been in power since 1949, would ‘never renounce the use of force [to achieve unification] and will take all necessary measures to stop all separatist movements’.”
October 16 – Financial Times (Kathrin Hille): “China’s leader Xi Jinping has used his biggest agenda-setting speech in half a decade to warn the US against further support for Taiwan, chiding ‘external forces’ for soaring tensions in the Taiwan Strait and suggesting they would be to blame if Beijing felt compelled to attack the country. ‘Facing severe provocations from the Taiwan independence forces and from interference by external forces, we resolutely carried out a major struggle against separatism and interference,’ Xi said…”
It was an important speech, though it’s left to future historians to judge how important. For years now, I’ve fretted the U.S. and China at loggerheads. I’ve worried that a bursting Bubble would provoke a Beijing move on Taiwan – as a distraction, as much as a mechanism to stoke nationalist fervour against the American and Japanese antagonists. It all seems even more palpable after Xi’s speech.
Yet another wild market week. Options expiration surely helped fuel the equities rally. Bond market vigilantes celebrated their newfound power, first with the abandonment of Truss’s “mini budget” and, soon afterwards, with the abandonment of Liz Truss. A Reuters headline: “Australia Aims for ‘Responsible’ Budget After UK Mayhem.”
The British pound rallied 1.2%, as 10-year gilt yields sank 28 bps (to 4.05%). But except for the week’s final few hours of trading, the global bond market sure looked broken. Treasury long-bond yields spiked 34 bps this week to 4.34%.
Japanese 10-year JGB yields traded above the BOJ’s 25 bps ceiling. Meanwhile, the yen breached 150 to the U.S. dollar for the first time since the dark bursting Bubble days of August 1990. The Bank of Japan was said to have aggressively intervened to support the yen, with the curious timing of intervention at the Friday London close on U.S. expiration day. With a shaky BOJ juggling a collapsing currency and faltering bond market peg, there’s every reason to expect markets to launch an aggressive and sustained assault.
In a sign of the times – of the new cycle – Chinese stocks and bonds couldn’t muster even a modicum of a rally for the big Communist Party Congress. The Shanghai Composite declined 1.1%. More alarming, it was another atrocious week for China’s developer bonds. Country Garden (#1 developer) yields surged another 10 percentage points to almost 77%. Evergrande yields spiked 23 percentage points (250%), Sunak 30 percentage points (164%), Lonfor 17 percentage points (165%) and Kaisa 33 percentage points (220%). An index of Chinese high yield dollar bonds was up over 100 bps to yield a record 28.2%. The renminbi declined another 0.5% versus the dollar (down 12% y-t-d) to the low since January 2008.
With systemic fears mounting, China’s “big four” bank CDS rose moderately to new multi-year highs. China sovereign CDS jumped a notable nine to 122 bps, the high since 2016.
It took longer than I expected. But it appears Federal Reserve officials are becoming increasingly concerned. Bullard, Evans, Daly and Kashkari all suggested a more cautious approach to Fed tightening measures may soon be appropriate.
While the economy has for the most part remained resilient, housing markets are at the cusp of a serious downturn. At 6.94%, benchmark 30-year mortgage rates have spiked to a 20-year high. This will be a different bust than the post-2008 housing crisis. I don’t expect Phoenix and California’s “inland empire” to be at the epicenter. Instead, inflated high-end markets across the country are unusually vulnerable to the spike in mortgage borrowing costs. In particular, we’ll see how much leverage and nonsense infected the California housing Bubble over this most protracted period of loose Credit.
Original Post 22 October 2022
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