Andy Xie on China's Cash Crunch

Andy Xie echoes the same problems I posted in the past couple of weeks, which threaten a devaluation in China.

When the China tide goes out
The central bank isn’t in a position to inject liquidity to replace all the departing hot money. Because the Federal Reserve is likely to tighten for three years to come, printing money to replace all the hot money that is leaving would put the country’s exchange rate under mounting pressure to devalue, which may trigger a full-blown financial crisis.
Andy Xie doesn't believe a crisis is necessary though:
The bursting of the speculative bubble has had a limited negative impact on the livelihood of the people. China’s position as the factory of the world is solid. The export weakness is due to weakness in global demand, not competition.

As exports are still rising at twice the pace of global trade, China’s economy has a solid cushion from any downturn.

The country is experiencing an acute shortage of manual labor. If the property market contracts, it won’t lead to widespread unemployment.

College graduates are having difficulty finding jobs, but, this is mainly due to the current economic model, which drives growth through construction and factory production. Only changing the growth model can solve China’s problem with insufficient white-collar jobs.
This is the goal of the new leadership, but the big question is whether it is already too late to transition. What happens if growth slows further, or global trade contracts, or if trade barriers start choking off trade?
Indonesia printed money to finance capital flight in 1997 and 1998. The country collapsed afterwards, bringing down the government and the banking system. China must learn from this lesson and control money supply.

In 1998, China refused to print money and devalue. It reformed to deal with the pressure, which gave the country a decade of economic boom. The same could happen now. Just control money supply and reform to handle economic difficulties.
China's problems were much smaller in 1998. Taking bad loans off the balance sheets of banks back then was easy, especially with the economy growing at 10%. Xie goes on to identify what I believe in the main flaw in China's financial system:
Since the yuan is de facto pegged to the dollar, the outflow is greater than what Brazil or India faces, as hot money outflow is not discouraged by a lower exchange rate.
The yuan can resist devaluation for a long time, until it cannot. China can experience greater volatility and appear more stable, but if volatility reaches an extreme, it is China that will experience a cataclysmic event because the rigid systems that maintain stability today will break, just as Thailand's peg broke in 1997.

Another factor working to devalue the yuan is the run-up in money supply:
Further, the rampant monetary growth is losing impact on the real gross domestic product growth rate. M2 rose by 6.1 trillion yuan and the net increase in all sources of financing rose by 6.2 trillion yuan in the first quarter of 2013. But the nominal GDP increased by only 1.1 trillion yuan from the year before.
And then we come to the crux of the crisis, why I suggested that the Chinese Yuan Could Devalue 50% Or More:
If China insists on pumping liquidity to replace the outflow of hot money, it encourages capital outflow by holding up asset prices artificially high. As its money supply is five times the country’s foreign exchange reserve and the annual growth in money supply alone is two-thirds of forex reserves, replacing capital flight by printing money can go disastrous quickly.

In 1997-98, Indonesia did just that. It even borrowed lots of money from the International Monetary Fund to finance capital flight. When the U.S. dollar reserves dried up, the currency and the financial system collapsed.

When a country faces what China faces now, it can either raise interest rates or devalue the currency. Avoiding both just creates a bigger disaster.
I believe a devaluation is inevitable because I do not see deflation being contained, financially or psychologically. There will be a major decline in social mood that will lead to a crisis of confidence. Whether justified or not, the entire globe will question the Chinese model of growth, just as the world questioned American capitalism in the wake of 2008.

Longer term, I'm optimistic like Xie, but I believe his economic arguments lack the psychological impact of slower growth. For instance, he says lower property prices will only hurt the speculators and corrupt officials holding millions of empty apartments. This is like saying subprime will be contained to California or other markets. When a system swings into reverse, the impact reverberates across the entire economy. All of Chinese business will lose confidence if the market, which has moved for so long in one direction, suddenly starts moving the opposite way.


Elliot Waves in Solar Cycles?

One stumbling block for a Grand Supercycle top is imagining how the economy could collapse enough to fulfill the forecast waves. Here's one way.

Solar Flare poses huge threat
A solar flare that could wipe out the communications and electrical grids while frying a wide variety of electronics, quickly sending us back to the 19th Century.


Chinese bank offers 6% return up front for ¥1 million 1-Yr CD

Last week it was the deposit wars, with Chinese banks fighting for deposits as the cash crunch intensified. Now everyone is getting in the act and stepping up the battle. Banks are pushing their staff to get friends and family to purchase financial products. In addition to offering more than 6% and even more than 10% interest (these are major banks, the smaller credit companies are already offering well into the double digits as I noted in More On Yuan Depreciation, China's Great Depression), big banks are also offering cash up front. One advertisement offers 60,000 yuan cash on the spot for customers who purchase a 1-yr 1,000,000 yuan CD, or an upfront payment of 6% interest, plus 33,000, or 3.3% interest at maturity, for a total of 9.3% interest.

Banks have also cut their fees for customers moving cash into the banks, while shutting down their systems to customers trying to move cash out of their accounts. (See: Bank Outages Trigger Cash Worries in China for news of the latter.)

There is a full on scramble for cash in China.

银行多管齐下揽储 100万存一年定期当场可提6万

Liu Jun Luo: Gold going to $500; Chinese yuan will collapse; China will nationalize dollar deposits

One thing I always warned about was a China gold puke. Gold bulls did not realize the bubble mentality in China. House flippers and stock chasers gave up on these markets after the stock market burst and the government cracked down on lending. They turned to gold and subsequently helped push it to a record high in September 2011. That peak in gold happened only months after the Chinese real estate market was hampered by the Chinese government.

Back in late 2010, Liu Jun Luo was looking for a gold crash, stock market crash in China and major U.S. dollar rally. Now he is getting it.

China stock market will collapse, gold will implode to $500 中国股市的崩盘和黄金暴跌到500美元

He compares China's historical collapses, when great wealth was concentrated and squandered by the Emperors. He notes that at $1900, the market value of gold was $11 trillion, but the paper gold market, mining shares, derivatives, GDP of gold producing nations and related CDS were worth $15 trillion. Thus from a leveraged position, taking down the price of gold can have a huge impact. The U.S. will earn trillions against China's trillions in losses. The real crash has yet to even begin, he expects gold will collapse to $500 in what I can only assume is a major deflationary collapse in China.

China's "money panic" is the central bank's fear of a dollar rally 中国“钱慌”是中国央行对美元将暴涨的恐惧

Those believing the market explanation for China's money panic are self-deluding fools. At present, China's deposit reserve ratio has reached 20% , China's banking sector loan to deposit ratio is 75%. Our deposit reserve ratio can be reduced to the 8% to 10% level. The European and American banking deposit ratio is 120% .

Therefore, a reduction of 5% in the deposit reserve ratio is equal to the release of four trillion yuan money supply. And by raising the upper limit of the banking sector's loan-deposit ratio, the central bank can release a few trillion yuan in money supply.

In theory, China's central bank has more than ten trillion it can immediately put into the market. But why has China's central bank has deliberately created this "money panic?" Does China's central bank not understand the seriousness of the rate of decline in China's economy and the out of control rise in currency transaction costs?

In the last month I have been reminding everyone on Sina Weibo— "the rate of decline of China's economy will far exceed everyone's worst expectations and people will flee China's stock market like rats escaping a sinking ship."

2012 end of the year I published a book , "Surviving the Great Depression - 2013 error for the central bank pays the bill " speaks very clearly - the Chinese Economy in 2013 is faced with the disastrous causes of a Great Depression:
(A) the Bank of Japan to launch devaluation of the yen exchange rate;
(Two) the U.S. government began a neutral fiscal austerity;
(Three) In the face of rapid economic decline and the rapid rise in interest rates, China's central bank takes the policy of indifference.

From 2010 onwards, when the Dollar Index was 74, China's central bank made the strategic decision that the dollar would devalue over the long-term. Therefore, China's central bank began selling dollars and buying the euro, the yen and commodity currencies to diversify China's foreign exchange reserves.

However, beginning in 2013 , China's central bank suddenly found the U.S. economy has been gradually recovering. The euro zone economy has continued into a disastrous predicament. Meanwhile, the Bank of Japan launched a policy of devaluation of the yen.

Between July and October, the Chinese central bank will manufacture China's disastrous stock market crash. The hidden past strategic errors of judgment will now come to light, exposing China's bad debts.

From 2010 onwards, China's central bank took 3 trillion in foreign reserves and converted 2 trillion into non-US currencies, this is the root of the future Chinese economic disaster. roots. In all of human history, there is no central bank that committed such a stupid, catastrophic mistake.

The real farce is that China's central bank in the coming months will reverse its past dumping of dollars; it will turn into a frenzy of dollar buying. Including a rapid nationalization of domestic U.S. dollar savings.


Political reform in China taking place through economic channels

The missing component to the story of China's cash crunch is political. The losers in this case are the corrupt bureaucrats and party insiders who are leveraged to the hilt. These are the insiders who stopped reform in 2005 and took control in 2008, using the central bank as their personal piggy bank. Growing wealth helped secured their political position. Reformers such as Li Keqiang, who want to build a middle class, have to break the grip of these CCP insiders before they can have a free hand to reform. This is why I remain long-term bullish on China, even if I believe there very likely will be a short-term economic crisis. The crisis is actually a political transition.

Scalpel in hand, Chinese Premier Li stirs reform hopes
"Welcome to Doctor Li Keqiang's surgery," analysts from Standard Chartered said in a note.

"We had suspected that Premier Li would want to drive significant reforms. We underestimated, however, his apparent willingness to make policy choices that would risk putting further downside pressure on the economy."

Here is what I wrote more than a year ago in Socionomics Watch—The battle for China
Ask Chinese citizens and they may tell you Wen Jiabao is just playing "good cop" in a show for the people, but from what I've read of Li Keqiang's policy ideas (one of which I covered in China tax reform), he appears to be putting some of Wen's ideas into practice, albeit in economic policy, not politics.
Exactly what we see unfolding today. Even Chinese disagreed with me when I told them Li Keqiang is a reformer (though some of that may be cynicism born of experience), but the facts now speak for themselves.

A few weeks after that post I also wrote: Liberals aim to unleash new wave of reform, which looked at the censoring of leftists. A month after that, I wrote Why is Wen Jiabao criticizing the banks?
Wen Jiabao is targeting the banks because they are the linchpin of the centrally planned economy. The state-owned banks lend to state-owned companies controlled by high ranking party members. Political reform in China has failed because financial reform in China has stalled. Fresh off a political victory, Wen Jiabao is pressing for financial reform and he does not expect to see any changes. What he is doing is paving the way for Li Keqiang to follow through on his rhetoric.

People who are surprised at what is happening in China have not been paying attention. And most people who are paying attention, do not understand what is taking place. This is as much political as economic.

Australia Labor dumps its PM; Liberals have inside track to victory

More than a year ago I wrote about the battles within Australia's Labor Party in Australian Labor party internal dispute puts the U.S. GOP to shame
Rudd resigned from leadership (rather than be fired) in 2010 and was replaced by Gillard. The proximate cause was his support for a mining tax, but it was social mood that was his undoing. The party was weak in the polls and sought a leadership change to maintain power, and the analysts note that Rudd is more popular with the electorate, Gillard with party insiders.
Internal disputes forced Rudd from power in 2010, but the internal battle intensified and continued until now, when Rudd has turned the tables and knocked the prime minister from power.

Australian government dumps PM Gillard for former leader Rudd
Australia's ruling Labor Party elected former leader Kevin Rudd as prime minister and dumped Julia Gillard on Wednesday, in a dramatic move to try and head off a catastrophic defeat at elections due within three months.

The return of Rudd could now see Australia go to an election in August rather than the set date of September 14, to cash in on his greater popularity with voters and an expected honeymoon period with the electorate.
Rudd resigned after proposing an unpopular mining tax that looked set to sink his party in upcoming elections. This time around, Gillard was growing unpopular. Although students tossing sandwiches at her didn't help her poll numbers, it was recent comments about women's issues that caused a nearly 7 percent drop in her support among men. It was an attempt to steal from the Obama playbook (a war on women), but it backfired badly.

Back in 2010, the Labor gambit worked. The new PM, the first female, enjoyed a boost in support and early elections led to a Labor win. This time, I expect a different outcome: the Liberals are coming back into power.

In any case, the shakeup at the party level has one major cause: social mood. The Australian dollar plummeted in May, with the stock market also falling at a healthy clip. Commodity prices are tumbling again, as they did in 2010 when Rudd and his unpopular mining tax were shelved. Labor could always come up with something to entice voters because technically they haven't lost them yet, but the odds are stacked against them. The trend in social mood favors the Liberals.


More On Yuan Depreciation, China's Great Depression

One chart to show why China should worry about Fed tapering too
Why should China worry if Renminbi is under depreciation pressure again?

FX inflow and outflow have tremendous impact on China's domestic monetary policy. When capital flows into China, in order to keep Renminbi exchange rate stable, the PBOC is forced to inject more liquidity into the banking system. Although someone may argue that the PBOC has issued bills and raised reserves to avoid excess liquidity injection, it does not seem to be the case. There are two problems here. First, the net bill issuance and reserve raising has never been enough to sterilize the capital inflow in recent years. Sun Guofeng, the deputy-head of PBOC's monetary policy department, said in his book that FX inflow can explain 25% of the deposit creation in China in the past decade. Second, PBOC bill itself is a quasi-money instrument as it is very liquid and people can use the bill as collateral to borrow so it is pretty hard to argue that issuing PBOC bills can effectively sterilize the excess liquidity.

When capital flows out of China, as we saw from 4Q2011 to 3Q2012, domestic liquidity creation and monetary expansion would be much slower. Of course the PBOC can inject liquidity by cutting reserve requirement ratio or doing reverse-repos, but the problem is that China has enjoyed excess liquidity for so long that even if liquidity situation goes back to normal China would feel thirsty. If the central bank failed to be proactive, liquidity situation could only go worse. Moreover, what we are seeing this year is that very fast credit expansion led to pretty low GDP growth (by China standard), so what would happen to economic growth if credit expansion slows down?
Normal is a crisis for China. If China swings into crisis levels faced by normal economies, it will be China's Great Depression.

For a less dire forecast and a very detailed look at what's going on in China: All About the Maos: Charting China’s Cash Crunch
Is this Lehman with Chinese characteristics? The answer is no. The central bank has vast resources at its disposal to prevent a downward spiral. But it does highlight increasing stress in China’s financial sector, as growth in the real economy pushes toward a 20-year low.

....The current squeeze suggests that events may have run outside the central bank’s control. Seven-day borrowing rates touched 28% in trading Thursday, a record high. That sparked rumors in the market of everything from a default by a major bank to a secret injection of liquidity by the PBOC (later denied by the banks).
This sentence is important because many people believe the Chinese are better able to control their economy because they have more control over their economy. These people give too much credit to the Federal Reserve, but they give even more to the PBOC, when neither has any real power to control the economy. They can act within it and nudge it easily when the economy is running smoothly, but research has shown the central banks track interest rate changes in the economy, moving short term rates up and down after the bond market has made the move. When things breakdown, the crisis will happen entirely out of the central bank's control. Therefore, assuming the bank can control it is the wrong way to think about a crisis, though it is a valid argument for why there may be no crisis now.

In my opinion, this crisis is more serious because the anecdotal evidence reached street level. Not two or three weeks before the cash crunch began, the microfinance and credit companies selling trust products started advertising on the street, pushing their products next to the real estate agents. I've probably seen them before, but this time they were out everyday, something I have not seen before.

Socionomics Alert: Brazil on Fire! And Angry Legos!

Listen folks, if you don't believe socionomics has merit, then explain how the world's #1 football nation, the country with more World Cup victories than any other, the nation that is undoubtedly the favorite to win as host of the 2014 World Cup, is in the streets protesting spending on the World Cup!

The World Cup riots: One million Brazilians protest at government spending £18billion on tournament
More than a million Brazilians took to the streets of at least 80 Brazilian towns and cities in demonstrations that saw violent clashes and renewed calls for an end to government corruption and demands for better public services.

Riot police battled protesters in at least five cities, with some of the most intense clashes in Rio de Janeiro, where an estimated 300,000 demonstrators swarmed into the city's central area.

Television images showed police firing tear gas canisters and rubber bullets into crowds of young men, their faces wrapped in T-shirts. Other demonstrators were shown detained lying on pavements.
It's very simple: Brazilians aren't angry about spending on the World Cup. The people are in a negative mood and they are lashing out at the largest, most obvious target, which isn't really the spending on the World Cup (and Olympics), but the corruption surrounding it.

If social mood was positive, we would instead be treated to stories of the great infrastructure projects being built in Brazil, how this would benefit Brazil's economy, and how the World Cup and Olympics will serve to show the world the new Brazil. Instead, Brazil's president pledges to hold dialogue with protesters
"We cannot live with this violence that shames Brazil," she said in a nationally televised address. "All institutions and public security forces should prevent, within the limits of the law, every form of violence and vandalism."

Rousseff spoke even as new demonstrations broke out on Friday, including one that for several hours blocked most passengers from entering or leaving the country's busiest international airport, outside Sao Paulo.

The protests have come out of seemingly nowhere over the past week. More than 1 million people took to the streets on Thursday in the biggest demonstrations in Brazil in 20 years.

The nameless, leaderless movement - composed largely of students and the middle class - has pulled together a wide range of grievances including bad public transport and healthcare, corruption, and the billions of dollars that the government is spending to host next year's World Cup.
The protests didn't come out of nowhere, they came out of negative social mood. Here is a chart of iShares MSCI Brazil (EWZ), which takes into account declining stock prices and the depreciating real.

Leaving Brazil, we can can see another impact of negative social mood: angry Legos.
Researchers have discovered that the faces on LEGO Minifigures are becoming increasingly angry and less happy. Combined with a trend towards more combat-related LEGO themes, a team led by Christoph Bartneck at the University of Canterbury said "we cannot help but wonder how ... this impacts how children play."
If researchers are concerned, they ought to get to the root cause: social mood. Social mood likely affects how children develop, which is why there is the historical pattern of 4 generations reflected in the works of Strauss & Howe, and also in ancient Chinese sayings such as "wealth does not pass the third generation." It's not something to get worked up over, but it is an interesting look at where the effects of social mood can show up.


Chinese Yuan Could Devalue 50% Or More

In 1933, the United States devalued its currency by 75% (against gold) in order to combat the relentless deflation of the Great Depression. China will eventually use the same strategy to get out of its own depression.

In the 1920s, the British wanted to return to the pre-war gold standard. Having run up a huge debt to finance the war though, the pound should have devalued versus gold; instead the pound was intentionally overvalued. The U.S., the world's largest exporter at the time, cooperated with Great Britain and inflated its currency to aid Great Britain's economy.

In the late 1990s and into the 2000s, China, one of the world's largest exporters, inflated its currency (through the currency peg) and aided the U.S. economy. China was to the U.S. as the U.S. was to Britain in the 1920s.

In the 1920s, European countries could not easily export to the U.S. due to tariffs (and the undervalued U.S. dollar). Instead they financed their imports with loans from America. In the 2000s, Americans could not export to China due to, among several factors, tariffs and an undervalued yuan. Instead they financed their imports through loans from China (via the Treasury market).

In both cases, there were huge buildups of reserves: gold flowed to the United States, U.S. dollars flowed in China. Both nations had huge overcapacity because they were providing a huge portion of global production. When the U.S. went into a depression and nations began devaluing their currencies, they quickly exited the depression because the could no longer afford U.S. imports and began producing for themselves. Today, China is loaded with overcapacity aimed at global markets that may very well close to them in a global recession or depression.

Chinese Inflation

Back when the Chinese yuan was pegged at 8.28 to a U.S. dollar, whenever a U.S. dollar entered the Chinese financial system, it was exchanged by the People's Bank of China (PBOC) for 8.28 renminbi. Most economists and analysts believed the yuan was undervalued at the time, but there was a lot of disagreement about how much it was undervalued. At best, I can say that had the peg had been maintained, eventually the real value of the Chinese yuan would reach that exchange rate of 8.28 to $1 and even move lower thanks to galloping inflation.

So was the yuan over or undervalued before it began rising in 2005? Almost everyone said it was undervalued, but what was the real value? At the time there were many numbers bandied about, many were in the range of 20-40% undervalued. Say it was 30% in 2005, just as the yuan was allowed to float. That means the real value of the yuan in 2005 was about 5.8 to 1, when the yuan began to rise from 8.28 to $1. At 6.1 yuan to 1 dollar the currency is still weaker (versus the U.S. dollar) than it was in real terms in 2005, and yet the Chinese central bank and government have stated in the past year that the yuan is "fairly valued." (03/12/2012 China's yuan nearing fair value: PBOC's Zhou ) Therefore, in real terms, depending on your initial value for the yuan, it may actually have fallen in real value since 2005 or been flat relative to the U.S. dollar.

So has the yuan been appreciating or depreciating in real terms? The central bank still maintains a dirty peg: it allows the yuan to trade in a band around a price set by the central bank. While the market is increasingly allowed to set the value within the band, it is only allowed to do so within the confines of the central bank policy and China clearly had political reasons to allow the renminbi to rise versus the U.S. dollar. By 2008 there was a growing risk of trade retaliation by the United States, in 2012 it was a topic of the Presidential campaign and in 2013 the EU is implementing anti-dumping tariffs on Chinese solar panels, with calls for more tariffs on Chinese goods. Since China's leaders can more easily exchange between political and economic costs, we should be open to the possibility that the yuan has a far larger political component to its value than other currencies.

The Yuan Has Depreciated Before

In 2008, China ceased appreciation of the renminbi and went back to a fixed U.S. dollar peg. Not to defend the economy from the currency's rise, rather to protect it from falling at a politically insensitive time and preventing its collapse along with other emerging market currencies that had been leveraged against the U.S. dollar. China did the same thing in 1997, refusing to devalue during the Asian Crisis.

But consider this chart (Source: Interday and Intraday Movement of USDCNY). From the link: In this chart, the green dashed line stands for the cumulative movement of USDCNY central parity, or fixing price, since 2006. The red line shows the cumulative result of USDCNY intraday movement, i.e. the difference between today's close and fixing. In contrary, the blue line is the cumulative result of interday movement, or the difference between fixing and last day's close price.

(click to enlarge)

What the chart shows is that there were periods in 2008/2009 and again in 2011 when traders were pushing the yuan down on a sustained basis, but the central bank was pulling yuan higher by adjusting the exchange rate (the fixing or the midpoint in the trading band).

This is clear evidence that the Chinese yuan is either fairly valued or at least experiences selling pressure from time to time. In light of this, consider the latest rally in the yuan which has been artificially driven by currency arbitrage (How Fake Exports Caused The Yuan Rally). Exporters are feeling the pinch, particularly as China's trading partners see their currencies devalue against the U.S. dollar. Investors often focus on the USDCNY exchange rate, but the movement in the dollar versus other currencies is still more important for China than the movement of the yuan versus the dollar. The yuan's rally is coming on top of gains in the U.S. dollar versus many emerging market currencies.

Now, add in debt. Recently, I came across this article by Charles Dumas, Chairman of Lombard Street Research: Markets Insight: Weaker yen could burst China's asset bubbles. The conclusion is that the yuan may be overvalued by 33%, which implies an exchange rate of 8.11 yuan to 1 dollar. This isn't surprising if you believe the Chinese economy has relied on an expansionary monetary policy and is surprisingly close to the 8.28 peg from last decade. f emerging market currencies continue to depreciate versus the U.S. dollar (and thus the Chinese yuan), the amount of devaluation needed will increase.

Credit Growth

The parallel with the 1920s U.S. economy is clear: an exporter to the world with an undervalued currency. In the 1920s, England refused to accept that WWI costs left the pound in need of devaluation and re-pegged it at the old rate, leaving the U.S. dollar undervalued. The result was a boom in American exports, credit growth and U.S. gold reserves. In the 2000s, China undervalued its currency relative to the U.S. dollar, resulting in a boom in Chinese exports, credit growth and Chinese forex reserves. The fallout from this policy was a major economic depression in the United States and an eventual 75% devaluation of the U.S. dollar in 1933.

Instead of facing the music in 2008, China doubled down and unleashed a monster credit boom in 2009. This extended the boom for several more years, but it will not continue forever, and some analysts are already forecasting China's Minsky Moment, when cash flow is insufficient to service debt and rising asset prices are required. (Is This China's 'Minsky Moment'?)

What about the reserves?

China's currency reserves are considered a sign of strength, when in fact it was the result of a an undervalued yuan. If the Fed declared tomorrow that it would pay $5,000 cash for every oz of gold, the Fed would corner the gold market and reserves would grow. Those gold reserves would not be a testament to sound economic policy though, they would shine as a golden reminder of a massive inflation in money supply. Chinese reserves are a testament to the inflation created in the economy, inflation that fueled a massive housing bubble and infrastructure boom that has created all manner of debt financing. If and when there is a crisis, China may need to spend those reserves to defend the value of the currency.

China hasn't yet been forced to defend the value of the yuan because it hasn't allowed a full two-way flow in capital. The massive reserves stand ready to protect the value of the currency if need be, but they also serve as a piggy bank for the government to bailout the banking system. And some of those reserves are being invested in a pro-cyclical manner. Whatever you may think of China's long-term prospects, their investments in commodity-linked companies and countries is a bet on Chinese economic growth. If China suffered a major recession or depression, those investments would collapse in value and the government would either sell at a massive loss, or be forced to sell U.S. Treasuries should there be an outflow of capital.

Most people think China's central bank selling U.S. dollars is bullish for the yuan, but this is only true when they are selling from a position of strength. When China swaps dollars for euros, yen, gold or oil, it is positive for the yuan/dollar exchange rate. However, the further they diversify away from the dollar, the greater the potential volatility in the yuan/dollar exchange rate. The U.S. dollar remains the world's reserve currency and the world is very short of dollars (a dollar debt is a dollar short position).

When dollars flow out of China, it may be due to private demand. If a depositor wishes to buy dollars, they can go to any bank and get them. In the 1997 Asian Crisis, Thailand was selling U.S. dollars like mad and it was not good for the Thai baht. If Chinese and/or foreigners demand U.S. dollars more than yuan, the result will be a flow of U.S. dollars out of China that will sink the yuan.

How Stable Are Reserves?

China's large forex reserves have two historic comparisons: the U.S. in 1929 and Japan in 1989. (Never short a country with $2 trillion in reserves?) Monetary policy in 1920s America and Great Britain parallels that of China and America in the 2000s. While some China bulls dismiss the bearish talk on China's debt situation, the Chinese are not so sanguine. In an Instablog post, Could China's $3.2 Trillion Forex Reserves Be Gone In 5 Years?, I wrote:

Tan Yaling, head of the China Research Institute of Foreign Exchange says there was a recent article stating that if the only way China can stimulate the economy is through investment, then China's $3 trillion in foreign exchange reserves will be exhausted within 5 years.

She says speculation is the greatest threat to China's development and this speculation could exhaust China's reserves. Although China has $3.2 trillion in reserves, it isn't enough to protect it from hot money, not when the global forex market trades $5-6 trillion each day. If there is no long-term strategy to defend the reserves, they could be rapidly exhausted.

We've seen the price of infrastructure investment in China's rising debt levels, and we saw those speculative flows in April. Speculators sent the yuan higher, but they can just as easily send the yuan tumbling because the arbitrageurs don't care about the direction of the currency. Two things to keep in mind: the global economy wasn't in the midst of a major recession or financial crisis in April, and the Chinese government is committed to making it easier to exchange its currency. Even more volatile moves will be possible in the future.

Finally, if China decides it will pursue quantitative easing and flood the system with liquidity, it will have to create new money, a defacto devaluation of the yuan against its reserves. If the market responds to this change by demanding U.S. dollars, the defacto devaluation of the yuan will accelerate. China would have two choices: allow the yuan to depreciate and end the outflow of forex reserves, or try to hold the peg and hope that the storm passes before reserves suffer a critical loss and a currency collapse.

Investment Implications

Is the yuan going to fall 50%? When thinking about the non-linear effects of the financial markets, it isn't impossible. Much of the global economy and financial markets are all positioned for a rising yuan. Psychologically, the world is expecting a rising yuan. The odds of a crisis remain low, but if one begins, it will be large because most investors are on the other side of the trade. If China experiences a crisis, it will not be contained, but be far more volatile precisely because the economy and currency have been sheltered from market forces. Even without a major crisis, the pressure on the yuan will push it towards devaluation against the U.S. dollar in the future, not appreciation. That said, if analysts already think the yuan could be 30% overvalued, a decline to 50% would not be out of the cards.

If the Chinese economy experienced a major recession and currency devaluation, the U.S. dollar would be the main beneficiary globally, as devaluations spread across most emerging markets. This could be happening now with Brazil, India and Australia among the nations experiencing currency depreciation versus the U.S. dollar (and Chinese yuan). China's financial system is also showing signs of a crackup, with overnight interest rates hitting 13%.

Investors can use 2008 as a template. The U.S. dollar will rally strongly against most currencies. Commodity prices will continue to weaken.


Alipay Interest Account Attracts 1 Million Users

Alipay's Investment Service Attracts 1 Mln Users in Week
Alipay's online fund investment service has 1 million users one week after launching, the country's largest third-party payment platform says.

The service, Yu E Bao, was jointly launched by Alipay, the online payment service of Alibaba Group, and Tian Hong Asset Management Co. on June 13. It allows individuals to buy money market funds or other financial products using idle cash in their Alipay accounts.

Has China's Great Depression Begun?

Lots of coverage over at ZeroHedge:
China Interbank Market Freezes As Overnight Repo Explodes To 25%
China's Red Flags

"The Market Would Have Collapsed" Had The PBOC Drained: Chinese Liquidity Shortage Hits All Time High

I have been expecting this for years. I'm ready to trade it if it happens, but no need to jump the gun yet. For now I'm sticking with short positions on commodities and other assets that will remain weak due to changes in the Chinese economy. A crisis will only accelerate and exacerbate the factors at work.


This IPO will be oversubscribed

Whenever they get around to an IPO of Alibaba. It's Alipay service now allows users to carry a balance, with current interest rates at 3.48%.

支付宝存钱也可以增值 风险管控面临考验 (Alipay can also save money added risk management and control to the test)


Biological Implications of Supercycle Top

First some background. r/K selection theory
In ecology, r/K selection theory relates to the selection of combinations of traits in an organism that trade off between quantity and quality of offspring. The focus upon either increased quantity of offspring at the expense of individual parental investment, or reduced quantity of offspring with a corresponding increased parental investment, varies widely, seemingly to promote success in particular environments.
In this context, r-selection makes a species prone to numerous reproduction at low cost per individual offspring, while K-selected species expend high cost in reproduction for a low number of more difficult to produce offspring. Neither mode of propagation is intrinsically superior, and in fact they can coexist in the same habitat, as in rodents and elephants.

Strauss and Howe’s Generational Theory, in the Context of r/K Theory
The theory states that our history has four phases which repeat endlessly. The phases are Crisis, High, Awakening, and Unraveling. Here, Crisis is r-psychologies confronted by the shortage of K-selection. This turmoil produces an adaptive shift in the population’s psychology towards a more K-selected, politically Conservative psychology. High is the environment of r-selected resource excess that is produced by a majority K-selected populace, living in an environment where these rewards are enjoyed by those who produce them. Awakening and Unraveling are just the leftists gradually increasing in number due to the r-selection, and fucking up a good thing until it all falls apart, and the Crisis returns.

There is one huge difference this time, and that is our use of public debt to increase resource availability and extend the period of r-selection. This has allowed for a slight increase in the population’s shift towards the r-psychology in this cycle, and lengthened the period of Unraveling. That all will increase the magnitude of the Crisis we will face. This would have been predictable, if you had viewed the increases in national debt which began around 1980 in the context of this work . The disturbing aspect of this is that when the collapse comes, the hardcore Left will be particularly loony, since their amygdalae have essentially no adaptation to a more free, competitive environment. Today, not having free government healthcare, and free cellphones is the same to them as being tossed into Lord of the Flies. When things get so bad that there is no food or housing, they will be capable of anything. The coming Crisis will be epic.
We know from history that birth rates fall during an economic crisis, but if Elliot Waves are a self-regulating phenomena, then the crisis is a response to an unsustainable growth in population. What made it possible up until now is the use of debt to fuel continued growth in the economy, beyond the natural rate. Also, we continue to see peak mood policies playing out by politicians and elites who do not understand that the peak is in the past. The pursuit of amnesty for illegal immigrants, instead of mass deportation, means the coming crisis will be even larger due to the continued addition of population into an economy unable to sustain it at current living standards. Odds are good that most illegal immigrants may eventually self-deport even after receiving amnesty, due to the collapse in living standards in a strained American economy.

90% Haircuts For Detroit; Municipal and State Workers Are Rich Minority

Wow. That is a real default, not even Greece needs haircuts that large.

Kevyn Orr said Friday that Detroit is asking creditors to take about 10 cents on the dollar of what they're owed. Underfunded pension claims will get less.
Pension benefits are vaporized! Teachers, firefighters, police, and municipal workers take heed: you pensions will be nuked. You are the rich minority when it comes to municipal finances.


Compare the climate models to the data

Background behind the chart is here: STILL Epic Fail: 73 Climate Models vs. Measurements, Running 5-Year Means

Chinese Academy of Sciences Approves AGW Skeptics Report

The volumes, Climate Change Reconsidered and Climate Change Reconsidered: 2011 Interim Report, are chock full of 1,200 pages of peer-reviewed data concerning the veracity of anthropogenic climate change. Together, they represent the most comprehensive rebuttal of the United Nations’ Intergovernmental Panel on Climate Change findings, which have been the basis of the climate change legislation movement across the planet.

The Chinese Academy of Sciences is set to present the publication on June 15 at a major ceremony in Beijing. The Academy employs approximately 50,000 people and hosts 350 international conferences each year, and is one of the most prestigious scientific academies in the world, ranked ahead of every Ivy League school save Harvard
That is the only nail needed to seal the coffin on the Kyoto Treaty and other global climate initiatives.


Russia Rising

During the Cold War, as much as the U.S. and S.U. were enemies, they were also both from the same side of the political spectrum: the left. Though the U.S. harbored a lot of right-wing sentiment, by the 2000s it was clear that the Bush Administration's push for worldwide democratic revolution, continued under Obama in Libya and elsewhere, was only different from the Soviet example by degree. It was a major difference to be sure, but the Soviets fought right-wing opposition in America by supporting leftist ideology. Similarly, the U.S. sought to undermine the Soviet Union in Europe with modern art: Modern art was CIA 'weapon'
The connection is improbable. This was a period, in the 1950s and 1960s, when the great majority of Americans disliked or even despised modern art - President Truman summed up the popular view when he said: "If that's art, then I'm a Hottentot." As for the artists themselves, many were ex- com- munists barely acceptable in the America of the McCarthyite era, and certainly not the sort of people normally likely to receive US government backing.

Why did the CIA support them? Because in the propaganda war with the Soviet Union, this new artistic movement could be held up as proof of the creativity, the intellectual freedom, and the cultural power of the US. Russian art, strapped into the communist ideological straitjacket, could not compete.
What is interesting today is, the Russians are now moving solidly to the right. Where conflict was ideological and political during the Cold War, in the future it is more likely to be cultural. Instead of allying with leftist college professors in America, influence is more likely to flow through churches.

Russia set to pass strict anti-gay law that could see foreigners deported for 'sexual propaganda'
A number of regions have already adopted a similar law, and now MPs from President Vladimir Putin’s United Russia party want to implement a nationwide ban on “gay propaganda”.

The law defines the rather nebulous concept as “spreading information aimed at forming non- traditional sexual behaviour among children, suggesting this behaviour is attractive, and making a false statement about the socially equal nature of traditional and non-traditional relationships”.
This is compelling because most people look at this on the surface and see some authoritarian tendencies and cynical political maneuvering by Putin. And both may be the case, but there's a kernel of truth the makes the authoritarianism and cynicism popular. If we look at history, homosexuality tends to peak with a civilization. On the cultural front, one of the best signs of a major peak in social mood is the gay marriage issue, and the Russians are lining up for the coming bull rally in traditional culture. As the foremost purveyor of peak social mood morals and culture, the U.S. is very exposed to a drop in social mood along the cultural vector. The Russians don't have to do much except get out front of the coming anti-American sentiment that will be focused on issues such as gay marriage, single motherhood, feminism and promiscuity. They are preparing for a battle and a multi-decade to multi-century trend that the U.S. government is wholly unprepared for.

EU Coming Apart, Good News For UKIP

Germany to Deport EU Citizens
German Interior Minister Hans-Peter Friedrich announced Friday that the government would begin deporting poor Bulgarians and Romanians who had moved to the country to take advantage of the generous welfare benefits.

America is in a pre-revolutionary state

A discussion of current political events in the United States, from "Political Insiders." Some readers may think I was exaggerating in, Are you ready for Wave 3? American government will be paralyzed, but at about 9 minutes into this video, they discuss the need for special committees to investigate each of the current scandals, to which the host replies, if they do that, the Congress will be knee deep in it and nothing will get done. Congress is often derided for getting nothing done, but they are attentive to events and issues. If the scandals come to consume Congressional attention, the government will be paralyzed because it be focused entirely on scandal. Should Wave 3 break out and take the economy and stock market down sharply, the scandals will greatly impact how the government responds.


Muslims might want to leave England; European system designed for street violence

While the American government may be paralyzed by scandal, far greater political changes may occur in Europe, where far right-wing organizations may rise to power, or simple take over the streets through mass violence.

In the UK, the government has known for years about Pakistani pimps forcing British girls into prostitution, but did nothing about it.

The Real Threat to British Elites
In the many Pakistani grooming cases in England, Ali G types would convince silly little white girls that they were their boyfriends, provide them with drugs, then browbeat them into proving their love by having sex at a party with all the pimps’ Uncle Jamaals.

The genius of the system is that the pimps don’t pay the girls, not even their room and board. After each party, they dump them back at their moms’ council flats.

Is this rape?

Of course. These girls are adolescents, far too young to give consent to being gang-banged.
The response by the British elite was the same as the whole ruling class across the West: charge anyone who spoke up about it with racism.
It might seem insane that this kind of Bronze Age predatory pattern would work so well in a sophisticated country such as England, but that’s exactly why it worked: Noticing patterns is now derided as “stereotyping.”

Moreover, the highest priority in Europe is to never provide any fodder for right-wing organizations. Thus, a decade ago when a Channel 4 documentary crew working on a snoozer about social workers in Bradford stumbled upon this widespread practice, the police insisted that Channel 4 postpone the documentary because it might help the BNP in upcoming elections. The network complied.
As I've stated many times, when one uses an extreme term to define centrist or common sense positions, one does not simply banish an opponent to the extremes of debate. One moves the extremists into the center of the debate. Now we are seeing the full effect of this in England, where decrying everything as racism has made the far-right the go to destination for British people discontented with the government. And since social mood is set for a big decline, the far-right groups in England are set for a surge in membership.
It’s difficult for Americans to grasp precisely why European elites are so terrified of populist organizations such as the BNP or the ascendant English Defence League that they instinctively cover up the crimes of barbaric foreigners.

A major difference between the US and Europe is that almost every European country has a rudimentary set of localist/nationalist organizations for young men already in place due to the more organic nature of sports over there.

...Still, unlike American sports, soccer furnishes the skeleton of a system by which nationalist loyalties could potentially be organized.

This scares European elites. To them, Pakistanis are no challenge. Sure, they’re good at gang-raping little girls, but they’re hardly a threat to the establishment. It’s European men—with their talent for self-organization—who frighten Europe’s ruling class.
Here's more information on the English Defence League: Special Investigation: English Defence League and the hooligans spreading hate on the High Street
Certainly, no one should doubt the group’s intention to bring race ­conflict on to the streets. The last time the EDL marched through Luton, 250 of them went on the ­rampage in an Asian area of the town. Shop windows were smashed, cars overturned and a number of people were attacked.

The EDL — and sister groups such as the Welsh Defence League — have been stirring up trouble for the past 18 months by exploiting legitimate ­concerns over Islamic extremism.
In addition to calling people with "legitimate concerns over Islamic extremism" racists, in England they put people in jail for saying or writing things determined to be racist. One woman faces prison time because she ranted about foreigners while riding the subway, for example. Therefore, if an individual risks jail time for merely speaking about their dislike of foreigners, why not take an extra step towards violence? Particularly since, violence of the mob is impersonal, whereas speaking publicly makes one an individual target. Europe has designed a system that encourages mob violence because it effectively punishes mob violence less harshly than it punishes politically incorrect speech. Let that sentence sink in, it is no exaggeration of the situation in most European countries, though England may be the most extreme in terms of its prosecutions for hate speech.

What is going to happen if social mood plunges in England? The streets will be controlled by the English Defence League.

Are you ready for Wave 3? American government will be paralyzed

The headline isn't overly dramatic, though Americans may take it that way. In most of the world, a fall in the government means the ruling regime is removed from power. I use it in that sense, except it is more serious in America because much of the government is not elected. I foresee not just the wholesale collapse of the Obama regime, but an even deeper crisis that strikes deep into the heart of government.

We now can clearly see the outlines of a political crisis worthy of a Wave 3 collapse in the stock market. In 1973-1974 a greater than 40% collapse in stocks accompanied the Watergate scandal. That was a Constitutional crisis because it involved law breaking by the President, but it was a relatively contained scandal in that removal of the President (in that case via resignation) was enough to end the crisis. In this case, it appears the problem goes far deeper. In fact, it may be so deep that even removal of the entire Executive Branch officials would not stem the damage.

I have previously presented the Michael Burry case. He was targeted by the IRS and the FBI after writing an article critical of the Federal Reserve. His article was not political; it was critical of the Federal Reserve's monetary policy and inability to see a housing bubble. You can read it here: "I Saw the Crisis Coming. Why Didn't the Fed?" From his example we know two important facts. One, the government is targeting anyone critical of it, regardless of politics. Two, the government is coordinating across agencies.

Now we are learning just how deep this crisis reaches:

Now we have five agencies involved. IRS, FBI, EPA, OSHA and ATF. The government has now acted along three separate lines: it has abused IRS power to intimidate political groups, asking illegal questions as part of the tax exempt process. It has targeted individuals involved in these groups with personal audits. It has targeted the businesses of people involved with these groups.

There has been coordinated action across government agencies to target and abuse individuals who were deemed enemies of the State. These are not anarchists plotting to set off bombs, nor communists or fascists working in the employ of foreign governments. Rather these are ordinary Americans exercising natural rights as basic as speech. It is not an exaggeration to say this is the biggest peacetime abuse of power since King George III because the evidence is building for a very wide, and very deep systematic crisis within government. At best, the scandal may have been concocted by multiple agency heads, and the mass jailing of many high ranking officials would serve to send a message. But if the problem goes deeper and reaches into the permanent state, the bureaucrats who are not tied to an administration, it speaks to corruption so deep that whole agencies may need to be abolished and government stripped of its powers.

You don't have to agree with such outcome and I am not proposing that outcome will come to pass. What I am proposing is that the U.S. government will be paralyzed by this crisis because it could grow into an existential crisis for parts of the government. If much of the country fundamentally distrusts the government, there is no possible way to reform it because the problem isn't the people running it, but the system itself. A crisis this deep does not even need to result in a partisan battle: both left and right may agree on the need to reform, but reform so fundamental will be very difficult to agree on because of its great import. The government and the public's attention would be consumed by this debate.

Now imagine there is a concurrent collapse in stock prices and economic activity. The government will not take action because the debate will be over government itself. Even if you expect a much more limited scandal, the story is growing into something that will at least result in a scandal as large as Watergate.

Pay attention to the growing scandals. If Wave 3 is truly as large and histroic as anticipated, we have the outlines of a political scandal to match it.