Submitted by Jeffrey Snider – Alhambra Investment Partners
China’s trade estimates continue the trend of the global economy pushing closer to recession, assuming that it is not already there. We know that the lower part of the global supply chain below Chinese manufacturing and assembly, the resources and materials flow, has already been pushed beyond simple recession in some places, like Brazil, into defining a new disastrous economic state. What is left arguable is the end markets that precede all of this where economists and economic forecasts simply dismiss increasingly dark financial indications, especially commodities but not limited to them, as if the global supply chain were in high working order at the top but mysteriously chaotic just underneath.
That view is, of course, absurd. There are feedbacks and amplifications (and counterbalances) to consider, but the obvious track in these kinds of economic reflections are all working in the same direction; the one far and away from recovery in any part. That is why oil traded today below $37, copper threatens to trade below $2 and swap spreads continue to find new ways to overtake, perhaps, yield curve inversion.
Exports declined by nearly 7% in November in China while imports were marginally better than October at -8.7%. For the global supply chain, neither of those figures truly deliver the full extent of the economic disassociation. China’s imports in November 2015 are down almost 15% from November 2013, and a little more than 10% lower than November 2011!
It is, however, the export side that drives the industrial machine in China, stretched now beyond blatant overcapacity. The reason for that is decidedly simple given China’s history with the eurodollar expansion – and now decline.
China was built, quite literally, with eurodollar finance funding industrial expansion to service eurodollar finance funding more and more consumption in end markets, especially the United States. In the early part of the housing mania, from January 2002 through January 2005, Chinese exports grew 134% (a surge reflected by proportional increase in the PBOC’s monetary functioning). Even after the housing bubble burst here (and for Europe) and the trend began to slow, China’s exports surged by 94% from September 2005 through September 2008. By comparison, in the past three years China’s exports have grown 10%; not per year, total. When 20-40% year-over-year growth is your economic baseline, -3% (so far in 2015 YTD) is near catastrophic.
China managed the slowing, which occurred all the way back in 2012, with internal monetary orthodoxy. Such “stimulus” only served to harden this massive overcapacity and imbalance, and to do so with enormous bubbles of historic proportions (that we still don’t have a clear idea of not just size but extent). However, and this point is either misunderstood or criminally underappreciated, it is the “dollar’s” financialism that drives both ends of China’s experience. As I have pointed out repeatedly of late, the PBOC’s own balance sheet is driven primarily by “dollar” and global financial condition. The central bank has, in the past, attempted to “smooth” out fluctuations with internal yuan-only policies, but those are short-term and highly inefficient given the starting point of dramatic overcapacity.
In other words, what the PBOC does internally to counterbalance any deviation in its forex assets is only meant as temporary; either the “dollar” conditions or global trade (somewhat redundant) must rebound to that pre-crisis baseline or by simple math it all has to revert.
That is the entire point of China’s reform that began in late 2013. The PBOC was finally awakened by the persistence of the 2012 slowdown, realizing that it was not yet another “transitory” aberration but rather the coming natural reversion in the whole of the global supply chain starting, sorry Janet Yellen, from the top down. Thus, internal Chinese monetarism was re-prioritized to attempting to manage that baseline reversion – in both trade and finance. The problem trying to direct and prod, carefully, the downside of massive bubbles is obvious. In 2015, especially after March, the PBOC just lost control of the process – and what we see below is (one of) their increasingly desperate attempt(s) to get it back.
While that was undoubtedly in part due to the internal strains of just the attempt itself, the very, very clear shift in China’s monetary dynamics after March this year demonstrate that it wasn’t internal conditions that forced the PBOC’s hand. By any rational count, it has been this renewed “dollar” turmoil that injected so much unwelcome volatility and strain. While that was plainly obvious in the events of August, it has been only marginally less so since then. As noted yesterday, the huge sigh of relief from economists over China’s “capital” flows in October was a mistake, one starting from anachronistic orthodox philosophy and understanding.
The Financial Times today is much more conditioned and reasonable, in light of China’sNovember trade data:
China’s merchandise trade surplus remained elevated at $54bn in November, the fifth-largest surplus on record, although down from an October’s high of $62bn.
In spite of the surplus, however, the renminbi on Tuesday traded at its weakest intraday level in almost four months at midday at 6.4181 per dollar. If that level persists, it would mark the currency’s weakest close since 2011.
China’s foreign exchange reserves posted their third-largest monthly decline on record in October, central-bank data showed on Monday, reflecting large capital outflows and dollar sales by the central bank to curb renminbi weakness. The latest data imply that foreign exchange outflows linked to investment were heavy last month but that inflows from trade cushioned the impact on reserves.
I believe that last part is correct, and thus gives us some indirect insight into the ongoing upheaval in the “dollar” network toward China. In other words, if China’s trade flows “cushioned the impact on reserves” and yet there was the “third-largest monthly decline on record” in October and worse in November, then the exchange problem away from purely trade finance was, and continues to be, gigantic. The Financial Times classifies that as “foreign exchange outflows linked to investment” but that presupposes a destination; in truth, it is our “dollar run.”
Because the PBOC is assumed to have been “selling dollar assets” so that there might resume an orderly exchange rate as the central bank “buys yuan” that these media outlets further assume the market is “selling”, then that means private Chinese market participants must be “buying dollars” with the “outflow.” Yet, these cannot be found; anywhere. Since the numbers we are talking about are just enormous, you would think the US stock market and all risky assets, from junk bonds to commodities, would be booming with all the “inflow” from China in this zero sum game that international forex is supposed to be. None of that has occurred; in fact, in far too many places, such as commodities, junk and even money markets, it appears quite as if there are “outflows” on both sides of the dollar/yuan exchange!
That is because there is, namely that the global “money supply” of wholesale eurodollars is contracting both to reflect this altered, perhaps permanently shrunken global economy and to be the very means to enforce those perceptions. The PBOC is not trying to “buy yuan” that the private market is discarding in outflows, they are hanging on, barely, straining to fill the “dollar” gap as the eurodollar tide recedes; supplying “dollars” in various wholesale formats so that the whole financial network, dollar to yuan, onshore and off, doesn’t just blow open (again) into chaos and full disorder. The exchange rate, by virtue of telling us the relative cost structure of financing “dollars”, is a barometer of funding stress for China. Economists never got the memo that the very nature of China’s legacy of pegging yuan to the dollar opened up China’s version of the “global dollar short.”
Rather than running into countless contradictions and inconsistencies, China’s trade and financial indications are in quite good harmony; and that is precisely the problem.