Category Archives: China

China, Crash, Trading

China runaway train ?

David Dredge of global hedge fund Fortress has built a career studying, predicting and protecting against the world’s major financial crises. The recent convulsions in global sharemarkets are “just the beginning” of a painful adjustment as money drains from the emerging market economies, he says.

“August 2015 will go down in the record books, much like July 2007 or July 1997, as the beginning of the coming contractionary cycle,” says Dredge who is the co-chief investment officer of Fortress Convex Asia Fund.

August 2015 will go down in the record books, much like July 2007 or July 1997, as the beginning of the coming contractionary cycle.

David Dredge, Fortress

He’s a believer that markets move in long cycles, which “despite all efforts to the contrary, central bankers have not by any means gotten anywhere close to eliminating”.

Hedge fund Fortress says all emerging economies are in the midst of a painful adjustment after a "burst of credit expansion".Hedge fund Fortress says all emerging economies are in the midst of a painful adjustment after a “burst of credit expansion”. Photo: AP

“Like weathermen have not eliminated seasons,” he says.

Singapore-based Dredge says the current volatility in financial markets is in the early stage as markets react to a correction of global imbalances that will last from18 months to three years.

The global economy is made up of nations with a deficit of capital – the West – and those with a surplus of capital – the East and emerging markets, he explains.

Policy determined by deficit

“The flaw is that those with the surplus have all tied their currency to the main protagonist on the deficit side – the US.

“So monetary policy is determined by the deficit of capital side and flows through the currency linkage, and you end up having some form or another of the same monetary policy on both sides, with economies that are 180 degrees diametric to each other.”

The financial links to easy-money policies in the US have unleashed a burst of credit expansion in emerging markets that has proved unsustainable and is now in the process of unwinding.

That is forcing a painful “market-induced tightening” that will affect  the growth of emerging markets as credit expansion is halted and reverses.

The “simplest measure of these imbalances” is foreign exchange reserves, which have swelled in the past few years but are now being liquidated, tightening financial conditions in emerging markets.

“When the hose is on and credit is pouring from the deficit to the surplus side, the FX [foreign exchange] reserves increase and are indicative of the growing size and the location as to where the imbalances exist – because that’s where the most money is going.”

China’s foreign currency reserves peaked at $US4 trillion ($5.7 trillion) in mid-2014 but have since run down to about $US3.6 trillion.

‘In the inverse of imbalance’

“Each crisis occurred at the peak of FX reserves. The emerging-market FX-reserves graph looks exactly like the US debt to GDP because they are just in the inverse of the imbalance.”

Dredge says that differentiating among emerging economies misses the point of what is occurring. Capital is draining from the emerging markets as conditions have tightened, and has been since the “taper tantrum” of May 2013.

“In December 1999 the point wasn’t whether you should invest in Apple or Microsoft. The point was they were both going down [as the tech bubble deflated]. And that’s where we are now.

“The [credit] contraction might be triggered in China with retail margin lending in the equity market, or in Malaysia with recognition of corruption.

“But the trigger is not what we are trying to compare. It’s the potential risk, which is the excess credit creation in the last cycle. In that sense Brazil, China and Malaysia are all the same.”

Dredge co-manages the Convex Asia fund, a “volatility fund”, which manages about $US200 million and seeks to deliver outsized gains in times of market stress.

Stay ahead of spreading fire

He says he’s attempting to stay ahead of the spreading fire and that means looking for cheap exposures to volatility. Interest rate volatility is low and, while foreign currency volatility may have risen, it is below many of the peaks reached over the past five years. Corporate credit spreads, too, are around post-financial crisis lows despite a fair-sized correction in corresponding equities.

“This is indicative that we’re just at the very beginning of this,” Dredge says.

Where does Australia fit in as the cycle turns dark for emerging markets? We’re special in the sense that we have not pegged our currency to the US.

“It is just about the only non-manipulated currency in the entire world, along with New Zealand. By allowing the currency to move and avoid being a hard linkage to the monetary policy whims of the global reserve currency, it takes a lot of the pressure off.”

But there has still been a build-up of risks as credit has grown virtually interrupted and our economic linkages to China make us vulnerable to, not immune from, any shocks.

“Australia came through many of the last several cycles better than most because most of the volatility was allowed to take place in the currency.

“This has allowed the asset volatility to be far less than it otherwise would have been. But that means credit has built up and imbalances, while far less than they would have been, have been allowed to persist.”

 

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Central Bank, China, Crash

Why did the market Crash ?

When stock markets are free-falling 10+% in a matter of days, it’s natural to seek some answers to the question “why now?”

Some are saying it was all the result of high-frequency trading (HFT), while others point to China’s modest devaluation of its currency the renminbi (a.k.a. yuan) as the trigger.

Trying to finger the proximate cause of the mini-crash is an interesting parlor game, but does it really help us identify the trends that will shape markets going forward?

We might do better to look for trends that will eventually drag markets up or down, regardless of HFT, currency revaluations, etc.

Five Interconnected Trends

At the risk of stating the obvious, let’s list the major trends that are already visible.

The China Story is Over

And I don’t mean the high growth forever fantasy tale, I mean the entire China narrative is over:

  1. That export-dependent China can seamlessly transition to a self-supporting consumer economy.
  2. That China can become a value story now that the growth story is done.
  3. That central planning will ably guide the Chinese economy through every rough patch.
  4. That corruption is being excised from the system.
  5. That the asset bubbles inflated by a quadrupling of debt from $7 trillion in 2007 to $28 trillion can all be deflated without harming the wealth effect or future debt expansion.
  6. That development-dependent local governments will effortlessly find new funding sources when land development slows.
  7. That workers displaced by declining exports and automation will quickly find high-paying employment elsewhere in the economy.

I could go on, but you get the point: the entire Story is over.  (I explained why in a previous essay, Is China’s “Black Box” Economy About to Come Apart? )

This is entirely predictable. Every fast-growing economy starting with near-zero debt and huge untapped reserves of cheap labor experiences an explosive rise as the low-hanging fruit is plucked and the same abrupt stall and stagnation when the low-hanging fruit has all been harvested, leaving only the unavoidable results of debt-fueled speculation: an enormous overhang of bad debt, malinvestment (a.k.a. bridges to nowhere and ghost cities) and policies that seemed brilliant in the good old days that are now yielding negative returns.

The Emerging Market Story Is Also Done

Emerging currencies and markets have soared on the back of the China Story, as China’s insatiable demand for oil, iron ore, copper, soy beans, etc. drove global demand to unparalleled heights.

This demand pushed prices higher, which then pushed production (supply) higher, as the low cost of capital globally enabled marginal resources to be put into production with borrowed money.

Now that China’s demand has fallen off—by some accounts, China’s GDP is actually in negative territory, despite official claims that it’s still growing at 7% annually—commodity prices have crashed, taking the emerging markets’ stock and currency markets down. (Source)

Here is a chart of Doctor Copper, a bellwether for industrial and construction demand:

Here is Brazil’s stock market, which has declined 54% in the past 12 months:

These are catastrophic declines, and with China’s growth story over, there is absolutely nothing on the global horizon to push demand back up.

Diminishing Returns on Additional Debt

The simple truth is that expanding debt has fueled global growth. Though people identify China as the driver of global demand for commodities, China’s growth is debt-driven. As noted above, China quadrupled its officially tracked debt from $7 trillion in 2007 to $28 trillion as of mid-2014—an astonishing 282 percent of gross domestic product (GDP).  If we add the estimated $5 trillion of shadow-banking system debt and another year’s expansion of borrowing, China’s total debt of $35+ trillion is in excess of 300% of GDP—levels associated with doomed to default states such as Greece and Spain.

While China has moved to open the debt spigot in recent days by lowering interest rates and reserve requirements, this doesn’t make over-indebted borrowers good credit risks or more empty high-rises productive investments.

Borrowed money that poured into ramping up production in emerging nations is now stranded as prices have plummeted, rendering marginal production intensely unprofitable.

In sum: greatly expanding debt boosted growth virtually everywhere after the Global Financial Meltdown of 2008-2009. That fix is a one-off: not even China can quadruple its $35+ trillion debt to $140 trillion to reignite growth.

Here is a sobering chart of global debt growth:

Limits on Deficit-Spending (Borrowed) Fiscal Stimulus

When the global economy rolled over into recession in 2008, governments borrowed money by selling sovereign bonds to fund increased state spending.  In the U.S., federal borrowing soared to over $1 trillion per year as the government sought to replace declining private spending with public spending.

Governments around the world have continued to run large deficits, piling up immense debts since 2008.  The global move to near-zero yields has enabled governments to support these monumental debt loads, but even at near-zero yields, the interest payments are non-trivial. These enormous sovereign debts place some limits on how much governments can borrow in the next global recession—a slowdown many think has already started.

Here is a chart of U.S. sovereign debt, which has almost doubled since 2008:

As noted on the chart: what structural inadequacies or problems did governments fix by borrowing gargantuan sums to fund state spending?  The basic answer is: none. All the same structural problems facing governments in 2008 remain untouched in 2015. These include: over-indebtedness, bad debts that haven’t been written down, insolvent banks, soaring social spending as the worker-retiree ratio slips below 2-to-1, externalized environmental damage that has yet to be remediated, and so on.

Central Bank Stimulus (Quantitative Easing) as Social Policy Has Been Discredited

In the wake of the Global Financial Meltdown of 2008-2009, central banks launched monetary stimulus programs aimed at pumping money into the economy via bank lending. The stated goals of these stimulus programs were 1) boost employment (i.e. lower unemployment) and 2) generate enough inflation to stave off deflation, which is generally viewed as the cause of financial depressions.

While it can be argued that these unprecedented monetary stimulus programs achieved modest successes in terms of lowering unemployment and pushing inflation above the zero line, they also widened wealth and income inequality.

Even as these programs made modest dents in unemployment and deflation, they pushed asset valuations to the moon—assets largely owned by the few at the top of the wealth pyramid.

Here is a chart of selected developed economies’ income/wealth skew:

The widespread recognition that the benefits of central bank stimulus mostly flowed to the top of the pyramid places political limits on future central bank stimulus programs.

The 2008-09 Fixes Are No Longer Available

In summary, the fixes for the 2008-09 recession are no longer available in the same scale or effectiveness.  Expanding debt to push up demand and investment, rising state deficit spending, massive monetary stimulus programs—all of these now face limitations. This means the central banks and states have very limited tools to reignite growth as global recession trims borrowing, investment, hiring, sales and profits.

 

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China, Crash

Everything you’ve heard about China’s stock market crash is wrong

(Source : http://qz.com/486476/everything-youve-heard-about-chinas-stock-market-crash-is-wrong/ )

This week’s Chinese stock market implosion has been widely viewed as a reaction to the Chinese government’s devaluing the yuan on Aug. 11—a move many presume was a frenzied bid to lower export prices and strengthen the economy.

This interpretation doesn’t stand up to scrutiny. First, Chinese investors haven’t been investing based on how the economy is doing, but rather, based on what they think the government will do to prop up the market. The crash, termed “Black Monday,” was more likely a reaction to the central bank’s failure over the weekend to announce a widely expected cut to the bank reserve requirement since previous cuts in February and April had boosted stock prices. The government eventually caved andannounced a cut on Tuesday (Aug. 25).

Second, the crash happened nearly two weeks after the devaluation, and the government only let the yuan depreciate by about 3% before swooping in and propping up its value again—which hardly helps exporters since the currency’s value effectively rose some 14% in the last year.

The devaluation probably had more to do with breaking the yuan’s tightly managed peg to the US dollar, an obligation that has been draining the economy of scarce liquidity as capital outflows swell.

Both moves—the government pulling back from its market bailout and the currency devaluation—stem from the same ominous problem: China’s leaders are scrambling to find the money to keep its economy running. To understand the broader forces that led to this predicament, here’s a chart-based explainer tracing its origins:

China used its exchange rate to stoke growth

China has long pegged its currency to the US dollar at an artificially cheap rate. Keeping the yuan cheaper than it should be, even as export revenues and foreign investment gushed in, allowed China to amass huge foreign exchange reserves, as we explain in more detail here:

A cheap currency has also powered China’s investment-driven growth model (more on this here). By paying more yuan than the market would demand for each dollar, the People’s Bank of China (PBoC) created extra money out of thin air, sending it sloshing around in the economy. (Meanwhile, the PBoC prevented from driving up inflation by setting its bank reserve requirements unusually high, as we explain here.)

Easy money, easy lending, easy growth. This was especially true after the global financial crisis hit, when China pumped 4 trillion yuan ($586 billion in 2008 US dollars) into its economy to protect it from the fallout. The resulting double-digit growth attracted foreign investment and hot money inflows, raising demand for yuan. To buoy its faltering export industry, the PBoC had to buy even more dollars to prevent surging yuan demand from driving up the local currency’s value.

1
1

The government pumped the stock market

But growth is now slowing, making the $28 trillion in debt China racked up in the process even harder to pay off.

About a year ago, the government turned to pumping up the stock market. The thinking behind this move, says Derek Scissors, economist at the American Enterprise Institute, was, “Hey, why not address our huge problems by replacing debt with equity?” In other words, a bull market would help indebted companies raise new capital and pay off overdue loans. But eventually the market tanked.

So starting in early July, the government launched a sweeping stock market bailout, vowing to prop up the Shanghai Composite Index until it hit 4,500. The problem is, every time it has neared that target level, investors start selling in anticipation that the government will pull back its support. As a result, the Chinese government has now spent as much as $1 trillion to prop up stocks.

Hot money fled the country

While some investors were betting on stocks, others had seen the writing on the wall and were getting out—swapping their yuan for other currencies. Starting in late 2014, the influx of hot money reversed course, and speculative investment flooded out of China. One measure of that is the drop in (mostly) short-term trade finance from foreign banks, which started in Q4 2014:

Another is the fall in foreign exchange that Chinese banks are holding:

Once people started selling the yuan, others began fearing that their yuan holdings would lose value—so they sold too. Lower demand for the yuan should have lowered the currency’s value relative to the dollar. But the PBoC had to keep the yuan’s value stable. Not only had it promised to do so as a requirement of joining the IMF’s basket of central bank reserve currencies; the yuan’s stability and gradual appreciation has long attracted foreign capital into China, says Carlo Reiter, an analyst at J Capital Research. To continue propping up the yuan’s value, the PBoC started selling dollars from its precious reserves in exchange for yuan:

Buying back yuan lowered liquidity, however, which raised borrowing costs, putting a damper on borrowing and investment and threatening deflation:

Higher borrowing costs exacerbated the country’s $28 trillion in debt, much of which has been borrowed at variable interest rates.

The rising stock market crimped bank lending

As investors shifted money from their banking deposits into brokerage accounts to buy stocks, liquidity tightened, leaving banks with less money to lend, says Christopher Balding, finance professor at Peking University. To keep the economy growing, the government continued to pressure banks to lend.

To help keep credit flowing, the Chinese government launched a bailout in early July (which, as we mentioned earlier, cost the government more than $1 trillion.) To fund this bailout, interbank lending by state-backed entities has surged, says Carlo Reiter, analyst at J Capital Research. In July, government institutions lent 9.3 trillion yuan to banks, mostly to boost the stock market, he says.

However, the flood of interbank capital eventually caught up with the PBoC. Adding even more money into the financial system put downward pressure on the yuan.

This brings us to the Aug. 11 currency devaluation, which likely occurred because the yuan became too “expensive to defend,” says Reiter. Nevertheless, the exchange rate has leveled off over the last few trading days—a sign that capital outflow is so great that the central bank has once again resorted to selling dollars for yuan.

Already, this “battle to stabilize the currency has had a significant tightening effect on domestic liquidity conditions,” wrote Wei Yao, economist at Societe Generale, in an Aug. 25 note. In other words, the government’s grand plans to reduce its debt woes while preventing capital from flowing out may have the perverse effect of causing more of both.

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China

China’s Stunning Stock Market Moves in One Huge, Annotated Chart

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Asia, China

Q&A: China’s currency devaluation

China’s central bank weakened the renminbi by its most in two decades on Tuesday. The unexpected move fuelled talk of “currency wars”, although some interpreted it as a welcome gesture towards market reform and financial liberalisation.

What happened?

The People’s Bank of China devalued its currency by setting the daily “fix” for the renminbi 1.9 per cent lower — the sharpest shift on record. The move caused investors to push the currency to its lowest level in nearly three years.

What’s the daily fix?

Each day at 9.15am in Beijing the PBoC sets a midpoint for its tightly controlled currency. When the market opens 15 minutes later investors are allowed to trade the currency 2 per cent either way from this midpoint.

Why now?

An obvious catalyst is the slowing economy: in the first and second quarters China’s economy grew at an annual rate of 7 per cent, the slowest pace in six years. Data at the weekend showed exports tumbled 8.3 per cent year-on-year in July, far worse than expectations for a 1.5 per cent decline. A weaker currency should help make Chinese exports competitive.

So China is trying to spur exports? Isn’t that a currency war?

Not necessarily. The stated purpose for the move was market reform. The central bank said this was a one-time move to enhance “the market-orientation and benchmark status” of the renminbi. Previously, the PBoC would set the currency wherever it liked. Now it will give markets a voice: the daily fix will “refer to the closing rate of the interbank foreign exchange market on the previous day”.

Is there pressure for market reform?

Before the end of the year the International Monetary Fund will decide whether to include the renminbi in its special drawing rights, a global reserve asset comprising the dollar, euro, pound and yen. Inclusion would mean endorsing the renminbi as a formal reserve currency.

Last week the IMF hailed China’s progress on financial reform but called on authorities to take further steps to increase foreign access to its onshore stock and bond markets. The IMF only conducts a review of the SDR once every five years, so the PBoC could be stepping up its efforts to liberalise the currency as part of its quest to internationalise use of the renminbi.

So this is a triumph for market reform?

Perhaps, but it is hard to say. The renminbi had been under pressure to weaken for months because of capital outflows but the PBoC restrained any depreciation by setting the fix higher and selling forex reserves. Today’s one-off depreciation eases some of that pressure.

Many economists were optimistic about the action. Those at Barclays called the new mechanism “a revolutionary move”. But we will not know if China is truly letting the market have a say in the currency’s value until we have seen it move in a direction that would not be supportive to its own goals.

The Chinese currency has a soft peg to the US dollar, which has surged this year and contributed to the decline in Chinese exports. A weaker renminbi could support the economy, so Beijing could simply be allowing the currency to slide and use the talk of “market reform” as political cover; otherwise it would be controversial for the currency to be devalued.

Does this matter outside of China?

Yes. China is a huge consumer of commodities and if the move is interpreted as a sign of economic weakness, there will be ripple effects. On Tuesday every currency in the region weakened against the US dollar — those of New Zealand, Taiwan, South Korea, Singapore and Australia fell by 1 per cent or more.

Dollar strength could make the Federal Reserve reluctant to lift interest rates, as that would cause further upward pressure on the US currency.

Within China, the nation’s airlines lost 9 per cent of their market value, on average, as a weaker renminbi will inflate the cost of oil, priced in US dollars. The same effect forced shares of Qantas, Australia’s flagship carrier, to fall as much as 4.1 per cent.

What are the risks?

Investors have been pushing for the renminbi to weaken and if they are allowed to determine where the fix is, it’s possible the currency could depreciate quickly. Stuart Allsopp, head of country risk at BMI Research, a unit of Fitch, warns that investors could now see the renminbi as a one-way bet “and start to position against the currency, raising the prospect of more substantial [renminbi] weakness and more economic uncertainty”.

What now?

The key question is whether Beijing really does allow the currency to trade more freely. Last year the PBoC moved to stomp out one-way speculation, when the renminbi was continually appreciating, resulting in the currency’s first annual loss in two decades. If investors begin to push the renminbi lower, Beijing may feel the need to act again. If it does not, neighbouring countries that compete for exports may complain.

The US could be a tough position: it has asked for market reform for years but if China allows the daily fix to be determined by market forces and the currency depreciates, hurting US manufacturers, it is not obvious how Washington should respond.

 

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Asia, China

Stop it ! Talk about China instead.

The population of Greece is slightly less than the state of Ohio’s, while its gross domestic product is just a little bit bigger than the economies of Kazakhstan, Algeria and Qatar.

Instead of focusing on Athens, investors should be much more worried about what’s going on in China. You know, that country with about 1.4 billion people and the world’s second largest GDP?

The Shanghai Composite and Shenzhen Composite have both plunged about 30% from their highs due to legitimate concerns that Chinese stocks are in a bubble.

China’s government is taking steps to try and minimize any more pain in the market. But that could backfire.

Regulators announced Sunday that they would make more capital available for an entity that will allow for even more margin lending, the practice of borrowing money to buy stocks. Buying on margin is incredibly risky.

Many experts believe the Chinese stock market’s surge earlier this year was partly due to average investors taking on debt to invest in stocks.

And when stocks first started to fall last month, many of those investors had to quickly sell their investments to pay back the loans. That fueled an even bigger drop in stock prices.

shanghai composite china index

It could get worse as investors realize that the slowdown in China’s economy should hurt corporate profits.

“Exuberance for Chinese stocks isn’t backed up by fundamentals,” said Michael Pento, president and founder of Pento Portfolio Strategies, in a report Monday morning. “Instead, it appears markets are being levitated by continued government borrowings and manipulations.”

A move by big Chinese brokerage firms to keep buying stocks until the Shanghai Composite reaches a certain value could also be a problem.

Lei Mao, an assistant professor of finance at the Warwick Business School in the United Kingdom, worries that the government may be inflating the value of larger companies at the expense of many smaller firms.

To that end, the Shanghai Composite, which is home to many larger, established Chinese companies, did rise more than 2% Monday. But the Shenzhen, which is where younger, riskier tech stocks tend to trade, fell nearly 3%.

“These distortions, in today’s market, create a significant flow of funds to large state-owned companies – a ‘flight to state’. Plus they might create the reasons for another free-fall in the near future,” Mao said.

Why does this matter to people outside of China? A rapidly sinking stock market is often a sign of an economy in turmoil. Remember 2008? And 2000?

Since China is the second largest trading partner for both Europe and the United States, it goes without saying that a healthy Chinese economy is good news for the developed world.

All that talk about the possibility of Greek contagion if it is forced to drop the euro and bring back the drachma? That seems overdone too.

Economists at the Royal Bank of Scotland tweeted out a chart last week that showed that U.S. banks have nearly ten times as much exposure to China than Greece.

And Kathleen Brooks, a research director for FOREX.com, wrote in a report Monday that “sentiment could suffer across the Asia region and further afield” if China is unable to stop the bleeding in its stock market.

China is a massive consumer of commodities as well.

Oil prices dropped Monday — and while many were quick to blame Greece and the drop in the euro, that doesn’t make that much sense when you think about it.

“Look at the stories written about the drop in the price of oil today, and they’ll be talking about how the demand for oil drops because of Greece,” said Chuck Butler, managing director of EverBank Global Markets, in a report Monday. “I have to think that’s a bunch of bunk. China? Yes. Greece demand? No!”

Of course, you can’t ignore Greece entirely. But don’t get too caught up with the latest headlines from Europe either. China matters a lot more to the global economy — and your portfolio.

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China

China’s richest man might have been running a massive fraud

The only thing we know for sure is that stock in Hanergy Thin Film Power, a solar panel company equipment owned by what was at the time China’s richest man, fell 47 percent last Wednesday. We don’t know exactly why it fell, or even how much its Chairman Li Hejun lost when it did, since he apparently upped his bet against his own company in the days before the crash. Just that it did.

When you put all the pieces together, though, it looks even worse. It looks like Hanergy might be China’s Enron: an Energy Company of the Future™ whose stock price could only go up as long as it was borrowing money and could only borrow money as long as its stock price was going up. In other words, a house of cards that was just waiting for the first piece to fall.

Now, the first thing to know about Hanergy is that it’s really two companies. There’s the privately owned parent corporation, Hanergy Group, and the publicly traded subsidiary, Hanergy Thin Film Power (HFT). So far, so normal. The curious part, though, is that almost all of HFT’s sales are to its parent company at a net profit margin of 50 percent. And even more curious is that the parent company hasn’t actually, well, paid for most of the solar panel equipment it’s ostensibly bought from HFT. Through 2013, only 35 percent of the accounts between the two had been settled.

 

http://www.washingtonpost.com/blogs/wonkblog/wp/2015/05/27/chinas-richest-man-might-have-been-running-a-massive-fraud/

 

 

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China, Trading

The Crisis and the renminbi’s international role

The Global Financial Crisis has increased the importance of the renminbi as an international currency. This column describes how the status of the remnibi has changed relative to that of the dollar and the euro. It also discusses what their future as future currencies would be. The author suggests that within 10 years, the renminbi would be at least at par with the dollar as a regional trade settlement currency in East Asia. It is also likely to become a close second to the euro as a world reserve currency.

The increasingly important status of the renminbi

According to the Triennial Central Bank Survey (2013) in 2007, just prior to the eruption of the US subprime crisis and two years before the emergence of the Greek sovereign debt crisis, forex deals with the US dollar on one side of the transaction represented 85.6% of total average daily foreign exchange market turnover, making it the most widely traded currency in the world.1 The comparable figure for the euro was 37%, putting it in a distant second place after the dollar. By contrast, the same metric indicates that with a meager share of 0.5%, the renminbi (RMB) was ranked in the 20th slot. In April 2013, the share of the USD had gone up to 87% that of the euro, down to 33.4%, and that of the RMB up to 2,2% of total average daily forex turnover.

Although the euro lost (and the dollar gained) some ground during the six years between 2007 and 2013, the USD and the euro maintained their first and second ranks, respectively. However, the RMB climbed from the 20th to the 9th slot. Although its share is still very modest, the rate of growth of transactions involving it is very large. If as some economists believe this trend persists, the RMB may match the Japanese yen and the British pound and achieve the status of a key currency within the next decade.

The view that the RMB will in due time become a key currency has been around for some time even before the Global Financial Crisis (Carbaugh and Hedrick 2009, Salvatore 2011). It is supported mainly by a record of fast rates of growth of the Chinese economy, by the growth of China’s share in international trade during the last 30 years, and by a somewhat similar historical precedent involving the USD a hundred years ago (Eichengreen 2011).2 Although China is already a giant on the current account side of the balance of payments, it is still behind in capital account transactions.3 In this respect, the RMB is obviously far behind major key currencies like the USD and the euro. In terms of both turnover on forex markets and use as a reserve currency, it is still dominated by lesser major currencies such as the yen, the British pound, the Swiss franc, and even the Australian and the New-Zealand dollars.

The impact of the Crisis on the relative positions of the USD and the euro vs. the RMB

The Global Financial Crisis triggered a number of changes in the relative positions of the US and the Eurozone on one hand, and that of China on the other. Although to date those changes have not appreciably altered the position of the RMB vis-a-vis the other two currencies, they have put in motion processes that have the potential to establish the RMB as a regional key currency within the next five to ten years. Foremost among those are the slowdowns in real growth and in international trade activity since the outbreaks of the subprime crisis and the sovereign debt crisis in the US and in the Eurozone, respectively. Admittedly, the ripple effects of the Global Financial Crisis also slowed down Chinese growth. Nonetheless, due to the persistence of the slowdown in real growth, particularly in the Eurozone, the relative position of China in terms of both GDP and share of international trade has risen in comparison to its pre-crisis level.

About a year after the November 2008 G20 Washington Summit on Financial Markets and the World Economy the leaders of the G20 group, of which China is a member, announced that this group would replace the G8 as the main economic council of wealthy nations. Since China was not a member of the G8 this change officially opened the door to its participation in decision making regarding the international financial system.4 It is likely that this official recognition of China’s increasing financial clout prompted Governor Zhou Xiaochuan from the People’s Bank of China (PBC) to propose a new international monetary system in which the IMF Special Drawing Rights would eventually replace the dollar as the world’s main reserve currency (Xiaochuan 2009). Although this proposal did not take off, it signalled the beginning of China’s involvment in attempts to reshape the international monetary system.

One of the conditions for becoming a key currency is the existence of deep and liquid bond markets in the currency. In terms of outstanding stocks, RMB denominated bonds are obviously far behind their US and Eurozone counterparts. However, by reducing the volume of new bond issues in both the US and the Eurozone, the Crisis initiated a process that is reducing this gap. In particular, the US subprime crisis dramatically reduced the volume of US net new bond issues. This volume dropped from a yearly average of about $3 trillion in 2004-2007, to about $200 billion per year in 2008-2013. The Eurozone sovereign debt crisis had an even stronger adverse effect. The net new volume of bond issues in the Eurzone dropped from a yearly average of slightly less than €2 trillions in 2007-2009 to practically zero between 2010 and 2013.5

By contrast, the issue of RMB denominated offshore bonds accelerated dramatically during those years. A RMB Road Map (2014) published by ASIFMA reports that offshore RMB debt sold in the first quarter of 2014 peaked at 31 billion USD following an increase of over 200% during the previous three years. If those relative trends continue for several more years, the yuan denominated bond market will quickly acquire a respectable (although not yet dominant) position. During the first three quarters of 2011, RMB trade settlements amounted to about 8% of China’s trade in goods and services.6 The Chinese government actively promotes such developments, particularly with trading partners within the ASEAN group of countries.7

http://www.voxeu.org/article/global-crisis-and-global-renminbi

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Asia, China

How much does the ancient game of Go, or weiqi, reveal about Chinese military strategy?

Orginal post is here : http://thediplomat.com/2014/12/maritime-southeast-asia-a-game-of-go/

Over at The National Interest last week, Asia-Pacific Center professor Alexander Vuving ran a nifty longish essay explaining China’s grand strategy in the South China Sea in terms of the Japanese game Go, or weiqi as the Chinese call it. It’s well worth your time. Read the whole thing.

Explaining strategic behavior in terms of the games inhabitants of a civilization play is a cottage industry. Henry Kissinger, to name just one major figure, has drawn the parallel between Go and China’s deportment around its periphery.

For Alex, insisting that Beijing’s moves in the South China Sea are trivial is misguided. That’s thinking inspired by chess. Pawns as largely expendable, strategy largely linear in character. Yet by deploying seaborne counterparts to the pawn — white-hulled coast-guard ships, the fishing fleet, reclaimed islands and reefs — China encircles and exerts influence if not control over swathes of sea and sky where it bills itself as the rightful sovereign. Sovereignty means physical control of territory within certain boundaries on the map. Pawns backed by more powerful forces bring about control over time.

The geospatial thinking of a Go master, then, may be on display in maritime Southeast Asia. This supplies Beijing a psychological advantage. What looks unimportant to Westerners steeped in chess constitutes steady, incremental progress toward permanent control of territory that Beijing has pronounced an inalienable part of the motherland. It also represents steady erosion of freedom of the seas in the China seas — a process that could discredit the principle of freedom of the seas across the globe, with unknowable but certainly baneful results. Unless, that is, you think surrendering a principle on which the liberal system of trade and commerce is built is a price worth paying to appease Asia’s big brother.

But — and you knew a but was coming — I would affix an asterisk to Alex’s commentary. People are not cultural automatons. The games they play may influence how they think, but they do not determine their actions. Or, if they do, it verges on impossible to demonstrate how such factors shape conduct in the real world. If policymakers, executors of policy, or ordinary people report that Go, or chess, inspired them to do this or that, then fine. That’s about as close as it gets to proving causation. Short of that, tracing the impact of strategic culture is largely a matter of conjecture. We know culture exists, and we know it’s important. Measuring it or forecasting its effects is an elusive task, fraught with ambiguity. Hence the asterisk.

It’s also crucial not to oversimplify. Cultural influence isn’t uniform within a given mass of people. I’m virtually sure, to name one Western example I know well, that chess — linear strategy employing cost/benefit logic and pieces with varying capabilities — exerts zero influence on what I say and do. The Naval Diplomat has played little chess, has no talent for it, and — perhaps not coincidentally — has no interest in it. That would nullify Alex’s analysis if — heaven forfend — I ever attained high office. One doubts, moreover, that Go is that all-pervasive among the Chinese that it overrides ordinary cost/benefit logic, Confucianism, the tenets of Marxism-Leninism, and on and on. Go is not all-important. In short, let’s not oversell the social and cultural dimension of strategy.

And lastly, even if you assume Go or chess do provide thumb rules for appraising Eastern or Western behavior, there are countervailing strands of culture within any society. Culture is a mélange, not a simple list of traits or influences. Asians like surrounding and controlling territory? Sure they do. But they have also proved receptive to the Western strategic canon, in particular the writings of Carl von Clausewitz. Mao quotes Clausewitz repeatedly. And Clausewitz was a thinker and martial practitioner who urged statesmen and commanders to subordinate the chaotic, nonlinear world of armed conflict to rational — linear — logic.

Do Westerners prefer the linear approach? Sure, I suppose you can say that. But they also like to encircle and crush opponents. The Battle of Cannae, where Carthaginian forces surrounded and annihilated a Roman army, became a metaphor for European strategists that endured into the twentieth century. That’s rather Go-like. Westerners are direct? Sure, but the figure of Odysseus, who embodied craft, guile, and cunning, also runs through Western strategic thought. Deception has its place in Western warmaking and diplomacy.

And so forth. It’s helpful to think of civilizations as possessing dominant and recessive characteristics. Policymakers or strategists may have certain strategic preferences — Asians for the geospatial approach and gradualism, Westerners for punching opponents in the mouth — but certain situations can bring forth the recessive traits. Trying to discern what action will summon forth what response from an antagonist is more enlightening, and informative, than projecting behavior solely from the games people play.

That is all.

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China

Beijing’s maritime encirclement strategy compared to Go

 

Alexander Vurving from the Honolulu-based Asia-Pacific Center for Security Studies takes the Chinese board game of weiqi or Go to describe the country’s grand strategy in the disputed South China Sea in an article written for the website of National Interest magazine on Dec. 8.

Vurving said that while chess is a game of checkmate, Go is a game of encirclement. “There are no kings, queens or pawns as there are in chess, only identical stones whose power depends on where they are in the larger arrangement of the pieces. If chess is a contest of armies, weiqi is a struggle between configurations,” he wrote. While chess players focus on the destruction of the enemy’s physical power, Go players strive for control of strategic positions.

China’s land reclamation programs in the Spratly and Paracel islands is a symbol of the nation’s strategy to occupy strategic positions. The most powerful weapon China has in the region is its nuclear submarine base at Yuling on Hainan island. Vurving said however that the location of the submarine base remains far from the disputed waters. What China is most likely to do is to expand its influence in the region through the use of fishing boats and lightly armed government vessels, he said.

Quoting from a senior US diplomat, Vurving said great powers do not to go to war with each other over rocks. A leading scholar of Chinese naval development said that an international incident in the South China Sea will not bring major danger to the global balance of power nor even to the normal functioning of the international system. From the perspective of Go players, China’s strategy in the disputed waters is a masterclass in how to play the game, according to Vurving.

The goal of this strategy is to gain control of the region through creeping expansion instead of major battles. With its land reclamation, China can slowly expand the territory it controls in the South China Sea. Vurving said the first step for China is to avoid open armed conflict as much as possible. Second, China must try its best to control the most strategic positions over the disputed region.

Third, Vurving said China has to develop these strategic positions into strong points of control. The People’s Liberation Army must establish important logistics and military bases in the region for power projection in the future, he said. China’s grand strategy is basically trading quantity for quality, according to Vurving. Five of the six reefs of the Spratly islands currently under Beijing’s control are among the most strategic features in the archipelago, the author said.

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