Trade War with China

Economics, Premium POM21 Comments

Understanding the RMB and Transforming the Existing Exchange Arrangement

China needs to increase foreign RMB demand so it can begin to phase out the accumulation of US dollars and maintain stability in its own domestic economy.

China is trapped because its economic model is based on exporting cheap goods and receiving US dollars in return.  Chinese business owners exchange these dollars for RMB through the People’s Bank of China.  This forces China to expand the RMB market which keeps the valuation down because RMB demand predominantly exists within China.  This is what China is attempting to change as it internationalizes the RMB and creates asset markets based on the RMB.

These excess US dollars which are accumulated by the PBoC are used to purchase US Treasuries and other foreign assets.  A simple method of understanding this relationship can be viewed as China taking the dollars and investing them in US Treasuries with an expected maturity date and yield, or return on investment.  The dollar bills go back into the Treasury and are subsequently re-distributed back into the American economy.  This domestic re-distribution of dollars has contributed to upward valuations of the stock markets, real estate, and overall credit markets, as monetary planners find creative ways to prevent an oversaturation of the domestic dollar market.

This is compounded by Chinese efforts to take US dollars out of the mainland and invest in assets around the world.  China is bursting at the seams with US dollars and can only send so many back through the official Treasury channel.  Expanding Treasury holdings outside the fluctuating range which currently exists would work against the objective of reducing Treasuries.  As such, Chinese business owners are allowed to move capital under the radar and inflate real estate markets around the world while purchasing Lamborghini’s to cruise around in Western cities.

The objective for China is to continue expanding the foreign RMB assets and markets so it can reduce the amount of US dollars it accumulates, and shift its economic model from a trade-exporting one to a trade-services one.  The difference between both is that exporting is based on tangible products, while services would consist of RMB denominated financial assets, loans, and use in balancing trade with economic partners instead of dollars.

The more the RMB international capital market develops, the more China can export its own products for payment in renminbi.  This means less USD accumulation and reduced need to purchase US Treasuries with those dollars.  It also means a reduced amount of Chinese shadow-capital being invested in Western real estate markets.

As dollar accumulation decreases, and RMB denominated trade payments increase, the PBoC can begin to allow the currency to appreciate, which in turn will strengthen its monetary position internationally and energize the whole cycle for expansion.  Less dollar accumulation means less Treasury purchases, and less Treasury purchases means incremental RMB appreciation.

This will also allow the USD to begin its depreciation cycle, which is something American monetary planners desperately need in order to increase exports and bring back domestic jobs for American workers.   The Trump administrations scripting on China currency manipulation and trade practices are a direct assault upon the historical framework which has kept the USD appreciated against the RMB.  These are attempts to shift the narrative and should not be considered a coincidence.

This existing monetary dynamic is the exact reason why China could never dump US dollars.

First, flooding America’s shores with trade dollars would increase the risk of speeding up inflation and causing the dollar to depreciate at a fast rate.  This would also depreciate the investment China has made into US Treasuries and cause the RMB to appreciate at a rate that would slash its exports and cause havoc in the domestic economy.  The civil unrest which would develop from this is something the Chinese government wants to avoid, especially with the upcoming 19th National Congress of the Communist Party of China.

Second, there isn’t a viable alternative to US Treasuries as other assets, such as the euro, are not as stable and cannot provide the liquid market which would be necessary to support and encourage global growth.

The overall Chinese debt-to-GDP ratio, including government, financial sector, personal household, and business, has now exceeded 300%.  The world’s collective debt is around 324% of GDP.  There’s obviously a problem here which is developing at a fast pace.  Any attempt by either America or China to suddenly change the monetary dynamic which exists between them, without the agreement of the other, could topple the whole house of cards.

China’s domestic credit market is going to be facing enhanced pressure.  The solution for this problem is for China to continue internationalizing the RMB and further open domestic on-shore financial markets to foreign investors.  Beijing can no longer continue to expand domestic growth by enlarging credit markets.  It needs to attract foreign capital and investment into RMB denominated financial instruments.

But there is the rub.

China is reluctant and skittish about opening their domestic markets in fear of manipulation and sabotage from outside influences.  But if it doesn’t, its domestic credit market will implode.  The patient strategy of incrementally internationalizing the RMB and opening capital markets at a match pace can no longer be allowed to continue.  Things must be accelerated and transformation encouraged.

The pressure which the Trump administration is beginning to put on China regarding trade practices is meant to force this change.  It’s in America’s interest for China to phase out USD accumulation and open its on-shore capital markets.  This will cause the RMB to begin appreciating against the dollar and will be a huge step towards the multilateral restructuring which is needed.

As China is strengthening the exchange arrangement policies of the RMB, the domestic troubles which are developing in America, along with the “Trump is unstable” narrative, will contribute to the change in investor attitude towards the dollar.  Demand will begin to decrease and international investors will seek opportunities elsewhere at exactly the time when China is opening its domestic capital markets and expanding the international role of the RMB.

This is not a coincidence.

Though there may be some liquidity “bleed-off” from markets as interest rates increase in America (which is another reason for China to shift away from Treasury accumulation, as it puts further pressure on the RMB), a large financial and economic crisis cannot be allowed to develop and take hold of the international investor mind.

The development of a trade war between China and America will serve as a catalyst for the broader transformation.  Trump has the ability to end the exchange rate arrangement himself if need be, and in fact may do so as the answer to Chinese manipulation, but it would work much better if both sides agreed on timing and message before big forex shaking events were to be implemented.  – JC

This article is copyrighted by POM Media©2017. As Premium content permission is not given to be copied and re-posted.

JC Collins can be contacted at jcollins@philosophyofmetrics.com

21 Comments on “Trade War with China”

  1. My point on this article might just be a bit indirect, or tangential, but how do you (or any of the readers) see the bonds market developing?
    I´m not an expert in economic matters at all, but there seems to be some red flags up when it comes to the US bonds market… which could obviously quickly affect the European one.
    Is there any rational basis for this to happen, or is it just some more fear mongering info?
    Some people “in the know” (at least in theory), like Greenspan, Soros and top Black Rock executives say that the Bonds market is starting to look like an “inflated bubble” in deed.

    Thoughts?

    1. Disclaimer: I am no expert either!
      But I agree, bond markets have looked bubblicious for quite a while. Here’s another blogger saying the same:
      https://capitalistexploits.at/2017/06/world-whack-market-absolutely-100-going-crash/

      As JC has mentioned, in accordance with his main thesis, the USD has been steadily depreciating since Trump took office. If this continues much longer, or even accelerates, one would think that international investors will increasingly realise the USD has entered a bear market and start selling their dollar denominated bonds, causing the bubble to deflate. This is only one way it could play out but looks reasonably probable IMHO.
      However, always keep the old saying in mind: Markets can stay irrational longer than you can stay solvent! In other words, if you’re thinking of shorting bonds, it may be worth waiting for a clear signal that the bubble has burst.
      Disclaimer 2: the above does not constitute financial advice!
      Cheers,
      Jon

      1. Hi Jon,
        thanks for your message.
        No worries man, I don´t take it as financial advise 🙂

        That idea re the dollar denominated bonds is what is lurking in the back of my mind.
        And yes, I´m thinking of getting rid of my US bonds, but if I wait too long, then the market will beat me, and the whole thing is for the investor to beat the market.
        JC has never said anything directly related to this that I can remember of, even though he might have and I just can´t recall it.
        But connecting what he posts in his different articles, I think like you, that that market might soon deflate.
        JC if I´m wrong, please correct my error.

        Hmmmmm… decisions, decisions…

  2. Hello, JC

    In other post you have written before you were expecting a substantial increase in USD valuations by October ahead, have you changed your mind with the present post? It seems to be so under my view. Could you clarify this, please?

    Regards

  3. Excellent post, thanks.
    Regarding the trade war, Bannon seems to be the main visible architect, we shall see whether he can force it through. But what are we to make of this:
    https://finance.yahoo.com/news/steve-bannon-crash-economy-no-135402406.html

    In particular, the chart and numbers, which would appear to suggest that China has no case to answer, at least in terms of overall trade imbalance. Raised my eyebrows, but I don’t know whether it is cherry-picked data.
    File under “fake news”?

  4. There is one comment in the article that is a recurring theme in the articles I read an it concerns me:

    “This will also allow the USD to begin its depreciation cycle, which is something American monetary planners desperately need in order to increase exports and bring back domestic jobs for American workers.”

    To me, that says domestic jobs will come back but the purchasing power of the wages may be 30% below today. The reduction in the real cost of the exported goods has to come from somewhere and the fragmented chaos of the sellers of labor have always lost to the organized greed of the owners of capital.

    The clueless working poor, who will probably not be qualified for those jobs, may see the same 30% reduction in the purchasing power of their already low wages. If that happens, I do not see how this ends peacefully.

    1. All of this will happen as interest rates increase and the inflation cycle deepens. Periods of inflation are always complimented by real wage increases. There is a lot of misunderstanding and fear mongering about inflation and other economic metrics, but wage increases are seldom mentioned, as it depressurizes the fear mongering angle. As an example, there is a big deal made in some circles about how much value the US dollar has lost since 1913. But real wages increases are never mentioned. The dollar hasn’t lost 90% of its value over this period because wages have increased proportionally. There are of course areas where the proportion is distorted for a period of time, but these always adjust eventually.

  5. Hello,

    First of all I must apologize for not commenting very often such incredible thoughts and informations coming from JC and the best followers oh this blog , who will recognize themselves.
    I’ m always late on readings , that’s why I doesn’t add my perspective on subjects where a lot has already been discussed .
    Now on this particular theme , about the risks inherent to a chinese trade war and the prospect of inflation , I globally agree whith JC ‘s article .
    In a certain way , America is right now where Britain was a century ago . Over extended commercial and monetary domination ,and the beginning of a new trend , rebellion of the vassals who took 30 years to end the British Empire , which morphed into that anglo-american power.
    US Dollar will decline slowly as it happened to the British Pound , among increased tensions all around the globe , some of these manufactured tensions being pretext to justify shift and adjustements in the monetary equilibrium .
    JC laid out the most probable scenario for the next 20 years . Inflation is coming around , as we can see some sparks in the CRB index which still has to stabilize

    Maybe because of some wars disrupting the flow of energy , or basic materials , I don,t know . But also because a big part of the newly created money has to go somewhere .
    If you look at the chart of the US$ Trade Weighted Index , you can see the double top which took 15 years to materialize .

    https://fred.stlouisfed.org/series/TWEXBMTH#0

    May be I’m wrong , but the down path will continue , slowly but surely , while the RMB will strenghten as the new monetary world ( should I say Order ? ) will emerge via the IMF / SDR .

    And it won’t be done without wages increases along the way , but with enough lag to never catch up completely . So , if I see it correctly , we had a real excess in CRB prices just before the financial crisis and now the consolidation is ongoing , with the index going back and forth inside a newly created range from 160 to 500 pts.
    During this phase , the shift from USD to SDR should prevent a new major peak in CRB prices and permit a slow increase in wages to reach a new equilibrium in the buying power between the West and the emerging nations .
    It won’t be without crisis , but JC is there to prevent us from being lured in the eternal media hysteria
    .
    Must say that I really enjoy being part of the POM community !

  6. I thought this article, although not perfect, gave a good overview of the geopolitical situation:
    http://www.zerohedge.com/news/2017-08-19/gavekal-coming-clash-empires-russias-role-global-game-changer

    It is a relatively long piece which touches on many pertinent aspects of the changes the world is going through; here are just a few key points mentioned which I found most interesting:
    – The MIC needs an enemy. The obvious choice should be China but US business interests are too integrated there, hence they pick on Russia, going against Trump’s instincts.
    – The real motive behind China’s Silk Road 2.0 lies in the fact that the US navy has the ability to take control of shipping lanes should they wish.
    – Saudi Arabia could choose to betray the US and start accepting RMB for their oil. This would put immediate downward pressure on the USD. It is even suggested that the recent weapons deals they have done during Trump’s visit could be a prelude to such betrayal.
    – HK announced already that it will soon be possible to buy gold contracts in RMB – this solves the problem that Saudi and Russia, among others, would otherwise be faced with, i.e. what to do with all their RMB.
    – It will increasingly make sense for Germany to turn its back on the EU project and embrace Russia. I find this hard to imagine but after the next German elections who knows?

    Any thoughts welcome!

    1. Thank You Redjon great thoughts and insights!

      I have been meaning to make a comment on the USS Navy Ship John McCain “incident” on 21 August around the Malaysian waters. In another similar incident,
      the USS Fitzgerald collided with a container ship off the coast of Japan in June!

      In the intelligence community, we are told, there is no such thing as a coincident. There are patterns in both cases and one common thing appears to be the term “Hacked”! This term is very much overused and it is now applied to anything that can not be answered logically. The question that should be asked is that how come the most sophisticated piece of technological achievement that is possibly more intricate or equal to a spacecraft sent out to space by Nasa can be “hacked”? And what does it actually mean?

      A US Navy ship is a standalone machine in the middle of the ocean with no wire (Copper, Fiber etc.) or even radio wave or otherwise, that is accessible to the public or any enemy. So are we supposed to believe that a Romanian taxi driver actually hacked into a ship in the middle of the ocean and took control of it or is there another story which we are not told about? Are we looking at a new weapon system developed by an adversary of the US that may be a nation OR a cabal/force that operates as a pressure group on a large scale? Could this be a force from a James Bond movie? A lone leader of a group that puts pressure on a powerful government?

      All the above may be my wild imagination but in the absence of any real info and only snippets of photos and news, creates what is commonly known as “conspiracy theory” and yes, I am now thinking along the lines of a conspiracy theory. If you find this unbelievable or even sensational, please have a look at the photos of the both Navy ships. Does it make any sense for two similar accidents to a powerful navy ship to have a such a dent that looks like a photoshop job?!

      The recent Present Trump’s speech regarding the sending of 4000 troops to Afghanistan was heavily criticised but this could either be a diversion OR actually to cement the presence of the US forces in Afghanistan that IMHO will be the fort against the Chinese takeover/control of the entire region. Afghanistan has Lithium and both China and US will need plenty of it.

      The mention of Pakistan, that is the most unstable nation possibly on this planet and the alliance of US and bolstering of India to control Pakistan may not be so far fetched. A weak and super corrupt Pakistan can be the point of penetration by the Chinese, given the Saudis flirting with the Chinese to pay them in RMB. So your following points may be very close to the truth:

      “– The MIC needs an enemy. The obvious choice should be China but US business interests are too integrated there, hence they pick on Russia, going against Trump’s instincts.
      – The real motive behind China’s Silk Road 2.0 lies in the fact that the US navy has the ability to take control of shipping lanes should they wish.”

      We are also hearing of a potential and looming war between China and India in which India may be overrun by China’s people’s army in a short time, although China does not want to be dragged into a war, yet. Also that China has borders with Pakistan, India, and Afghanistan too and ground warfare and infiltration is possible.

      I believe, Trump’s intention in extending forces in Afghanistan is to extend the stay of the US troops and not to fight any force there now simply because there are no wars going on in Afghanistan but any evacuation of the US forces from that country will create a power vacuum that will only be filled by China. The Saudi’s funding of the corrupt Pakistan military/Intelligence with the backing of the CIA is no more as Saudi’s are not in a powerful situation any longer. Therefore the option of the return of Taliban or any other serious Islamist group to take full control of Afghanistan is not there and that leaves only China to fill the gap by the Silk Road 2.0 cover. Chinese can pour money to Afghan tribal leaders and buy them all out, they seem to have a lot of cash and USD to burn anyway. So it is possible to assume the US will not allow the Chinese peaceful or unpeaceful takeover of Afghanistan to happen, even if it means assisting and funding the Taliban again!

      1. Lol, Carpe diem we seem to be looking in a similar direction. When I hear about the USS McCain I think about Sen. McCain who recently had brain surgery. Now both McCains are in need of recovery. Remember John McCain’s most theatrical no vote for repealing the Affordable Healthcare Act (Obamacare). I mean since we are speaking in a conspiratorial tone.

        As to the hacking…I believe it to be possible. Also I believe it to be the underlying cause for China launching their own quantum communication satellite, I believe last year. Here is an article that dumbfounded me a long time ago.

        “A 15-year-old computer hacker caused a 21-day shutdown of NASA computers that support the international space station, and invaded a Pentagon weapons computer system to intercept 3,300 e-mails, steal passwords and cruise around like an employee.”

        http://abcnews.go.com/Technology/story?id=119423&page=1

        And another for good measure.

        “‘I HACKED International Space Station’ claims expert who said he could steer planes”

        http://www.express.co.uk/news/nature/579295/I-HACKED-International-Space-Station-expert-said-could-steer-planes

        It seems Afghanistan is one side of a vice to squeeze Iran. Remember when Trump traveled the Middle East recently? He was said to have started a NATO type system with Saudi Arabia. If so this would be the other side of the vice.

        And since you mentioned the CIA check this article out. Notice the photo for the article…a CIA logo.

        “Trump and the “Deep State” The Government Strikes Back”

        https://www.foreignaffairs.com/articles/2017-08-15/trump-and-deep-state

        Here is another interesting perspective on Afghanistan. I can’t believe I’ve learned how to spell Afghanistan…lol. 🙂

        https://www.youtube.com/watch?v=An_A5rZAEqo&t=32s

        And since laughter soothes the soul. Yes this is a satire report so don’t take it serious but its funny nonetheless.

        https://www.youtube.com/watch?v=Syjp9lsWBhc

        1. Hi Dane and Thank you for the excellent clips and for sharing your thoughts.

          I did say JC’s articles and POM cause us to have synchronistic experiences, so here’s the proof for you Dane 🙂 …JC is a Magi I’m sure.

          That Jonathan Pie fellow is hilarious 🙂

          I actually didn’t consider the satellite “hack” and it’s a good one to think about as the possibility of a potential access to the control of the machine.

          The Foreign Affairs site seems to reflect the CFR views, which is a deep state franchise if not the think-tank for them. That is the place HRC used to “pop in” to check her day to day mandates! Also, Afghanistan speech by Trump seems to be a part of a potential deal with the Deep State in return for peace with Russia! I wonder if the Navy damage was arm twisting so they force Trump to submit. Anyway, it’s all speculation as we do not have proper info and the news from MSM, well, you might as well forget about it as it is all nauseating garbage.

          Also, interesting clip about Afghanistan. It used to be a beautiful and peaceful country up until 1974 and then it became a hellhole and the educated secular people left the country and Pan-Islamism was installed by Berzinsky and co. I recall lots of young Europeans (Hippies) used to go in busloads to Afghanistan to smoke everything that was banned in Europe (Hashish, Opium etc.). I had a German lady colleague in the 90’s who told me she spent 6 months of paradise in Afghanistan as she was on a constant High for that period. Great lady though but she was older than me a real hard core hippie of the era. Remember that Afghanistan’s primary export is Opium. I may have inadvertently suggested said what could be in the package for peace! wink wink nudge nudge 😉

          1. Hello Dane,

            I just read this rather intriguing article by the Foreign Affairs website. This site as I mentioned earlier an outpost for Anglo-Zio-American propaganda operation. Despite my absolute rejection of Pan-Islamism and the terrorism which it has brought in this world, I find the article shows the favoritism of totalitarian crypto-democratic and vassal states of both US and Israel, in this case, the Azerbaijan Republic versus the Islamist Mullahs. One of the contributors is Dr. Brenda Shaffer, whose speciality is the Caucuses region and she is an Israeli citizen. Her job is and has been to create a war between Armenia and Azerbaijan. A recent report regarding Israeli made drones given to Azerbaijan regime that resulted in the killing of several Armenian soldiers. Israel is doing its best to create a conflict in the south Caucuses region between Armenia and Azerbaijan.

            Armenia is a Christian nation and in fact the first Kingdom in the world that accepted Christianity as its state religion. So it seems, Israel’s survival since at least 1974 and the take over of the Likud Party may have been to create conflicts all around. The strange thing and the irony is that Israel has great relationships with Saudi Arabia the world sponsor of Islamist Terrorism but hates the ancient and Christian Armenia!

            I can, therefore, think Foreign Affairs website’s intentions are dubious imho.

            https://www.foreignaffairs.com/articles/central-asia/2017-08-24/how-us-promotes-extremism-name-religious-freedom?cid=nlc-fa_twofa-20170824

      2. Carpe Diem, personally I think we can take Trump’s word for it, his purpose is “killing terrorists”. But that doesn’t preclude additional purposes of course! So you may well be correct that keeping a strategic presence there is the hidden agenda.

    2. Hi redjon. Germany is a difficult one to call. Since much of this seems to be stemmed around a similar reformation as the Protestant reformation long ago I looked at the religious demographics of Germany. Doesn’t help a bit really, but it is from 2016.

      36.7% Not religious and minor religions
      28.5% Catholic Church
      26.5% Evangelical Church
      1.5% Other Christian groups
      1.9% Orthodox Church
      5% Islam

      https://en.wikipedia.org/wiki/Religion_in_Germany

      It would seem there should be a huge sell to the 36.7% in order to tip the scales one way or the other. But since the Ancient and Accepted Scottish rite seems to be making a stand perhaps the diverse groups will form an alliance such as the religious consolidation we have spoke about in an effort to form another reformation.

      At the end of the Protestant Reformation Germany was split between Catholic and Protestant. Perhaps the Berlin Wall’s erection was a dividing line for this in 1961 and Trump’s Mexico wall could be to to once again make this division because Mexico is 88% Roman Catholic with Protestants and Evangelicals comprising the second largest group with 5%. To me when JC says a Berlin Wall moment for the US it’s the same division just within the US. The US has 48.9% Protestant and 23% Catholic.

      Are we in a reformation? If so what is it being called this time?

  7. Hello redjon,

    Most of the key points you mentioned in Gavekal’ article could effectively happen . And I wouldn’t be so surprised .
    But what I can’t imagine is a scenario where Germany leave the european project . Europe , as it stand , may well be a very twisted political project who need a lot of reforms , but in my opinion I don’t see a new monetary order without a european currency , as Europe is a big commercial partner for the rest of the world , and in the IMF.
    There a lot of people in Germany , including political and business people who are really upset with the new sanctions about Russia .
    May be Germany will turn his back from US rules and trade more with Russia , why not ? There ‘s already business deals with Iran , made by France and Germany , despite US sanctions . Why not with Russia ?
    For China it could be wise to manage more and more deals with Europe. I’m not sure , but I think the ECB accept the RMB as a reserve currency now .
    Russia and China are game changers , and chess players . And there is a burning fire inside Washington …..

    1. Ledude, I totally agree with you as it stands, under Chancellor Merkel. But if a “new modern nationalist” gets into power there, all bets are off!

  8. “As such, Chinese business owners are allowed to move capital under the radar and inflate real estate markets around the world while purchasing Lamborghini’s to cruise around in Western cities.”

    What happens when this is no longer a valid avenue? Will the real estate bubble burst sending property values back to normalization? I get refinance offers in the mail everyday. I’m not taking the bait because I see the false increase in equity. But I also see many in town falling prey to equity loans to satisfy wants…and a few needs. If…or when the real estate bubble pops it could put a lot of people upside down in their mortgages again couldn’t it?

    It seems like legal money laundering.

  9. “”China’s current public debt level, by our definition, which is a broad definition, is still moderate in an international context,” said Alfred Schipke, the IMF’s senior resident representative for China.

    The rapid rise in debt, rather than overall debt, has caused concerns, he said.

    He said the key to ensuring more sustainable growth is to implement reforms and prevent debt from continuing to grow at the rapid pace it did in recent years.

    Reform efforts include closing loss-making factories, as they may pose risks to the nation’s banking system, according to Raphael Lam, the IMF’s deputy resident representative for China.”

    http://www.chinadaily.com.cn/business/2017-08/25/content_31082397.htm

  10. Philipines president Duterte has spoken about the return of Marcos’s Gold! Duterte is in the same flank as the US president and his rhetorics about/against Obama is well known. The “Gold” he is talking about is the looted gold by the Japanese Imperial Army in WWII that were hidden and some discovered by Ferdinand Marcos. Could this release of the Gold be in any way to fund the anti-Globalism camp given the rumors of a vast amount of gold that could clear debts!! Just speculating but the timing of this announcement is interesting as we are told that September/October is a chaotic period!

    http://news.abs-cbn.com/news/08/29/17/duterte-marcoses-ready-to-return-gold-bars-portion-of-hidden-wealth

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