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Mike Holt

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  • China's Slowdown Could Have Much Further To Go [View article]
    China's One Belt One Road initiative has already been experiencing funding shortages.
    Oct 3, 2015. 08:48 PM | 1 Like Like |Link to Comment
  • China's Slowdown Could Have Much Further To Go [View article]
    China's economic growth is constrained by a number of factors:

    1. Its current growth has been driven by debt-fueled Fixed Asset Investment spending and this has grown to a much larger percentage of their GDP than domestic consumer spending. So, it will be difficult to walk the talk of "rebalancing" the Chinese economy toward increased domestic consumer spending without resulting in a slowdown of aggregate GDP growth since its unlikely that the smaller base of consumer spending will grow at the same 18% to 20% rate at which Fixed Asset Investment spending--now equal to almost 50% of China's GDP--has been growing.

    2. Rebalancing the Chinese economy toward increased domestic consumer spending will require entrenched interests that hold high positions of power within the Chinese Communist Party to accept cutbacks in funding for the industries that they control and from which they profit handsomely.

    3. China's banking system is clogged with non-performing loans that are not written down because they are guaranteed by the government, as is just about everything else in China which helps to explain why so much activity has little or no economic merit. Although some may believe that this debt can continue to grow in an unconstrained manner because China's one-party system has given PRC government leaders "more levers to pull" and in the past these extend and pretend tactics employed have allowed the CCP to minimize loan defaults and the risk of a banking crisis, the true non-payment status for loans far in excess of the 1% reported to be non-performing is subjecting Chinese banks to increasing liquidity pressures as they struggle for other means to generate needed cash flow.

    4. China's interior is much less developed than the coastal areas largely because China's economy remains heavily dependent upon trade and foreign investment, which generally does not penetrate into the inland areas. And, unlike the United States, for example, China has only one coastline, so attempts to develop the interior are met by less available foreign direct investment and higher transportation costs that make exports from those locations less economical.

    In light of the above, many have come to expect slowing economic growth in China as the new leaders of the CCP attempt to rebalance the Chinese economy toward more sustainable domestic consumer spending and, in the process, rein in debt, and crack down on corruption.

    However, more recently, Xi Jinping has been using every opportunity possible to promote China's One Belt, One Road "vision" which for now essentially represents an external extension of China's massive debt-fueled infrastructure spending programs with a longer-term hope that financing and developing trade links with other countries will result in new markets for all of the excess capacity that has also been developed in many industries as a result of all the frenetic, unchecked Fixed Asset Investment spending that has boosted China's GDP from less than $4 trillion in 2007 to more than $9 trillion today.

    So, investors questioning China's future economic growth must wait and see whether:

    1. China's economy will slow if efforts to rebalance its economy are pursued; or

    2. Even more massive levels of debt can be accumulated to finance China's external spending on its One Road One Belt [OROR] scheme.

    These developments may also alter expectations of an eventual increase in the freedoms to be enjoyed by PRC citizens. A rebalancing of the Chinese economy was originally expected to result in increased freedom for PRC citizens since this would naturally be accompanied by a diffusion of economic activity away from the existing structure that is dominated by central planning and financing by the large state-owned banks under tight control of the CCP.

    However, after encountering an unexpectedly high level of resistance from entrenched interests, Xi Jinping seems to have altered his course to favor a strengthening of state owned corporations that would also be the primary beneficiaries of China's IBOR initiative. But, this strategy could backfire if citizens of the PRC tire of waiting for their day to come, and investors who are becoming more aware of the true health of the Chinese banking system decide to pull even more of their capital out of China. If so, a third outcome may be possible, namely:

    3. A significant decline in the value of the RMB and/or a liquidity-induced Chinese banking crisis due to capital flight from China--on the part of both wealthy PRC citizens and foreign carry trade investors.

    Attempts on the part of the PBoC to avoid a devaluation of the RMB would require purchases of the RMB being sold, but funding those purchases would remove liquidity from China's banking system which could have even more severe consequences. But, if the RMB were to fall, this could hurt the chances of an IMF decision in six months to include the RMB among the basket of currencies making up the IMF's Special Drawing Rights. And that, in turn, could make it more difficult for China to borrow the additional funds it needs to finance its One Belt One Road initiative.
    Oct 3, 2015. 08:10 PM | 1 Like Like |Link to Comment
  • China's Slowdown Could Have Much Further To Go [View article]
    The fourth graph in this article illustrating loan growth in China deserves more attention than it receives.

    As you can see, after loan growth surged to almost 35% in 2010, the ~15% rate at which it has settled is still at least twice China's supposed 7% GDP growth rate if this so called "man made number" [in the words of China's Communist Party Premier Li Keqiang] can be believed.

    But, I very rarely hear reference being made to China's loan growth rate. This may be due to the fact that global debt levels are a problem throughout the rest of the world as well, and this has become the new "Third Rail" of politics, and economics, that policy makers prefer not to discuss.
    Oct 3, 2015. 12:59 PM | 1 Like Like |Link to Comment
  • Blowouts In The Markets: Beware Of Debt Financing [View article]
    I left out an important point in my comment above.

    After the paragraph referencing the short-term objective of the Fed to reflate assets in order to restore the health of the US banking system, I should have mentioned that this did not stimulate the US economy to the extent that likely would have resulted if such loose monetary policies were implemented in prior decades because the housing market was previously relied upon to serve as the primary monetary policy transmission mechanism, but the housing bubble essentially broke this monetary policy transmission mechanism. So, the loose monetary policies did not result in a commensurate increase in bank lending, although it did contribute to an increase in margin loans and the carry trades described in the paragraph beginning with the sentence,

    "Low interest rates have also encouraged capital spending in developing countries, most notably China."
    Sep 29, 2015. 12:12 PM | 2 Likes Like |Link to Comment
  • Divergence Drivers And The Dollar [View article]
    Hmmm, just as Eskimos have many different words to describe snow, I'm learning that Economists are able to make many distinctions regarding divergences in monetary policy.

    I thought the divergence between the monetary policies being implemented by the Fed and the ECB resulted from earlier decisions regarding the sequence of policy actions to be taken in an attempt to address the issues that surfaced during the 2008-09 GFC, i.e.,

    The US Fed prioritized restoring the health of the banking system in order to restore the flow of credit before efforts to rein in debt would be implemented [we're all holding our breath waiting for that to happen];

    In contrast, the ECB, possibly in conjuction with government leaders of various European countries, initially chose to reverse this sequence of policy actions, then learned that they got the sequence backward, and so are now implementing loose monetary policies intended to improve the health of European banks and the flow of credit in those economies.

    But, I will now familiarize myself with distinctions to be made in the trajectory of the monetary policies implemented by these and other central banks. Thanks for calling this to my attention. Someday, this may all make sense.
    Sep 29, 2015. 11:51 AM | Likes Like |Link to Comment
  • Blowouts In The Markets: Beware Of Debt Financing [View article]
    The conditions in Ireland are similar in many respects to conditions throughout the rest of the world.

    First, there is way too much debt.

    Second, aging populations result in reduced consumer demand, which manifests itself in slowing GDP growth.

    Third, globalization and technology have put downward pressure on wage levels for the majority of populations in developed countries.

    Fourth, homes represent the largest single investment on the part of most individuals, and was considered by many to be their retirement nest egg since stagnant wages made it difficult for many to accumulate retirement savings in some other manner. But, home prices have been inflated to levels that are not affordable to most potential homebuyers absent artificially low interest rates.

    Because our economies depend upon growth in order to function properly (I won't elaborate here), central bankers around the world have ironically attempted to fuel growth by encouraging more debt.

    In the past, when economic slowdowns were due to other factors such as excess inventory buildups, interest rate cuts helped to stimulate the economy largely because low interest rates resulted in lower home financing costs (home mortgage debt is the largest form of debt for most people), and lower home financing costs translated into new home construction as well as higher prices for existing homes. The resulting equity build up in those homes was tapped by many to finance current consumption that stagnant wage levels would not have permitted.

    But, when interest rates fell to their current historically low levels, this debt-fueled bubble in home prices burst, causing a disorderly deleveraging process that brought down the prices for many other assets as well.

    In the longer-term, what is needed is not so much an increase in GDP, but rather an increase in consumer demand to offset the declining demand on the part of aging populations in developed countries where living costs are higher.

    In the short-term, what was recognized was that falling asset prices jeopardized the health of our banking system, so rather than increasing interest rates that would have provided consumers with more income, central banks around the world have lowered interest rates in an attempt to reflate assets collateralizing a mountain of debt. Those with the most assets, owned outright or leveraged, could arguably increase their spending due to the resulting "wealth effect" but their spending, relative to the remaining 99% of the population is negligible.

    Low interest rates have also encouraged capital spending in developing countries, most notably China. The resulting debt-fueled Fixed Asset Investment Spending there has led to a boost in global GDP growth, but since most of that spending is non-recurring in nature and therefore largely unsustainable, that new engine of GDP growth was only temporary. Moreover, since much of that debt financing was directed toward increasing productive capacity, it has contributed to an increased supply of goods, rather than an increase in consumer demand which is actually what is so desperately needed.

    The lower debt-to-GDP levels in China permitted debt to grow much faster there than in other countries--accounting for about half of the $50 Trillion INCREASE in global debt since the 2008 GFC [so much for the promised orderly deleveraging process that was promised], from $150 Trillion to $200 Trillion. That debt-fueled economic activity did result in significant wealth accumulation in China, but for a variety of reasons that wealth was accumulated primarily in the hands of a relatively small percentage of PRC citizens.

    While similar periods of rapid economic growth in other countries likewise resulted in substantial amounts of wealth being accumulated in the hands of a few, e.g., the so-called Robber Barrons in the US during the Industrial era, the difference is that this wealth largely remained in the countries in which it originated. By contrast, a number of polls indicate that large percentages of wealthy PRC citizens--typically defined to include those with a net worth greater than USD one million--intend to leave the PRC within the next five years.

    In addition, low interest rates throughout the rest of the world, coupled with expectations of appreciation in the Fx value of the Chinese currency, have contributed to a large carry trade whereby funds borrowed cheaply in developed countries have found their way into China in order to take advantage of the higher interest rates available there--e.g., money market accounts, known as Wealth Management Products, that may yield 10% to 20% despite their one to three month maturities.

    If this capital flows out of China, and there have been some signs of this already, that calls into question whether the Chinese currency will continue to appreciate as it has in the past. If the value of the Chinese currency--the Renminbi, or RMB for short--was to decline significantly, this could result in a substantial reduction in the cost of Chinese goods exported to the rest of the world, and therefore a bonanza to all those consumers who have been struggling with stagnant wages and low interest rates on their savings.

    But, a decline in the price of Chinese goods could reduce revenues and profits for foreign corporations, putting downward pressure on their share prices, despite all the efforts of central banks around the world to reflate asset prices over the past several years.

    So, what comes next? Stay tuned, but hopefully this provides some useful perspective in the meantime.
    Sep 29, 2015. 08:13 AM | 3 Likes Like |Link to Comment
  • Divergence Drivers And The Dollar [View article]
    Marc, the 16th annual Geneva Report published last year provides some very interesting insights that help to put US and European monetary policy divergence into better perspective. Here's a link:

    This report was co-authored by Vincent Reinhart, who was previously the Chief US Economist for Morgan Stanley before he was succeeded by Ellen Zentner, who sat next to you on the "Word from Wall Street" panel last Thursday at the FPA's 15th Annual World Leadership Forum.
    Sep 29, 2015. 06:54 AM | Likes Like |Link to Comment
  • Divergence Drivers And The Dollar [View article]
    Something other than empty units in a high rise apartment building.
    Sep 28, 2015. 09:24 PM | 1 Like Like |Link to Comment
  • Divergence Drivers And The Dollar [View article]
    Thanks Marc. The concern raised by the comments made by various hedge fund managers was that the RMB could suffer a steep decline even if the PBoC was not seeking a maxi devaluation.

    But, after having shared that narrative with you, if your view is still that the yuan could weaken against the dollar but could still appreciate against other emerging market currencies, then I'm satisfied with your answer and I very much appreciate your feedback.
    Sep 28, 2015. 05:12 PM | 1 Like Like |Link to Comment
  • Divergence Drivers And The Dollar [View article]
    I linked the wrong article to my previous comment.

    Here is a link to the article that I meant to include.

    Bear in mind that, while China's Fx Reserves equal $3.75 trillion, it's M2 alone equals $18 Trillion, so there is a lot of cash that could be withdrawn from the country, and China's Fx reserves equal only 21% of that cash (a lower percentage than that for many Asian countries during the 1997 Asian currency crises).
    Sep 28, 2015. 11:41 AM | 1 Like Like |Link to Comment
  • Divergence Drivers And The Dollar [View article]
    Thanks Marc. Although it's not entirely clear exactly what is behind the YTD $300 billion reduction in the PBoC's Fx reserves, this Bloomberg article also describes some other alternatives other than capital flight and/or an unwinding of carry trades.

    Wishful thinking aside, it would still be interesting to note whether USD/CNY futures are now pricing in further depreciation of the RMB, rather than appreciation as in the past. Mark Hart of Corriente Advisors at one time believed that the RMB carry trade was between $1.5 trillion and $2 trillion, and that this carry trade was facilitated by RMB futures pricing-in appreciation of the RMB, which added, rather than detracted, from the potential profits to be made from RMB carry trades.

    Some also believe that the PBoC would have a hard time fending off declines in the value of the RMB if this carry trade was to begin to unwind, since PBoC purchases of RMB being sold would reduce liquidity in China's banking system (all else being equal) at a time when Chinese bank's are already supposedly feeling squeezed for liquidity, especially at month-ends when Wealth Management Products mature. History demonstrates that this twin risk of debt and currency crises increases the risk of both according to Professors Bauer, Herz, and Karb in Chapter 9, "Debt and Currency Crises" in Dr. Robert W. Kolb's book "Financial Contagion: The Viral Threat to the Wealth of Nations."

    The liquidity problems being experienced by China's banks, that are said to be clogged with NPL's that the banks don't write down because they are guaranteed by the government, is described in much greater detail by Logan Wright, PhD in Chapter 3, "'Deliquification' & China's Deflationary Adjustment" in the book "A Great Leap Forward?" co-authored / edited by John Mauldin and Worth Wray.

    If Logan Wright's detailed and seemingly well supported assessment is accurate, than the risks of further declines in the RMB seem very real and potentially significant, regardless of whether the PBoC would prefer to see the PBoC strengthen as part of their longer-term strategy of internationalizing the RMB, which would make it much easier for "China, Inc." continue borrowing at record rates.

    Any further thoughts to counter these arguments? These bearish sentiments regarding China's rapidly escalating debt and the questionable health of their opaque banking system are nothing new, nor is capital flight as evidenced by all the all-cash real estate deals that have been transacted by wealthy citizens of the PRC over the past several years. But, what's new is the recent surge in capital outflows, the BIS report indicating that no country has ever avoided a debt crisis after its debt/GDP ratios have risen as rapidly as they have in China over the past few years, and the manner in which the CCP seems to be desperately seeking ways to rein in debt without triggering a hard landing in the process.

    I would also point to the fact that foreign portfolio investment may also be on the wane if fund managers attempt to protect themselves against lawsuits from investors by adding disclosures to their investment offering materials warning that their funds could become illiquid if the CCP was to again decide to restrict sales of securities. Less capital flowing in, combined with more capital flowing out, and higher borrowing costs don't paint a very rosy picture. Will Xi Jinping's visit to the US succeed in attracting Foreign Direct Investment to the US even though US corporate managers and investors have learned to be wary of the fate that has befallen so many other foreign corporations that have attempted to expand their presence in China?
    Sep 28, 2015. 11:05 AM | 1 Like Like |Link to Comment
  • Divergence Drivers And The Dollar [View article]
    Thanks Marc! Since markets have been roiled recently by developments in China, I'd like to focus upon the risk of further declines in the Fx rate of the RMB due to capital flight, rather than PBoC policy.

    Specifically, are futures markets still reflecting an expectation of a rising RMB Fx Rate, or do they now price in the risk of further declines in the RMB?

    As you know, expectations of a rising RMB Fx Rate made carry trades much more affordable, so a change in those expectations could impact the profitability of carry trades by as much, or more, than a potential increase in short-term interests on the part of the US Federal Reserve--even though all eyes seem to be focused more upon the Fed's decision.
    Sep 28, 2015. 08:03 AM | 1 Like Like |Link to Comment
  • Why China's Renminbi Rate Will Be Going Down... And Down [View article]
    I agree with your premise that an acceleration of capital flows out of China--both by wealthy Chinese and by foreign carry trade investors--is the real issue that investors should be watching.

    Higher interest rates elsewhere that would increase the borrowing cost of carry trades is most often cited as a potential catalyst for this unwinding of the carry trade, but further devaluation of the RMB is a more important factor.

    The CCP has failed to reform its banking system that it relies upon to control the economy and ironically this has caused them to lose control over the economy, which is now suffering. So, rather than implementing long-term strategy they are desperately throwing things at the wall hoping something will stick. Their efforts to prop up the stock market bubble that was intended to offset a bursting of the property market bubble is an example of this. So, despite China's porous capital restrictions, savvy Chinese investors are moving their capital elsewhere, which is evident by all the all-cash real estate purchases by wealthy Chinese investors throughout the world.

    If the CCP instructs the PBOC to buy RMB to offset the decline in the RMB Fx rate, such buying will result in a decrease in the money supply at a time when liquidity is already being squeezed because banks must borrow vast amounts to conceal and deal with the fact that they are not receiving interest payments on many of the loans they are carrying at face value. And, the 40% plunge in the Shenzhen stock market since June has caused leveraged speculators and the banks that extended multiple (not just two) margin loans to them to be especially squeezed for cash at this time. So, further declines in the RMB seem inevitable. Those declines will fuel further efforts to get capital out of China, and M2 alone of $18 trillion far exceeds China's $4 trillion of Fx reserves.

    A decline in the RMB will be disruptive to the global economy, so harmful to the Chinese economy since it is the world's largest trading partner and also the world's largest creditor. And, since China has maxed out its internal spending on infrastructure and excessive / duplicative production capacity its most significant opportunity for growth was to build infrastructure elsewhere. A decline in the RMB will make those overseas investments much more expensive.
    Sep 8, 2015. 07:47 AM | 3 Likes Like |Link to Comment
  • Weighing The Week Ahead: Time To Revise The Year-End Market Targets? [View article]
    Jeff, given that many currencies have been plunging, I'm surprised that you haven't focused more upon that, and the role played by both slowing economic growth in China, efforts to rebalance their economy, and concerns regarding their spiraling debt.

    My view is that the risks emanating from China generally fall into two categories: financial contagion risks and trade contagion risks.

    Trade contagion already seems to have led to significant declines in commodity prices, much slower economic growth in countries with commodity-oriented economies or that conduct a lot of trade with China, and falling Fx rates for their currencies.

    For example, the Fx rate for the Canadian dollar is now at 1.32 : 1.00 largely because the economy of Canada (the US' largest trading partner) is oriented toward mining and natural resources. That means investors could scoop up stocks of Canadian companies [or real estate], for example, at 40% discounts due to the Fx rate change over the past year. Is this a "value trap?" Could the Canadian dollar fall further? In a world where attractive valuations for stocks or bonds are few and far between, I would think that value investors would be very interested in the answer to this question.

    The answer may lie in further analysis of financial contagion risks. Although it's widely believed that financial contagion risk is limited because the CCP has many means available to contain, or conceal, debt problems in China, capital has been flowing out of China for the past year, and this trend seems to be accelerating. Concerns about further devaluation of the RMB could amplify this, as would higher borrowing costs for the carry trade that has led to huge capital inflows into China [disguised as trade] to take advantage of higher interest rates there. Some claim that a comparison of China's reported Chinese exports to Hong Kong and Hong Kong's reported imports from China reveals that 80% of China's current account surplus actually represents hot money inflows.

    There are obviously many gaps in China's capital controls--at least when it comes to the "tigers' [vs. the "flies']--or it would not be possible for so many all cash real estate purchases by wealth Chinese investors to be taking place on such a large scale throughout the world. If, in addition to a reversal of the carry trade, more of these wealthy citizens of the PRC decide to transfer their wealth out of China, will the PBoC defend its currency even though buying RMB would result in a tightening of domestic credit just as patriotic Chinese speculators and the financial institutions through which they obtained margin loans must deal with large losses on their leveraged investments? Remember, M2 in China is over $18 trillion, so far exceeds China's Fx Reserves.

    What makes this potential debt crisis / currency crisis more interesting is that debt and currency crises can be positively correlated, and according to Christian Bauer, Bernard Herz, and Voker Karb (see Chapter 9 "Debt and Currency Crises" in the book "Financial Contagion" edited by Dr. Robert W. Kolb) twin crises are connected with comparatively high reserve ratios, which typically arises only in countries with fixed exchange rate regimes.
    Sep 7, 2015. 05:51 PM | 3 Likes Like |Link to Comment
  • Shanghai down sharply; PBOC sees end to "correction" [View news story]
    Even if GDP growth was 7%, whether that would be "healthy" would depend on how it was achieved. For example, if 7% GDP growth required a 20% increase in debt, that would be a very negative development. Of course, if debt continues to spiral out of control and GDP grew at only 4%, that would be even worse.
    Sep 7, 2015. 04:50 PM | 2 Likes Like |Link to Comment