Notes From Underground

The equity markets were gaga over the news from Apple and Facebook and trying to push through March’s highs when Twitter was busy raising the issue about a possible Russian incursion into Eastern Ukraine. The “breaking news” failed to gather strength and the markets were soon back into positive territory. Just as the equity markets were absorbing the Russian rumors, the precious metals were making recent lows on the back of stock market strength and better economic news from the U.S. For all you technical-oriented market watchers, the gold and silver both put in outside reversal higher days so we will watch to see if there is any follow through in the metals market tomorrow.

Making the rounds with the rumors of Russian troop movements was the talk about a London Telegraph article by a Notes From Underground favorite,Ambrose Evans-Pritchard[AEP]. The column, titled, “Suspicion Grows That China Is Exporting Deflation Worldwide By Driving Down Yuan,” is a very balanced piece as even the Evans-Pritchard maintains that he takes no view on “how far china intends to go with this” but is making his readers aware of the opinion of Albert Edwards of SocGen bank. Mr. Edwards maintains that deflation is taking hold in China and in an effort to prevent a massive slowdown in its economy is seeking to drive down the value of the YUAN to protect its export markets. The operative process is that China is busy buying U.S. and European bonds to in an effort to weaken its own currency. The YUAN is 3.1 percent lower on the year, hardly an aggressive depreciation, but it is an issue that some U.S. politicians have also raised. For the global economy, it is the idea of exporting deflation that is the biggest POTENTIAL PROBLEM. Again, this a theory and not in any way proven conclusive but let’s play with the potential fallout from the Chinese exporting deflation.

1. “The true picture has been masked by unsustainable levels of investment.” China through its own savings and foreign direct investment (FDI) has developed enormous productive capacity and if the Chinese economy fails to make to the move to a domestic consumer-based economy that huge amount of productivity will have to find a way into the world markets, putting pressure on prices everywhere. Japan, Europe and the U.S. are all trying to create a “modicum” of inflation to reduce their own homegrown deflationary pressures. If Chinese goods are flooding the markets it will put great pressure on corporate profits and remember that the world is awash in high yield corporate debt that is anything but high yield and not priced at all to the impact of China exporting deflation.
2. The recent action in the U.S. yield curves may be the result of China’s efforts to buy huge amounts of long-term Treasuries easily supplanting the effects from the Fed’s tapering. For now, I don’t believe that the moves in the 5/30 are the direct result of China but reflect a trading battle between giants. However, if the 2/10 curve were to break decisively out of its recent range I would be more receptive to the “China exporting deflation” school of thought, which would justify a flattening of all the yield curves where there is not a solvency issue.
3. If the Chinese are exporting deflation, then the ECB, BOJ and Federal Reserve are going to have a more difficult time igniting the inflation they are trying so hard to create to help relieve their own debt-burdened economies. The boogeyman of Chinese deflation will also act to pressure politicians in the U.S. and Europe to raise the scepter of Chinese mercantilism as the chief cause of high unemployment and low wages. Fed Chair Yellen  is very openly concerned about raising U.S. employee wages and downward price pressure from China will add to pressure on the Fed in how to resolve this dilemma.
4. If the issue presented by Mr. Evans-Pritchard proves correct then BUY GOLD. I know this will cause head scratching but it is not present inflation that is bullish gold but rather the fear of how CENTRAL BANKS WILL ACT TO DIVERT A DEFLATIONARY SPIRAL. It was interesting today that the GOLD/YUAN and GOLD/YEN both tested their 200-day moving averages before embarking on a violent corrective short rally. Again, nothing is proven with the Evans-Pritchard article but it does raise some important issues going forward.

***The Reserve Bank of New Zealand (RBNZ) did what consensus thought and raised interest rates to 3 percent. I was surprised that Governor Wheeler would increase rates with the KIWI close to 30-year highs and a potential slowing in China. The KIWI actually closed a touch lower in New York after Asia initially rallied the currency–a case of the consensus being correct and the price already in the market. The RBNZ stated its concerns about inflationary pressures building and it wanted to stem the recent rise in the NON-TRADABLE sectors of the economy. The central bank did note that the HIGH CURRENCY VALUE has been a headwind for exporters and the RBNZ does “not believe the current level of the exchange rate is sustainable.” Going forward the bank advises that the overnight cash rate (OCR)  “will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures, including the extent to which the high exchange rate leads to lower inflationary pressure.” Now, back to the Evans-Pritchard piece.

Tags: BOJ, China, deflation, ECB, Fed, Gold, gold/yen, gold/yuan, Janet Yellen, Kiwi, New Zealand dollar, RBNZ, Wheeler, Yuan

This entry was posted on April 24, 2014 at 6:10 pm and is filed under China, Currency, Debt Market, Fed, Gold, RBNZ. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.