G20 Meeting - China vs Japan

As the G-20 Summit begins this weekend, many financial experts will be watching for guidance on the direction of the global economy.

One of the more important factors are dictated by the valuations of the US dollar, Japanese yen and the Chinese yuan. I would encourage everyone to read the following two posts for a good background on the current situation.

I have added excerpts for both:

Japan Desperately Needs a Stronger Dollar, China Desperately Wants a Weaker Dollar: The Fed Can't Please Both - Of Two Minds, 4/7/16

Simply put, the stock market is a monkey on a leash held by central banks--just give the leash a little tug, and the monkey jumps. Bonds are a gorilla--harder to control, but still manageable--but foreign exchange is King Kong, trading $5 trillion a day and impossible to control beyond short-term manipulations.

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Japan sought to weaken the yen to boost its exports and inflation. Now the weakening dollar is crushing those plans, as the yen is soaring:

As the yen soars, Japan is being pushed into a self-reinforcing recession. After 20+ years of borrowing to fund fiscal stimulus, money-printing, bond-buying, etc., Japan has run out of options. Weakening the yen was the last best hope to boost exports and inflation.

The strengthening yen is an economic crisis for Japan.

Meanwhile, the strengthening dollar pushed China into its own crisis. China's currency, the renminbi (RMB, a.k.a. yuan), is a special case because its relative value is pegged to the USD by Chinese monetary authorities. The peg was about 9 to the USD in 2005, and in the following decade China pushed the yuan up to 6 to the dollar.

A currency peg means the pegged currency goes up and down with the master currency. As the dollar soared, it dragged the yuan higher, making China's exports more expensive. Given the stagnation of China's debt-bubble dependent economy, the last thing chinese authorities wanted to see was a faltering export sector.
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The Fed has a stark choice, and the 2-minute warning just sounded. It can break the informal Shanghai Accord to strengthen the USD to save Japan from the slow-moving catastrophe of a soaring yen, or it can let the USD weaken further to placate China and the commodity-dependent economies.

What it can't do is please everybody. This is the inevitable consequence of manipulating markets: you end up being unable to please anyone, because your constant manipulation has created unsustainable carry trades and speculative gambles.

The FX market is about to blow up in the Fed's face, and there's nothing they can do about it. What central banks fear most are markets that are not tightly controlled by central banks. The world's central banks are about to sit down to a banquet of consequences arising from seven long years of relentless manipulation.

Is China About to Shock the Market? - Daily Reckoning, 7/26/16

The Shanghai Accord, agreed in Shanghai, China on February 26, 2016 was an effort to give China some relief without having to devalue CNY against the U.S. dollar (USD). The solution was to keep CNY pegged to USD, but weaken USD against the euro and the yen. China has a larger trading relationship with Europe and Japan than it does with the U.S. The Shanghai Accord gave China the currency relief it needed against major trading partners in Europe and Japan without breaking the peg to the dollar and upsetting global capital markets. It was a neat solution. The only losers were the yen and euro, which had to get stronger under this plan.

From early March to mid-May 2016, the Shanghai Accord worked like a charm. The yuan was stable against the dollar, and the dollar got weaker against the yen and euro. U.S. stocks staged a major rally from around 16,000 to almost 18,000 on the Dow Jones Industrial Index. It seemed that all was right with the world.

Unfortunately, the Fed could not leave well enough alone. Instead of celebrating this truce in the currency wars, the Fed reneged on its weak dollar promise in May, and began talking about interest rate hikes possibly in June or July. The hawkish tone was expressed by several regional reserve bank presidents, notably James Bullard, Loretta Mester, and Esther George. The dollar rallied almost 4% in a few weeks. That’s a huge move in currencies where changes are usually registered as small fractions of 1%.

To summarize, China and the United States had an agreement to both devalue their currencies together. A stronger Japanese yen was the result so the agreement was broken by the United States. Both China and Japan desire a weaker currency. Clearly, they both cannot have that.

There have been financial experts who have predicted a massive yuan devaluation:

Hedge Fund Which Predicted The Subprime Crisis Expects Massive Yuan Devaluation In 2016 - Zero Hedge, 1/19/16

But, according to Hugh Hendry, a massive yuan devaluation ends the world!

Hugh Hendry: "If China Devalues By 20% The World Is Over, Everything Hits A Wall" - Zero Hedge, 3/26/16

'Tomorrow we wake up and China has devalued 20%, the world is over. The world is over. Euro breaks up. The world is over. The euro breaks up. Everything hits a wall. There's no euro in that scenario. The US economy, I mean everything hits a wall! Everything hits a wall!

The dollar strength that you imagined is devastation because you just eliminated dollars. They're a scarce commodity. You've wiped them out. And China is a pariah state.

It's a 'Mad Max' movie, right. OK, China gets to be the king in 'Mad Max' world. How appealing is that? There is no world after the tomorrow where China devalues by 20%. There is no world. Yeah, it's looney tunes to believe that, people say, 'oh wow, they needed to catch a break.'

Their share of world trade has never been higher. They're facing no pressure, immense terms of trade improvement, and you would destroy world trade. World trade is down 25%. You would probably have passport restrictions, the world is over.'

The Bank of Japan is currently on pace to continue buying stocks - are they really going to buy even more to devalue their currency??

The Bank of Japan's Unstoppable Rise to Shareholder No. 1 - Bloomberg, 8/14/16

Already a top-five owner of 81 companies in Japan’s Nikkei 225 Stock Average, the BOJ is on course to become the No. 1 shareholder in 55 of those firms by the end of next year, according to estimates compiled by Bloomberg from the central bank’s exchange-traded fund holdings. BOJ Governor Haruhiko Kuroda almost doubled his annual ETF buying target last month, adding to an unprecedented campaign to revitalize Japan’s stagnant economy.

Here is a hint of what might be coming:

China Turmoil Looms As Traders Bet On Post-G-20 Yuan Tumble - Zero Hedge, 8/31/16

Offshore yuan bears have already started building short positions to speculate on declines after the G-20 gathering, according to Ken Cheung, a strategist at Mizuho Bank Ltd. in Hong Kong.

“The China data for July demonstrated China growth momentum has been weakening," he wrote in a note. "The PBOC might have a less strong intention to maintain yuan stability after the G-20 summit, and allow yuan depreciation again if expectations remain well-anchored."

And if the Yuan starts tumbling, then US equities will quickly follow.

 Another wild card is the ECB and the impact on German banks. 


Deutsche boss: negative interest rates are 'fatal' - The Telegraph, 8/24/16

Deutsche Bank's chief executive has warned of the "fatal consequences" of the European Central Bank's negative interest rate policy, which he said punished savers and could even undermine the recovery.

So, the Federal Reserve seems to be in a box with no clear way out!