You know you are in trouble when even the smart guys stop making sense. Here's Andy Xie:
Between a Crutch and Walking Stick
Why the dollar has got to go as the world's reserve currency – and how the euro will replace it
China and Japan are supporting the euro zone by purchasing government bonds that the market shuns today. China and Japan have US$ 4 trillion in foreign exchange reserves and are capable of bridging liquidity problems that some of the Eurozone economies are facing.
What China and Japan can do is to stop market panic from leading some otherwise viable economies down a vicious spiral of rising interest rates, rising debt burdens and bankruptcy. Economies that are not viable in the first place shouldn't be helped.
China and Japan's actions help themselves in two ways. First, the euro is the only alternative to the dollar for global trade, commodity pricing and storing foreign exchange reserves. If the euro falls apart, the U.S. Federal Reserve will be further emboldened to pursue inflation to decrease the U.S.'s leverage or indebtedness at the expense of dollar holders. China and Japan hold vast dollar assets.
The problem in the Eurozone and elsewhere including China and Japan is insolvency rather than insufficient liquidity. China and Japan must look to their own solvency. Japan's deflation and China's hyperinflation are symptoms of both countries' inability to service their accumulated energy- and money debts.
Neither China nor Japan can rescue the EU whose consumption assets -- its residues of 'modernity' -- are basically worthless.
The economy is so bad that I got a pre-declined credit card in the mail.
Both China's and Japan's foreign exchange surpluses are liabilities, not assets. Japan has ruined itself attempting to maintain the value of its current account which has been leaking value for over 20 years. China is destroying the value of its currency attempting to support the value of its foreign exchange reserves. Along with buying worthless 'empty cities', malls and high rises, (and automobiles and freeways) China buys trillions in foreign bits of colored paper, pretending that the act itself bestows upon the colored paper some real worth. This is a bad 'stupid pet trick' joke the Chinese are playing on themselves.
This is the part that Andy Xie misses which is puzzling. It indicates how far out along the gangplank the waste- based culture has been led by its marketing department.
When the Chinese buy euros or dollars it 'sells' its own currency. Chinese dollar holders discover there are good and better reasons not to sell them to the central bank but to sell them instead to the 'loan- shark' economy. The central bank must bid for the dollars or euros which in turn reinforces the credibility of the 'underground' dollar market which offers a better price.
Part of this is the maturing process of a country creating a convertible currency where one does not currently exist. China will take its lumps as the yuan becomes freely exchangeable for other moneys, if only due to the serious shortage of yuan overseas: its 'float'.
China expanding its yuan- float both domestically and overseas will reduce its value. The yuan's current 'value' represents both the flow of dollars to China along with a yuan 'scarcity premium'. As more yuan flow into circulation the scarcity premium evaporates - they aren't scarce anymore! This dynamic and the domestic dollar trade takes place against a background of the flood of dollars and other foreign currencies into China which tends to press the yuan's value upward.
China's dilemma is acute: it can either bid for dollars or allow these dollars to trade within China's domestic economy. China bidding against itself for dollars supports the value of the dollars it already owns. Doing so validates the domestic dollar market even as the bidding devalues the yuan while increasing circulation- plus velocity stokes hyperinflation. Bidding also pisses off the US Treasury Secretary: not bidding for dollars means the value of China's dollar reserves erodes with an upward revaluation of the yuan. Instead of hyperinflation there is a dramatic loss of Chinese output even as Geithner grins. China is caught between a rock and another rock.
The fact that the yuan does not appreciate despite massive dollar inflows toward China indicates there is a large, Chinese domestic market for dollars that pushes the yuan price lower.
All this explains why China urgently needs to reduce its F/X surplus even as its interest rate differential with other nations causes it to balloon. China and Japan are trapped by their surpluses. Lending to Eurozone banks that have demonstrably destroyed vast amounts of funds to date indicates both China and Japan have exhausted ideas about what to do with the surpluses.
Here's this from the Dave McWilliams @ the Irish Independent
Last night, over a jar, the (Swiss) bankers told me that the flows of cash from Germany have been huge because the average well-to-do German is taking his savings out of the euro and putting them on deposit here in Switzerland. The fact that the Swiss banks normally offer no interest on deposits and still get huge inflows is indicative of the fragility at the heart of the euro.
They also explained that lots of money is coming from Ireland. These guys, who I worked with years ago, have never really seen any business from Ireland and certainly during the boom they looked on with a sense of trepidation because they had seen this before.
Now they are getting calls from Dublin on a daily basis.
They have concluded that this is because the banks and the Government can't be trusted. These investment bankers -- serious financial people -- agree that the Irish taxpayer has no business bailing out the banks. At the table last night were two bondholders, men who invested in the Irish banks in the good times. They are now embarrassed because they were taken in by the Irish and European spin.
So here are the so-called mysterious "bondholders" and even they don't expect to be paid. They made a mistake and they should bear the consequences.
In their eyes, there is now a direct link between the ongoing Irish government guarantees and the flow of money out of Ireland. However, their view is precisely the opposite view to that held by our Department of Finance and the Irish Central Bank.The bankers here see a pattern which has been repeated in every financial crisis in the past The more time that goes by, the less credible they become. The more any government bluffs and provides guarantees, the less those guarantees are worth and it gets to a stage where the guarantees are worthless because the State simply doesn't have the money to back them up.
This is the logic of capitalism. When you pile more and more financial burdens on the population in order to bail out the banks and to guarantee banks, the chances of the population being able to pay all this back diminish. This increases the risk. As the risk increases, capital gets scared and leaves. There is a well-established pattern in this development.
China and Japan pouring F/X reserves into the euro rathole erodes depositor confidence and accelerates runs out of euros. Quantitative Easing PR and other central bank maneuvers does exactly the same thing. This is another 'stupid pet trick'. The establishment fools exactly nobody but their own marketing departments and the mainstream news media.
China does not have enough euros to guarantee all the liabilities on EU banks' balance sheets. The Euro- banks aren't simply insolvent, they are walking bankrupts. The big shots might not believe this but the bank depositors instinctively understand what the smartest central bankers cannot grasp.
The economy is so bad right now if the bank returns your check marked "Insufficient Funds," you have to call and ask if they mean you or them.
What the bankers do understand is that any deleveraging 'haircuts' mean a complete loss of confidence along with depositor flight which are what is taking place across Europe right now. Bank runs and credit destruction are the inevitable outcome of three years of pointless guarantees.
Part of this is the macro- economic conundrum which has a country being able to have an independent monetary policy, the free flow of capital and fixed foreign exchange but not all three simultaneously. This dynamic is called the 'Unholy Trinity' and is a well- known aspect of macroeconomics:
This is also why zero interest rate policies, open market operations, bond purchases and other PR stunts by central bankers have failed completely in the US and elsewhere. Money values are set by swapping cash for absolutely vital crude and crude products by billions of users in the greater world. Just as the dollar value of yuan is set by millions of Chinese citizens on the streets of China, the 'fuel value' of dollars and other currencies is set by millions of drivers in gas stations every day all over the world. Value is scaled beyond he grasp of the handful of central bankers, business managers and economists. Priced in crude, both dollars and euros have value, this is determined by the willingness of consumers to offer dollars and other currencies and the producers to accept them.
Dollars are a de- facto hard currency freely exchangeable on demand for a valuable physical good. The 2011 oil/dollar has much greater mobility value compared to the 1913 dollar which could only purchase a Model T jalopy and run it over rutted dirt tracks. At the same time, compared to oil, what the economy offers now in exchange for dollars is a bad joke.
The economy is so bad BP Oil laid off 25 Congressmen.
Twenty five Congressmen aren't worth anything! Without independent monetary policy the nations are left with either currency exchange pegs and capital flows. China's peg means an unhindered flow of 'hot money' capital into China fueling hyperinflation. Trying to staunch capital flows writes 'fin' to the yuan/dollar peg and Chinese 'growth'. Right now China 'enjoys' the worst of both worlds as both the Peoples Bank of China and the US Federal Reserve are stuck with oil- valued hard currencies.
In the Eurozone the currency peg between nations is absolute: an Irish euro is absolutely the same as the German version. What remains from oil- determined ECB monetary policy and the 'euro/euro peg' is capital flight ... the race of depositors out of European banks. Staunching the capital flow would mean a euro breakup as there is no way to have multiple values for the euro in different EU countries.
The effort of central banks to become relevant by attempting currency depreciation and creating liquidity is doomed by the crude price. Reducing currency value -- and increasing fuel prices -- is a form of economic suicide. Fuel becomes unaffordably expensive just like real estate was in 2005. When the fuel prices are not matched by earnings the outcome is demand destruction. People cannot buy what is unaffordable. The outcome as is the case with real estate in 2011 is a return to high currency values, that is low crude prices.
These low prices are not what they might have suggested in the past which was an excess of crude supply: rather they indicate a customer base lacking discretionary purchasing power.
This is the outcome of high currency value: the usual hoarding and decline of commerce as capturing currency value becomes the only economic activity left standing. People go broke, the cannot buy fuel or anything else. Welcome to 1933!
Since 2007 the question has been whether the crisis is a matter of liquidity or insolvency. The Establishment has from the beginning acted by hosing the finance sectors with liquidity from all angles. The idea has been that sufficient liquidity would allow the consumption based growth 'perpetual motion machine' to restart on its own. The onrush of liquidity has failed. Expanding both the Federal Reserve and US governments' balance sheets has bought 17% unemployment and GDP @ 2002 levels. A few more of such liquidity victories and the entire country will be ruined.
The flood of liquidity directed toward banks are claims promised against depositors, retirees and our young children. Our policies aren't just ineffective but sadistic.
The depositors look to retrieve what liquidity they have left out of harm's way. They follow the example of the 'smart money' which has been cashing out of finance assets and taking their dollars out of the country into tax havens.
The solvency issue is not limited to finance and money. We live beyond our credit means and also our energy means. Serious people in high offices hold serious discussions about our energy future and wind up promoting more of the same: auto- first transport: SUVs and giant pickup trucks. Failure to address the central issue of energy insolvency erodes confidence ...
The failure to hold bankers accountable and to rein in derivatives, central bank money laundering along with pointless political finger- pointing does the same. The public waits for the establishment to 'get serious'.
The economy is so bad a truckload of Americans was caught sneaking into Mexico .
The only real cure is conservation and its finance analog thrift. Unfortunately, this is off the table for the sake of faddish 'style'. The future is conceded to the force of events. This means the bailout game is finished: past the point of diminishing returns. Even China the 'super- sovereign' cannot do the impossible.
Any euros that China or anyone else would pour into EU banks down the chimney would simply run out the door into Swiss francs, or traded for gold and silver. The flight to precious metals isn't a currency trade so much as a vote of no- confidence in the world's policy makers who refuse to face reality. Remember Ireland's bank deposit guarantee?
Ireland guarantees six banks’ deposits
John Murray-Brown Neil Dennis
Ireland’s government on Tuesday unveiled a wide-ranging guarantee arrangement to safeguard the deposits and debts at six financial institutions in response to turmoil in the financial markets.
The scheme, which guarantees an estimated €400bn (£315bn, $567bn) of liabilities, covers retail, commercial and inter-bank deposits as well as covered bonds, senior debt and dated subordinated debt.
Most depositors were already covered by an existing deposit insurance scheme for up to €100,000. But Tuesday’s initiative was primarily aimed at easing the banks’ short-term funding, which had seized up in recent days.
The short- term liquidity lockup was a symptom of systemic insolvency that was not recognized. The 'Great Moderation' long run of growth in China and elsewhere resulted in a flood of credit and declining real interest rates. Credit chased a shrinking base of quality investments flooding instead into speculation. This is how the business cycle operates. The longer a credit expansion lasts the longer time exists for negative real interest rates to inflate asset bubbles. Eventually, real output is insufficient to service the overhang of debts. This is Hyman Minsky's 'Financial Instability Hypothesis'.
Adding the cost of negative real interest rates to real fuel costs results in an economy that is unable to fund itself organically. This is what is being endured worldwide right now. Even if liquidity allows debt service, credit cannot replace energy in the creation of real output.
Until this is accepted by the establishment and its functionaries the economy is going to be a bad joke.
I was so depressed last night thinking about the economy, wars, jobs, my savings, Social Security, retirement funds, our shrinking 401k Plans and our bleak future, that I called the Suicide Help line and was connected to a call center in Iraq. When I told them I was suicidal, they got all excited, and asked if I could drive a truck!
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