China and the threat of 'dumping Treasuries'

A recent Wikileaks article has exposed the Chinese mentioning their large holdings of US Treasuries while in conversation with the US as a not so subtle hint to back off on various international activites by the US, specifically selling arms to Taiwan.
From AFP (2011, Feb 21)

China's clout -- gleaned from its nearly $900 billion stack of US debt -- has been widely commented on in the United States, but sensitive cables show just how much influence Beijing has and how keen Washington is to address its rival's concerns. An October 2008 cable, released by WikiLeaks, showed a senior Chinese official linking questions about much-needed Chinese investment to sensitive military sales to Taiwan.
 "In that regard, the recent announcement that the United States intends to sell another arms package to Taiwan increases the difficulty the Chinese government faces in explaining any supporting policies to the Chinese public."
His comments came days after the Pentagon notified Congress it was poised to sell $6.5 billion worth of arms to China's arch rival Taiwan.

China's massive holdings of US debt have not escaped the public's notice either.  Even Saturday Night Live spoofed the relationship. (email readers may need to click through to see the video)

Link to SNL video


My response to China:
Bring It.
I dare you.
I double dog dare you.


One must ask how the Chinese have amassed such a huge wad of our currency and thus our debt when considering my dare to the Chinese. In short, the Chinese forcibly keep their currency undervalued by constantly intervening in the exchange markets.  They are doing so to keep their exports 'cheap' and their export factories busy.  They need invest all those US dollars in something so they end up in our Treasury bonds and bills.  Their huge holdings of our debt is a direct result of their mercantilist trade policies.

If the Chinese do not want to keep buying our debt the can very easily do so by not intervening in the currency markets, but I doubt they will do so in a dramatic fashion. Their low skill low wage factories cannot compete without an under priced currency.  The Chinese are slowly raising the Yuan but it is a challenge for them to wean themselves off the Faustian bargain they created.

Paul Tudor Jones of Tudor investments dedicates 14 pages to a discussion as to how the undervalued Chinese Yuan has created severe imbalances worldwide.  I suggest you read the whole letter  Mr. Jones' letter (2011 Feb 14)

Failure to address this issue - as one of the primary causes of the intractable unemployment currently plaguing the US -- has led to a series of second-best policy options . . . Indirectly, the peg has exacerbated the United States' large fiscal deficit while enabling our elected officials to delay the difficult spending adjustments that are inevitable.

So China, yes, you can threaten to stop buying our Tbonds.  We would pay a little more for our home mortgages but it would also staunch the flow of manufacturing jobs out of America.  You however would see a massive number of people thrown into unemployment and most likely a repeat of Tiananmen Square.

Your move.

Inside North Korea's propaganda machine

Here's a documentary on North Korea's propaganda machine and the people trained to fill it.  Remember the kids you see are some of the elite.  Unfortunately  I doubt the current wave of revolutions will break the bulkheads on this repressive country.

There are small scale operations attempting to tell the citizens of North Korea what really going on but I doubt it will amount to much at this level of intensity.







ht:
@limlouisa
@marykissel

Rising Risks Roundup

This weekend has been an eventful one for the world geopolitically and this week will see further events which shape the stage.  The riots in Libya and continued unrest throughout the Middle East had a dramatic affect on futures markets today as the regular markets were closed.

Libya News - NYTimes

Middle East news - Al Jazeera

The events in Libya are obviously in flux and getting hard news out of the country is difficult so the rumors and actual news will be mixed together and hard to clarify.

The affect on the markets today (Monday) was dramatic:

Crude oil up 6+% to 91

Silver up 7+% to 33.86

SP 500 down -0.64% to 1329.25 (Futures price)

While the rioting is getting the headlines the trouble in the Eurozone continues its slow burn. Ireland is holding elections this week and the party currently in power is predicted to be handily spanked in the polls.  The mood in Ireland is not good and there is some talk of repudiating the guarantee of the government honoring all senior bank. 

Meanwhile Portugal debt continues to drop in price. The 10 year is at 7.45% tonight  

This cannot go on forever.  The recent German elections sent a clear message that Germans are tired of paying for other people's problems.  

Tomorrows markets will be very interesting to watch. Oil prices are getting to a point where they are seriously hitting the consumer's pocketbook and another spike in oil (like the one in 2008) could seriously stress the already weak US consumer.  I'm not evening mentioning China and their continued raising of interest rates / reserve ratios.  That's for another time.

Further reading:

High oil prices hit US consumer:

http://bonddad.blogspot.com/2011/02/gas-prices-are-beginning-to-choke-off.html

Torturing the initial claims data

Initial unemployment claims data came out today and weekly unemployment claims decreased to 415,000.  The number has bounced around quite a bit recently causing some gyrations in the market and I thought it would be instructive to dig down a little further into the data.

One item to note from this first graph is how volatile the raw data is.  Note how around year end the unemployment claims spike up dramatically. Compare the raw data to the 4 week moving average seasonally adjusted data and you can understand why the claims data has bounced around so much recently; we are in the post holiday layoff period.

Next let us examine the year over year change in initial claims. What is actually impressive to me is how close the raw data and 4 week seasonal data track each other.   (Note these two graphs do not show today's data)  I have drawn in some black lines showing the rise starting in 2008, a peak in early March 2009 and then a bottom and rebound in early 2010.  Note this is the change in claims and as you can see we are still dropping on a year over year basis but the rapid fall in initial claims has ended and we are trending back towards zero. You can also see the most recent raw claims data is bouncing around quite a bit, again due to seasonal affects and possibly the weather.

Is the glass half empty or half full?

We can torture the data a bit further and just for fun and see what models predict will happen next. Using March 27, 2010 as the baseline (the peak in the rate of decline in initial claims)  I let excel extrapolate the data out another 15 weeks.  Bottom line is you can come up with either a positive or negative prediction depending upon how may polynomials you use.

Using a 2 polynomial regression predicts (R2 of .9712) claims are near their deceleration point and will then continue to keep dropping over time.

You want a bearish case? No problem!  Using a 5 polynomial  (R2 of .9763) regression initial unemployment claims will eventually reverse their fall in 12 weeks or so and start to rise on a year over year basis

Please note I'm not making economic predictions here, I'm just looking at the shape of a graph.  Going forward we have several cross currents pulling claims in opposite directions.  ISM data has been quite positive which may bode well for fewer layoffs in the future.  On the negative side we have higher food and energy prices as well as continues austerity by the states and municipalities.  As always stay tuned and I'll keep you informed.

HT creditwritedowns
He has done some great work on this data series and his articles were the genesis of this post:
http://www.creditwritedowns.com/2011/01/is-the-government-data-fudging-jobless-claims.html
http://www.creditwritedowns.com/2010/09/jobless-claims-still-not-pointing-to-imminent-double-dip-recession.html

China's reserve ratio raising is finally starting to bite

China recently raised the bank reserve ratio requirement again and it looks like this time it's really starting to bite. 7 day repo rates (what banks charge each other for a 7 day loan) spiked up just before year end but they aren't falling back down as I had alluded to in my previous post. 

7 day Chinese repo rate
3 month Chinese repo rate

As you can see from the 7 day repo rate chart the spikes have been getting larger at the end of each quarter, hinting at banks scrambling to find enough cash for their books at quarter close.  While the rate has dropped  in the 7 day, the 3 month has u-turned and is going back up near its pre-12/31 closings.  The Chinese stock market has been going down recently and this removal of cash from the system may be the reason.  If one continues to observe high bank repo rates it does not bode well for the Chinese stock market or the whole commodity/reflation/Australia trade in general.

Reading list

Some stuff I've been reading / watching

David Einhorn video
http://wealthtrack-appletv.blip.tv/file/4406653/  
ht: http://www.eurosharelab.com/

http://pragcap.com/three-things-i-think-i-think-20

http://www.creditwritedowns.com/2011/01/european-debt-dynamics.html
European debt dynamics.  Borrowing at 5% and growing at 3% just digs a deeper hole.

http://www.creditwritedowns.com/2011/01/cautiously-optimistic-into-2011.html
Address says it all.

http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100009218/the-dam-breaks-in-portugal/
Has Portugal already asked for IMF help and no-one noticed?  Would be ironic if this episode of Euroland bailout occurs quietly.   Long term the trend is NOT Portugal's friend:
http://www.bloomberg.com/apps/quote?ticker=GSPT10YR:IND
(Look at the 5 year history)

Portuguese recycling & Iceland recovery -- Why the Chinese and Japanese are buying EU debt

The recent news of both China and Japan buying EU debt provides a very interesting window into the various motivations of investors.  While most investors are leaving the PIIGS debt markets, China and Japan appear very willing to invest.  Why?  It appears the Asian nations' motivations are different than return of principal.  Both are exporting nations and if more European trading partners are forced into austerity measures of higher taxes and lower government spending their own export industries will suffer.

American policy makers should be mindful of this when negotiating with China. It may appear they have the upper hand when looking at their massive foreign exchange reserves, but China also needs our markets to keep their factories running.

Unfortunately Portugal looks to be the next domino to fall, Asian assistance notwithstanding.  FT's blog lays out the timeline I have previously alluded to: It appears once a PIIGS' bond yield pierces the 7% level a bailout eventually follows.

However even with these 'bailouts' and Euro Central Bank assistance the problem has not been solved. As austerity measures and budget cuts drag GDP down the burden of debt grows ever higher in a nasty feedback loop.
From Satyajit Das:

Cuts in government spending and higher taxes have mired the economy in recession. Falls in tax revenue necessitate increasingly deeper cuts in spending to try to stabilise public finances. In 2010, the budget deficit was forecast at 12% of GDP, even after spending cuts and tax rises worth Euro 14.5 billion   The problems of the banking sector are increasing due to the poor economic conditions. Hitherto largely confined to commercial property, problems are now spreading to the broader economy. Unemployment and lower incomes mean that householders are unable to meet payment obligations on mortgages and other loans. Weak economic conditions have affected businesses, increasing default levels. In the absence of strong economic growth, inflation and a massive devaluation, the peripheral economies, such as Ireland and Greece, may be unable to shrink themselves to solvency. A simple relationship demonstrates the unsustainable position:

Changes In Government Debt = Budget Deficit + [(Interest Rate – GDP Growth) X Debt]

In order to restore solvency, overburdened borrowers must stabilise debt and begin to reduce the level of borrowing. This requires GDP Growth exceeding interest rates, a budget surplus (through spending cuts and/or tax cuts) or a combination of these. EU/ IMF assistance to Ireland was designed to address the high yields on Irish bonds, which curtailed the State’s ability to borrow. But the 5.80% cost of the bailout debt requires an equivalent growth rate and a balanced budget simply to stabilise debt at current very high levels.

Meanwhile the recovery in Iceland provides contrast to the current austerity and higher tax drudgery in the weaker European countries:

The Nordic economy grew at 1.2pc in the third quarter and looks poised to rebound next year. It ends a gruelling slump caused largely by the "New Viking" antics of Landsbanki, Glitnir and Kaupthing, the trio of lenders that brought down Iceland's financial system in September 2008. . .

This has led to vastly different debt dynamics as they enter Year III of the drama. Iceland's budget deficit will be 6.3pc this year, and soon in surplus: Ireland's will be 12pc (32pc with bank bail-outs) and not much better next year . . . 

The pain has been distributed very differently. Irish unemployment has reached 14.1pc, and is still rising. Iceland's peaked at 9.7pc and has since fallen to 7.3pc.