Wednesday, December 19, 2018

Twas the night before Christmas.....

....and all through the bank.....not a creature was stirring.....ne'er the ghost of "Old Hank"....

Our investments were placed by the chimney with care in hopes that FED accommodation, continuing and exacerbating years of horrific, politically motivated policy decisions, soon would be there.....Oooppss.....Not happenin' today!


I know, I know....my poetry doesn't exactly flow.....but it's accurate....

Yes, it's that time of year once again.  It's that special holiday time when we take a moment or two to reflect on the year's events, set backs and successes.  We think about all of the wonderful times, family and friendships we've been blessed with.  We rejoice and marvel in how fortunate we've been to somehow skip gleefully, unscathed through the mine field of life, oblivious to the myriad financial disasters lying in wait for us at every turn and round every corner.



Last week, a friend of mine stopped by my office to share some Christmas cheer and, as is the norm with our discussions, our banter eventually morphed from the insurance industry, local business gossip, Holiday events and parties, family, gifts and the Cleveland Browns, to, finally, of course, Chinese Monetary policy.....as nearly all office conversations do nowadays.  Typical Yuletide chit chat.

When we were discussing the relative dollar/RMB strength, my (very smart) friend brought up a reference and a few related thoughts that I hadn't considered since I was a wet-behind-the-ears finance student at the University of Wisconsin, many, many years ago.  Thus, the genesis of today's post.  The term that came up was.... the "Triffin Dilemma".

For those of you who don't recall, or never had the pleasure of meeting Bob, the Triffin Dilemma is a reference to the work and related 1959 Congressional testimony of Yale economist Robert Triffin, who argued, in a nutshell, that if the US Dollar is/was to remain as the preferred currency to settle the world's international trade, the Treasury would be required to supply "the world" with sufficient US Dollar currency to support global trade growth.  As global economic activity would grow, specifically, trade transactions where America wasn't a party (but dollars were....think today's Petro Dollar transactions) the United States would have to run increasingly larger Balance of Payments deficits to support these transactions.  (i.e. providing a stable reserve currency for the world's trade). 

Simply put, continued, increasing, Balance of Payment (Current Account) deficits would be required by the United States if the US Dollar were to be used as the world's reserve currency.

Triffin argued, well ahead of his contemporaries, that the system would eventually become unsustainable ( the "Dilemma") as the amount of currency (backed by gold) required would mandate unfundable, ever increasing Balance of Payments deficits and/or threaten the confidence/stability of the US Dollar's gold backing/guarantee.  The Treasury would be forced to starve the world of dollars.

As is most often the case for truly revolutionary, yet painfully obvious economic thinking, Professor Triffin's work was largely ignored by politicians, bankers and business people until 1971 when everything he'd predicted became reality and what we now refer to as the "Nixon Shock", as Triffin expected, materialized.  The administration was forced to abandon the Bretton Woods Agreement, taking America off the gold standard, closing the "gold window", leaving the world with the US Dollar as a floating reserve currency.  The US Treasury would no longer exchange US Dollars for gold on demand.  The world would become a floating, market dependent fiat currency world.  The value of every currency would henceforth be determined by market forces (i.e. relative availability relating to supply and demand).  In theory, everything would, of course, be just fine.

So let's take a look at what's happened to the US Economy since we've dumped Bretton Woods, using one of my favorite charts.  (I can't take credit for it....citation below)




Beginning in 1947 (when my dad had just come back from his all-expense-paid French vacation on the beaches of Normandy courtesy of the US Army) up to 1971, we note that the bellwether indicators, Real Wages, inflation and GDP were in relative lockstep.  This is of course, before Al Gore invented the Internet, and high tech bankers came up with all sorts of sophisticated banking devices.  Once we entered a floating world, we observe that the indicators have diverged dramatically over time.  US GDP, both per capita and per FTE have skyrocketed.  We also note, to our chagrin, (using the collective "our" here presuming that most folks reading this will have some sort of a "job") that Real Weekly Earnings for full time workers are about the same as they were in 1971, even though Real GDP per capita/FTE has skyrocketed, as an apparent byproduct of productivity, as well as labor and capital seeking both its optimum use and lowest financial price-point/cost.  Economies around the world have been set free to export (and import) labor (jobs) capital and technology in competitive pursuit of lower costs and greater efficiencies and profits for the businesses who could navigate the new globalism.  The chart below describes the net impact of these monetary and regulatory policies on Western governments over time.

   
Ooopppsss......Oh Geezzz.....I'm sorry, by bad, that's actually a picture of last week's riots in Paris.....my mistake, I'm sure I'll locate that "productivity" graphic shortly, or at least by the time they put the fires out on the Champs-Élysées.

Anyway, as I was saying, here's the chart I was referring to.....



Oh crap.....I screwed this up again....this is actually last month in Venezuela, I guess a little government corruption and "a million percent" inflation, wiping out the life savings of main street folks (they probably didn't get their cash converted to Offshore USD/Euros in time) will rub those poor, pathetic huddled masses the wrong way from time to time.  We better get that wall up quickly, the US Southern border is just a few year's walk (maybe six months if they are in good physical shape) for these malnourished, unemployed, starving, "last resort" criminals.....I'll bet they are all members of MS13, or ISIS, or at least being actively recruited....if we could just come up with tear gas that doesn't hurt pregnant women, kids and old people....now that would be a technology worth an IPO!

Ok, now I've got it, here's the chart I was looking for (see below).  This chart, although not as graphic as the above photos, should absolutely scare the living-holiday-reindeer-snot out of any highly trained (or barely competent) economist reading it.   In economic terms, this chart depicts millions of people on the verge of starvation, going homeless or being shot and/or beaten to death in "real life".   Highly trained Economists, as we all know, have a completely different fear threshold than mere mortals.






The chart and table above were constructed based on data from the Financial Stability Board's 2017 Shadow Banking Monitoring report data set (2016 data) and the World Bank Development Indicators Data set (citations below).

The following is the most important statement in this post:

In broad, yet definitive terms, the chart above shows, with clarity, that the US Treasury and the FED have most likely lost control of the US, and by default, the global money/financial system.  (Please read that again....it's really important!....I'll wait....go ahead....read that one more time.....let it sink in.)

Ok....take a deep breath.....let's keep going...

A few days ago Janet Yellen discussed the idea that "The FED has no idea what they are doing" as a hypothetical topic (my words not Janet's), in general terms, blaming their "lack of tools", although not fully understanding or acknowledging that her continuation of "Bad Gauges" monetary policy was a major contributor to the gigantic mess we're in today.  Basing monetary policy on fudged, sampled, limited domestic metrics when the bulk of the systemic stress relates to foreign monetary policy (China), unregulated (off shore) funds flow, selective dedolarization and the Triffin-esque inability for the US Dollar to remain as the world's reserve currency, has become the undoing of the global financial system as we currently know it. 

“I am worried that we are in a deregulatory mode and I see a lot of pressures building in the system to go further to really weaken fundamental safeguards that were created in Dodd-Frank. We are a decade after the financial crisis so that would be worrisome and wrong to do,” Janet Yellen - speaking at the Women in Housing and Finance holiday event (12/12/18).

Hindsight being what it is, all of these "pressures" and off shore capital flight could have been mitigated, at least to some extent, had we begun to normalize interest rates sooner, put in China-style "selective" off shore capital restrictions, both in and out (Caymans, Luxembourg, et al), and taken steps to understand the true origin and exposure to the "brand-spanking-new" US$150+ Trillion in globalized "Fake Money" Financial Assets, destined for default, that US Bankers (read US Taxpayers) will be intimately involved in cleaning up.  As usual, the bankers made the mess, the regulators and legislators allowed it to happen....and the taxpayer will pay the bill.

Apparently, the FED has learned little from history, in October 2008, then New York Fed President Timothy Geithner observed that Europe “ran a banking system that was allowed to get very, very big relative to GDP, with huge currency mismatches and with no plans to meet the liquidity needs of their banks in dollars in the event that we face a storm like this.”  From the FOMC meeting transcript.

Here's some recent, behind the scenes video of the daily routine at the NY Fed's Open Market desk.  Note the sophisticated decision process, based on state of the art data and metrics.  The global economy, as we well know, depends on the meticulous execution of FED policy.


It's always been interesting to me that Amazon can track a US$4 parcel, time and date stamped,  from Shanghai, to Paramus, to my Cleveland office (knowing virtually everything necessary about the parties involved) and the FED/Treasury can't tell the origin, final destination or purpose  (without a court order in a complying jurisdiction) of a $50 Billion, US Dollar, layered wire transfer from Hong Kong to a Cayman Islands Bank.  Weird huh?

The FED's ability to manage the US money supply, while other entities are free to create trillions of Off Balance Sheet USD obligations is the equivalent of Amazon trying to do eCommerce without package tracking or inventory control.

Bear in mind that the most recent data (above) is the YE 2016 Data Set.  I would suspect that the data has been trending in a similar direction for the past two years.  i.e.) it looks much worse today.  Based on projected Asset Growth Rates we may have somewhere north of US$370 Trillion of Assets/Obligations on the world's books now, of which a significant chunk could be a tad over valued and poised to default.  Of course we won't get the 2018 numbers until the Spring of 2020, which is unfortunate.  As always, while the world's economists and politicians are relegated to looking in the rear view mirror, stocks, bonds, debt, derivatives and currencies are being priced in real time.

As you can see (above), I break the data/chart out into two sections, the first is what I call the "Old Money" and the other is what I lovingly refer to as "Fake Money".  Old Money is described as that held by established, seasoned, open economies with highly developed transparent, banking, taxation, and monetary systems.  Fake Money is best described as money held in jurisdictions where there is less transparency (perhaps a bit of chicanery) with financial asset location/creation and monetary policy, all having little to do with the underlying productivity of the  related domestic economies.  I've included China, the "usual suspect" Tax Havens (Caymans, Luxembourg, Switzerland, Hong Kong, et. al.) and "Other" (defined as everywhere else) as Fake Money.  Before I get bombarded with Greek, Italian, Middle Eastern, etc. emails resulting from my "Other" being defined as "Fake Money" located "everywhere else", keep in mind that as monetary policy goes, and I know you "Other" folks hate to hear this, but you are all along for the monetary ride.  Your sovereignty is a wonderful "feel good" convention, but it's largely irrelevant when compared to the Chinese/US/Tax Haven tsunami heading your/our way.   

The observations I'd make are as follows, regarding the change in composition from 2008 to 2016:

The "Old Money"

  1. Since the financial crisis the "World" has created additional financial assets (obligations) of US$81 Trillion (31% increase).  
  2. During the same period, Reported Global GDP has increased US$12.5 Trillion (19% Increase or about 2% at a compound rate)  This figure is several US$ Trillion less if you adjust for China's PGDP overstatement.
  3. Financial Assets housed in the UK, France and Germany have actually declined by 17%.  No wonder Paris is burning and Brexit is either happening or not based on the hourly headlines.  btw - Do you own any Deutsche Bank stock?
  4. Financial Assets housed in the Developed "Old Money" jurisdictions (US, UK, Germany, France & Japan) have increased a modest US$12.5 Trillion (7.4% increase or a 1% compound increase)
  5. The "Old Money" increase, offsetting the decline in the UK, German and France Financial Assets primarily took place in the United States ($22.4 Trillion or a 33% increase) presumably due to "Reserve Currency" obligations (i.e. the Triffin requirement)

The "Fake Money"

  1. If you've been reading this blog, or any other economic journals, papers or publications for that matter, you won't be shocked to hear that there's a sizable group of us who believe that the Chinese Communist Party has been cooking their books on reported GDP, Debt Levels, Currency, financial statements, transactions, NPL's, Asset Values, SEC filings, etc. etc. and virtually every economic statistic they've published over the last few decades.  Shocking....I know...but It's truly bordering on the absurd now.  (Luckily this blog is blocked on the Mainland and the CCP probably isn't reading this, so there's little/no chance that I'll be included in the Wanzhou Meng prisoner exchange package....I hope...) Anyway.....
  2. The "Off Shore" money is comprised of financial assets housed in the Cayman Islands, Luxembourg, the Netherlands, Ireland, Hong Kong, Singapore and Switzerland. (US$51.7 Trillion)  In 2016 "Off Shore" assets were approximately the equivalent of all financial assets housed in the UK, France and Germany combined.  There is little/no "GDP" directly associated with these Assets.  They are "Somebody else's money".  But whose?
  3. The same holds true for "Other".  i.e.) Every economy outside of the "Off Shore" Money, the US, China, Japan, the UK, France & Germany...the "rest of the World",  houses the equivalent financial assets (US$57 Trillion).  Again, this "Other" figure is about the same, in big round numbers, as that of the UK, France and Germany.
  4. Chinese domiciled financial assets increased from US$13.2 Trillion in 2008 to US$49.1 Trillion in 2016.  A 257% increase, or at about a 20% compound rate.  (again...not a typo)
  5. Even though the USD is currently the world's reserve currency, the currency of choice in most trade and global financial transactions, NEARLY ALL of the US$81 Trillion increase in Financial Assets took place in Fake Money jurisdictions.
During the same period (2008 to 2016) Global GDP grew at a compound growth rate of just over 2%.  An eyeballing of the figures would suggest that the world didn't require an additional US$81 Trillion of financial assets to create this meager growth.  More likely, this relatively large increase in Financial Assets (Generally $6 of assets per year for every $1 of GDP) was a byproduct of capital misallocation, kicking the can down the road, as Central Bankers attempted to stem the inevitable tide of defaults.

In the chart below we examine selected M3 from December 2008 thru August of 2018.  We also note that M3 generally tracks the asset growth in the Old Money/Fake Money chart above, with a few notable divergences....I would emphasize, that in the history of economics, we've never seen Money Supply growth/management like this in mature, industrialized economies.  Never.  We, for emphasis, now have to look at the world's monetary policy through Banana Republic spectacles.  That's where we're at. 

From the figures, we immediately note that the Eurozone M3 (Including the UK) has increased a whopping 54% (a 5.5% compound rate) while the Financial Assets of Germany, France and the UK have actually been on the decline (see above).  The ECB has been funding/carrying under-performing EU economies to the detriment of fiscally responsible economies for a decade.  Unfortunately,  Mario's amusement park is about to close.

Chinese M3 growth has been, well, I don't know that there's a word for it, a historic outlier perhaps?  The Chinese money supply has been growing at a compound rate of 20% (again, that's not a typo either).  Also note that China's M3 has declined slightly since the spring of 2018 when it surpassed US$28 Trillion.  As we all are well aware, China's fake GDP target has long been 7%-ish.  Productive GDP (PGDP) is probably about 4% +/-.  A 20% compound increase in M3 and related Financial Asset Values (loans/debt) should be frightening to any economist when compared to a PGDP that low.  What could possibly go wrong?   

Moving ahead, the world's dollar denominated obligations/assets today are truly unknown.  In the "good old days", financial assets in a specific jurisdiction were largely denominated in the domestic currency.  Foreign currency was electronically sent "back to where it came from" since domestic markets had little use for it.  Italian Citizens didn't own US Treasuries.  Russian Oligarchs didn't buy NYC penthouses through shell companies in the Caymans.  Chinese "entrepreneurs" didn't put "the world's biggest IPO" on the NYSE.  Now they do.  Today, there are roughly 200 currencies on the planet and about half of them (my guess) are pegged in some way to the US dollar.  Foreign Banks and businesses routinely take (and hold) USDs for domestic transactions, perhaps hedging the currency risk with creative domestic financial products or perhaps not.  Per the BIS, there is roughly US$110 Trillion in debt out there now (about a third of all financial assets), about double from 2005.  International Debt Securities comprise about US$23 Trillion of that.  Of course, most international debt is issued in or pegged to USDs.   





















We also know that Dollar Loans (i.e. debt that must be serviced and repaid in USD) made to Non-US, Non-Bank Borrowers is about US$10 Trillion now.  Note the growth of same....




Today, particularly in the Tax Haven Jurisdictions, we have no way of knowing (at least that I'm aware of) the composition, by currency, of the financial assets (and hence, obligations) held.  (Tim Geithner's concerns from the above FED FOMC minutes coming home to roost.)  We know that 90%+/- of the FOREX transactions around the globe have the US Dollar on one side of the trade.  There must be a reason for that, don't you think?

Anyway, the point of all of this is that all sorts of organizations, businesses and governments, outside the jurisdiction of the FED and the US Treasury, are issuing obligations in US Dollars.  Everyone seems to be making promises in US Dollars that, by definition (since access to US Dollars is at least theoretically, at the discretion of the US Financial System, FED/Treasury) they may not be able to keep.

Speaking of "promises" here's a Bridgewater chart from the The Long View @HayekAndKeynes I particularly liked:


The chart is yet another example of the burgeoning obligations being forced, or some would say, self-inflicted, on the US financial system.  Some/many of these promises, either foreign or domestic, won't be kept.  The only remaining question is which ones and when?

The Changing World.....

The point of all of the above is that the world and the way we finance it has changed significantly since 2008.....the waters are complex and muddied....let's sum it up:

"Money" is leaving the "Old Money" Domiciles and showing up in Off Shore Tax Havens at an unprecedented rate.  The impact here is two fold: First, the fleeing money largely escapes taxation in the originating, home domicile (or anywhere), causing domestic tax revenue shortfalls and increasing budget deficits.  Infrastructure and government services become underfunded/unfundable as a result of the capital flight and declining tax base.  Second, when this money moves offshore it's rarely used to fund "main street" economic growth anywhere.  It's not used to build businesses, bridges, roads or pay wages.  It's not spent, it's saved.  The money stays in financial products seeking/chasing a higher yield.  It creates bubbles and the cycle continues.

We can observe the same thing about Chinese Money, but to a much greater degree.  I've written ad nauseam about China's pegged Exchange Rate.  Chinese newly printed fake money and related influence is splattered all over the planet now, from Luxembourg to the OBOR participants, to the US$2.733 Trillion (Feb 2018) silly/fake IPO's on US exchanges, to a good chunk of luxury real estate in NYC, Vancouver, Silicon Valley and the Bay Area, etc. etc.  With the Chinese Money Supply  growing at a 20% compounded clip since 2008, it should not be remotely possible for the exchange rate to remain constant (within a range) when compared to every other major currency, as described in the FRED Chart below (RED Line is the RMB), yet the condition continues to exist.  The Chinese Communist Party has managed to "print" trillions of dollars and buy up Western Assets at a huge discount.  I've said this often....this was brilliant!






















Per the Triffin effect, the FED is left with two options, the first is to provide sufficient (ever increasing) dollar funding as globalization increases, putting tremendous pressure on the dollar and effectively monetizing US financial obligations (this might actually happen "by accident").  Under the current model, as global trade grows, more, cheaper dollars would be required by "the world".  Alternatively, the US could tighten (as is happening ever so slightly now), taking dollars out of the system, forcing the world to get by with fewer dollars and/or force a deglobalization/dedollarization, where everyone takes their political & monetary balls and bats and goes home.  We're actually starting to see this now e.g. Bop! Zonk! Splat!....it's "Tariff Man!".

(The Long View  @HayekAndKeynes)


The graphic below is from the December 17th, 2018 Yardini Research briefing.  Total Central Bank Assets  (FED, ECB, BOJ, PBOC) declining (tightening) by roughly US$1 Trillion since earlier this year to US$19.4 Trillion at the end of November.  I discussed these concepts and consequences in a 2016 post entitled: The Theory of Financial Relativity....  The conclusion at the time was "this can go on....until it can't". After reviewing recent central bank activity, it looks like the clock is about to strike "can't".




Central Banks are beginning to shut off the printing presses, shrink balance sheets and tighten. It's the equivalent of "taking away the punch bowl", however, not when the party just gets started, but after a two week bender in Vegas.  Remember all of those dollar bonds?  Global interest rates are finally (hopefully ever-so slowly and carefully) going up.  Remember my 9% rule?  For every 1% increase in interest rates, the value of a long bond drops by 9%?  That math is going to become painfully relevant again.

If the rest of the world is going to keep "trading", and globalization is going to continue, the "world" will need to come up with a substitute reserve currency, payment system or hybrid.  We need some sort of Utopian "floating" world with no cross border exchange restrictions for the dollar to be supplanted.  Since, we've come too far down the fiat currency path to go back (cryptos, pork bellies, bologna futures, oil, Glenn Beck's "doomsday" gold coins, or just about any surrogate "hard" assets, are all insufficient in both quantity and infrastructure to support the US$370 Trillion in current financial assets) the most probable course would be, believe it or not, that we continue down the same foolish, special interest supported, meandering path that we've been on, causing all sorts of senseless disruption.

I'd also suggest that today's political environment makes it impossible to solve this problem in a painless fashion.  "Cooperation" is a dirty word.  Cheating is in vogue.  Interestingly, history shows that horrific economic decisions are self correcting over time, although the results can be a bit unpredictable.  A heavily armed insurrection or two somewhere wouldn't be out of the question if this spins horribly out of control.  History also shows that the Dictators, Kings, Emperors, Imperial Grand Poobahs, El Presidentes' and their regimes rarely thrive when the commoners successfully storm the castle, so we can also expect some relatively radical changes in the way the world works coming to a Twitter feed near you.  Civilizations rise and fall based on monetary and economic policy....so let's hope and pray in the spirit of the holidays that this all somehow works out.

We're starting to see fragmented evidence of this "accidental accelerated deglobalization" already.
  1. Global asset values are beginning to correct.  Asset prices, real estate, equities, etc. will seek their economically supportable values over time, as they always do.  The DJIA swinging down 900 points today (24,057 down to 23,162 in response to a 1/4 point FED rate increase and some guidance) would be one small indicator that this process is underway.
  2. Current agreements, alliances and "promises" will be broken, NAFTA, TPP, the EU, the WTO, IMF, ACA, NATO, WTF, etc. etc. 
  3. There will be a rush to alliances between global trade partners and financiers based on perceived equitable relationships.  The operative word is "perceived" the less astute will be taken advantage of.  e.g..) The Chinese will "own" sub Saharan Africa, Venezuela, Pakistan, etc. etc. and all of the issues that go with these nations.  We're already beginning to see this with  bilateral currency/swap agreements, OBOR, investment commitments, etc. (Recent update)
  4. There will be a fitful, fragmented, fruitless movement toward a standard global, universal currency, perhaps based on an IMF/SDR concept as is resurrected by the CCP, as you'd expect, from time to time.  The PBOC has to do something to prevent the RMB from seeking its true value as they run out of options.  Per the IMF and SWIFT today the RMB is used in roughly 2% of global payments.  The RMB comprises only about 2% of Global Central Bank reserves. To be blunt, the idea that a propped currency which Chinese citizens feel compelled to stuff in their underwear as they board a plane, just so they can convert it to anything but RMB, might somehow become a "reserve currency" is delusional.   My guess is that, again based on the current political environment, all of this effort would be unworkable and the current IMF/SDR framework will simply erode or become non-functional over time.  Again, we'll see more trading partners leaving the sandbox as others get burned.  The Chinese will blame America and the Americans will blame the Chinese.  So it goes.      
  5. Enthusiasm for cross border listings is, of course, on the decline.  The SEC actually came out with a recent statement, inexplicably complaining about insufficient audits on Chinese companies that they, oddly enough, are responsible for regulating and chose to approve to list on US Exchanges.  Saying in their statement: "224 companies listed on U.S. exchanges, with a combined market capitalization of more than $1.8 trillion, have auditors located in countries that prohibit PCAOB inspections, most of them member firms of the Big 4 global audit networks. Almost all of the audit firms are in China or Hong Kong."  To reiterate, the figure I calculated was US$2.733 Trillion in February of 2018 so based on current price declines, US Investors are already down US$900 Billion this year because of these shams.  Only US$1.8 Trillion to go..... Nice work Jay!

The "Deep Throat Conundrum" or "Theft by Valuation"

Of course, the rarely discussed corollary to the Triffin Dilemma is what I'll refer to as the "Deep Throat Conundrum". 

The Deep Throat Conundrum. simply put, states that, in a floating currency world, an economy which continually runs large Balance of Payments (Current Account) Surpluses, using sufficient currency/capital controls can manage their exchange rate to a pegged value.  The "Impossible Trinity" can, for a frightening period of time, become possible.

If said economy (China) so chooses, that economy/country is able to print money and "buy" foreign assets at a whopping discount.  (i.e. Today, the PBOC by virtue of accumulated US Dollar reserves, rather than market forces determines the value of the RMB).  This "theft by valuation" (e.g. I print money in my basement and you sell me the Waldorf Astoria!....such a deal!) will most likely reset global asset values and topple the global financial system as currently constructed.

The "Conundrum" is only possible because the financial system we've (collectively "the world") developed and accepted is one built on the rationalization of amoral transactions and devices, justified by and in exchange for, significant compensation to the promulgators of same.  Carefully crafted legal work, perspective and related legislation directed by special interests, in the name of protecting privacy and promoting free markets has made just about any movement of money both impossible to regulate and "technically" not illegal per se.

Quite a Conundrum indeed.

Our Leadership

Since it looks like we're up against a good old fashioned market meltdown followed by QE money printing the likes of which we've not seen since the Wiemar Republic, enormous debt monitization, an eventual dollar devaluation/crash and an economic contraction of biblical proportions, it's indeed fortunate that we are guided by highly compensated financial professionals, relentless regulators and statesmen whose only concern is the well being of the American people.

Over the last few weeks, as the equity markets have begun to "take a dump" (technical bankers term), Yellen, Clayton, Geithner, Chanos, FED Officials, investors and the talking heads alike have all weighed in, in some form or another, describing in various degrees and terminology that something is a bit "wrong" with the markets.   Ray Dalio, a relatively busy guy, actually just took the time to produce a 450 page tome entitled "A Template for Understanding Big Debt Crises".  I'm forging through it over the holidays....as you might suspect, it's wonderfully written, but a really a tough read.  Lots to absorb and think about.  I'd also suspect that, since Ray has always been a big picture, time is of the essence kind of guy, I doubt that while he was writing this, he was thinking that:

"Hey.....everything is fine and dandy right now....perhaps I'll chronicle my concerns about something that could crop up around 2040....I've got nothing better to do.....no time like the present!"

That said, if you recall, back in 2008 "stay the course", "steady as she goes", "no need to panic" and "buy the dip" were all drinking games.  Here's just one of the many, many examples of the fantastic, well thought out guidance the US Retail Investor has available at their beck and call on the Internet:


If that's not inspirational enough for you, the video below is an outstanding  example of the integrity, truthfulness and transparency that US CEO's have become known for, standing by their decisions, relentlessly, fairly representing the unvarnished truth to their investors regardless of consequences or the impact on their stock price.



Finally, during the Holidays, in this festive time of jubilation, as we share tidings of great joy with our fellow men/women, we must be totally grateful for our political leadership.  We are truly blessed to be led by dedicated, compassionate, grounded intellectuals who use their giant "brains" to analyze complex problems, carefully calculating all of the possible permutations, consequences and ramifications of their meticulously crafted bipartisan policy, with their sole concern being the well being of the American people.  I, for one, am confident our future is in the best of hands.  If  anyone can get us through the soon to commence financial crisis, our current leadership can!  This administration, working in lockstep with Congress, as our founding fathers had intended, will deftly guide us toward the re-illumination of our shining city on the hill....       




Oh Geeezzz.....we are so screwed.....

Oh.....I almost forgot......MERRY CHRISTMAS!


Additional Reading

World Bank Development Indicators
https://datacatalog.worldbank.org/dataset/world-development-indicators

Gross GDP for China
https://fred.stlouisfed.org/series/MKTGDPCNA646NWDB

GDP World
https://fred.stlouisfed.org/series/NYGDPMKTPCDWLD
 
FSB Shadow Bank Monitoring Report - Excel Dataset
http://www.fsb.org/2018/03/global-shadow-banking-monitoring-report-2017/

Venezuela is in trouble....
https://www.cnbc.com/2016/11/02/venezuelas-problems-get-worse-as-protests-and-riots-become-more-violent.html


China - call for new reserve currency
https://www.ft.com/content/7851925a-17a2-11de-8c9d-0000779fd2ac

The World's Reserve Currency - USD
https://www.thebalance.com/world-currency-3305931

Carnagie Endowment - US Foreign Policy Impact on Middle Class America
https://twitter.com/i/broadcasts/1yoKMjmkLPzGQ

Michael Pettis - Thoughts on China & de-Globalization
https://twitter.com/i/status/1073253716030095360

Jim Chanos - Something wrong.....
https://www.cnbc.com/2018/12/13/jim-chanos-says-theres-something-wrong-with-the-stock-market-when-rates-this-low-cause-panic.html?__source=twitter%7Cmain

US Budget Deficit Widens in November
https://www.bloomberg.com/news/articles/2018-12-13/u-s-budget-deficit-hits-widest-on-record-for-month-of-november

Janet Yellen Comments - Inability of FED Policy to react to the next financial crisis - Market Watch
https://www.marketwatch.com/story/janet-yellen-is-worried-about-the-next-financial-crisis-2018-12-13?mod=mw_share_twitter

BIS - International Credit Markets
https://www.bis.org/ifc/events/ifc_armenia_2018/Tissot.pdf

Really Smart "Brains" are Required
https://www.mediaite.com/online/trump-claims-in-wild-interview-my-gut-tells-me-more-sometimes-than-anybody-elses-brain-can/

McKinsey - A helping hand to authoritarian government
https://www.nytimes.com/2018/12/15/world/asia/mckinsey-china-russia.html

Yardini - Central Bank Balance Sheets
https://www.yardeni.com/pub/peacockfedecbassets.pdf

China's Crumbling Reeducation System - The Onion
(For my Chinese readers out there, this is what's referred to as "Weisenheiming Sarcasm")
https://www.theonion.com/chinese-officials-vow-to-fix-nation-s-crumbling-reeduca-1819577410

The OBOR "dollar problem" - Financial Times
https://ftalphaville.ft.com/2018/12/18/1545130791000/The-Belt-and-Road-s-dollar-problem/

The RMB won't replace the dollar - Financial Times
https://ftalphaville.ft.com/2018/09/19/1537329600000/China-s-currency-will-not-replace-the-US-dollar/



Monday, December 3, 2018

More Dirty Laundry.....

Earlier this year I had written about how the epidemic money laundering conducted on Alibaba, Amazon and Walmart.com store fronts had contributed to the economic devastation of heartland America over the years. See my Amazon, Walmart,,,,,Chinese Potting Soil and the 34th Amendment.... post.

The New York Times recently picked up on the problem, as described in a wonderfully entertaining, head scratching article by Jenny Odell, cited below.

https://www.nytimes.com/interactive/2018/11/27/style/what-is-inside-this-internet-rabbit-hole.html?smid=tw-share

It's clear from the article that Jenny is a very bright, talented and inquisitive writer.  She's a faculty member and lecturer at Stanford.  I love the way she investigates and writes.  It's also clear that she's not a forensic accountant, since she, unfortunately, missed the main theme of what she's written about.  What Jenny has discovered and wonderfully described has been hiding in plain sight for years.  Jenny has stumbled onto an exceptional mini-chronicle of "weirdness" that's become endemic in US eCommerce.  Simply put, the Chinese Communist Party has designed an incredible ecosystem to facilitate money laundering, in their never ending quest for US dollars, using silly, questionable American e-Commerce storefronts.  The CCP has become relentlessly adept at running exceptionally goofy eCommerce frauds operating right under regulatory noses, which move untold amounts of US Dollars off shore in exchange for no real value. 

There is no other possible explanation for this coordinated buffoonery.  There's no apparent, easy way to fix this problem without significant Amazon and Walmart participation.  Unfortunately, both are effectively paid to look the other way. 

This is much more significant to the US Economy and monetary policy than we are prepared to imagine.   

Sunday, November 18, 2018

OptionSellers.com.....a prologue of what's to come.....

I don't know James Cordier and had never heard of him before last week. He's the CEO of OptionSellers.com. It appears that he somehow lost somewhere between $70 million and $150 million of his client's money (290 high net worth investors) last week.  His website has gone dark.....his mea culpa video (below) is heartfelt, sad, disturbing and unfortunately, darkly comedic.




I'm sure Jim's a really nice guy, but like so many money managers, I'd suspect he got caught up in at least some level of success, with the resulting sense of infallibility and hubris, most likely causing him to double down on his "I know I can't be wrong" bets with other people's money.  For today's Money Managers, being absolutely right ten years from now is the equivalent of being dead wrong for a decade. 

I particularly enjoyed the personal apologies to his clients, friends and "family" along with his emphasis on how hard he had worked to "keep the boat from capsizing from the rogue wave" that consumed him.  He recalled "walleye fishing on Lake Erie", regretted that he couldn't take the same clients "Bass fishing", thanked his Kansas City investors for the great barbecue sauce, owed another client a "Cuban sandwich" (probably not adequate compensation) and regretted not being able to join his French clients in Marseilles on the Riviera (presumably because the court is going to pull his passport).  His relating of how he was so consumed with protecting his client's money that he would "pour a glass of red wine" and trade right through dinner was also touching.

I also liked the reference to his father, steering an "800 footer" on the Great Lakes and that he was unable to navigate that darned "rogue wave" that "capsized our boat".

There are lots of great salesman masquerading as a strategists/experts out there right now.....I'd guess that this is the first (and perhaps most interesting) of what I believe will be a tsunami of collapses and odd video apologies coming from money managers whose salesmanship skills by far exceeded their ability to actually manage money.  You should probably view this clip as soon as possible as I'd guess his lawyers will probably have him pull it soon.

Jim, if you are reading this, and you really are sincere about your repentance, I'm hoping you have a loving family and support system behind you.  You'll recover from this and hopefully, at some point, find solace in a new career that makes better use of your salesmanship skills and far less of your decision making prowess.  If by some chance you aren't sincere, and you've already gutted the company, as is most often the way these things go, wiring what's left of your client's money into personal off shore life boats, I'm sure that will come out in the investigation(s) and well.....never mind what I said about that loving family and support system.  You won't be seeing them for a while.  In either case, you must be under tremendous stress right now, hopefully, you are making the right choices in consultation with your legal team as you work your way through this mess.  I sincerely wish you all the best.

That said, here's the first solicitation for what I presume will be more that a few recovery law suits.  Chapman/Albin, a Cleveland Ohio law firm apparently thinks there's at least some recovery avenue available against INTL FCStone, Inc. , or they wouldn't have taken this on (lawyers generally don't take cases where there's little/no probability of getting paid).  INTL FCStone, Inc. is OptionSellers.com's clearing broker and in all likelihood Chapman/Albin's recovery effort will be directed to breaches of "due diligence" and "know your customer" violations.  Discovery on these things is always interesting.  The phrase "what the hell were you thinking???" is often uttered under the claimant counsel's breath and a modified version of same is often described in the final settlement.  At least, as far as OptionSeller.com's 290 clients are concerned, they should consider themselves fortunate that there's a possible "deep pockets" involved in this mess.  Most wronged clients aren't always that fortunate.

The Only Reason I'm Writing This... 

Let me be clear, in the grand, macro scheme of things, OptionSellers.com is irrelevant (though it doesn't seem like it right now to the 290 clients who lost everything).  The only reason I bring this up is that the complacency, naïveté and refusal to acknowledge the incredible level of risk building in bloated asset prices is everywhere today.  As I've said throughout this blog, the risk inherent in global markets today is unprecedented.  Of course, there are lots of great money managers out there who are fully capable of navigating past "rogue waves".  But there are also far too many likable Jim Cordier's and "OptionSellers.com's" out there who just don't "get it".

OptionSellers.com is a sobering illustration of what can happen to the money of hard working people, literally overnight, when they put their money in the wrong hands.


Additional Reading:

OptionsSellers.com Podcasts

James Cordier Describing how Commodities can be used as valuable diversification strategy.

Sunday, November 11, 2018

Hello from The Maldives!.....and today's Quiz....

Geeezzzz.......I leave the states for a couple of weeks and everything goes to heck in a hand basket!.....

Alibaba announced unbelieveable singles day GMV today!  Fantastic!  US$ 31 Billion of socks, underwear, court ordered non-performing loans, failed construction projects and Jumbo Jets in receivership...all sold in one day by the vaunted Alibaba ecosystem!  Bravo! Totally unbelieveable!  This GMV is more than an average non-holiday season month's sales through Walmart's global distribution system ....shipped by Alibaba in just one day!

Amazing!

Keep in mind though that Walmart has thus far failed to monetize the lucrative "court ordered non-performing liquidation asset market" ....I don't see these asset classes on Walmart.com anywhere, so the figures aren't directly comparable.

For their next trick Alibaba management is going to pull a rabit out of their.....屁股

Today's Quiz

Which three publicly traded common stocks have produced the greatest  Market Cap decline (from top to bottom) in history:

Hint....it wasn't Lehman, Enron or even Facebook's hiccup.....and all three are ongoing....

Scroll down for the answer....

First, I've posted a few pictures of the Maldives below to stimulate your thought process. The Maldives atolls truly are paradise on earth.





























Fauna.....(crabs everywhere....cute harmless, curious little guys.....check your shoes before you slip them on.....just sayin')



Flora.....(wild flowers everywhere)



Maldavian heavy industry....OBOR money at work.  USD & Euros accepted everywhere...but nobody wants RMB....hmmmmm.  Interestingly, there's tons of new construction funded by USD loans from China.  Chinese bankers wouldn't be so stupid as to finance long term construction, using US$ with short term swap money run through the Caymans and Luxembourg?  They can't be that dumb....or are they they that brilliant?




























A friend of a friend of a friend's home in Bangalore.  I thought I'd swing by to say hello. Nice place.  He wasn't home.  Should have called ahead.  Security politely asked me to leave....bad timing.  Maybe next time.


Having a Diwali beer in Delhi.......




































Quiz Answer
(as of 7:00 AM 11/11/18 Maldavian time)

The three (3) greatest (ongoing) market cap declines in history are:

1.) PetroChina - US$ 807 Billion
2.) Tencent - US$ 235 Billion
3.) Alibaba - US$ 163 Billion

I think I'm beginning to see a pattern here.....




Calculations/Sources


1.) PetroChina - 2007-2008 - $807 Billion  $1.01 Trillion - $203 Billion
https://www.cnbc.com/2018/08/02/petrochina-did-not-fare-well-after-reaching-1-trillion-in-market-cap.html
https://www.bloomberg.com/quote/PTR:US

2.) Tencent - High - HK476x 9.45B shares = HK4.498T /7.8exrate = US$576B
Low - HK300x 9.45B shares = HK2.658T /7.8exrate = US$341B dif = US$235B

3.) BABA - $211.7 x 2.54B = $537.7 B compared to $145 x 2.54B = $375B = $163B
https://www.bloomberg.com/quote/BABA:US

Friday, November 2, 2018

Off the grid....

I skipped the BABA earnings call this morning as I'm pressed for time.  I'm catching a flight to India  shortly and am going to be off the grid (intentionally limited/spotty access) for a couple of weeks.

That said, I can't resist taking 20 minutes and review a few things from the Press Release that absolutely jumped off the page at me.  I'm sure, because of my limited time, I've missed some excellent comedy, nevertheless, I'll forge ahead.

Press Release:
https://www.alibabagroup.com/en/news/press_pdf/p181102.pdf
Presentation:
https://alibabagroup.com/en/ir/presentations/pre181102.pdf 
Webcast:
https://edge.media-server.com/m6/p/8fd6emny

Here are the Bullets:

A.) The format of the presentation has been completely updated!  Lots of pictures & graphics.  Sophisticated Investors LOVE pictures and graphics!  Nice work!

B.) On page five (5) of the Press Release, they reduced guidance giving the following rationale:

"In light of current fluid macro-economic conditions, we have recently decided not to monetize, in the near term, incremental inventory generated from growing users and engagement on our China retail marketplaces. We expect this decision to benefit SMEs on our marketplace platforms."

Again, I didn't get a chance to listen to the Investor Call Q&A, but I'm hoping that at least one of the analysts asked something like "exactly what the hell does that mean?"

C.) They've somehow managed to really tighten their belts, keeping Share-Based Compensation (SBC) at only US$1 Billion for the quarter, constant at 8% of Revenue from the same prior year quarter. (Pg. 10 & 11)  This is, of course, down substantially from the June 30th 2018 quarter where SBC topped 20% of revenue.  I'm not sure how the management team and the all those elite with their hands in the cookie jar can possibly scrape by on this pittance, but I'm sure US Shareholders are grateful.

D.) Equity Investees are continuing to be consolidated (hidden from view) yet the businesses in the catch-all category of  "Other Investees" have somehow, in aggregate, turned their fortunes around, booking a profit (increased valuation) of US$282 Million in the quarter.  Thank goodness they've finally got these undisclosed, money losing boondoggles under control.

E.) "Questionable Assets" (Investment Securities, Equity "Investees", Intangibles and Goodwill) now sit at US$71 Billion (59%) of the balance sheet, up from 51% of the Balance Sheet at the March 31st 2018 Year End and up from zero (0%) at the time of the 2015 IPO.  I'm sure these businesses are worth every penny of their current book value.  Balance Sheet (pg 24)

F.)  They also posted yet another "Gain on deemed disposals" of US$771 million in the quarter.  They are "deeming" asset write-ups and gains all over the place.  Seems odd when Chinese Stock Markets are in the dumper. (Pg 29)

G.)  The most amazing pronouncement in the Presser was that the self-proclaimed E-Payment juggernaut, Ant Financial actually lost money "net" in the quarter. (Pg 14)  Here's what they said.

"The loss was primarily due to net loss sustained by Ant Financial during the quarter as a result of its investments in user acquisition, product innovation and international expansion. In the September 2018 quarter, Ant Financial strategically stepped up its investment to acquire more users and capture growth opportunities of the offline payment market by leveraging its technology for financial service industries. During the quarter, domestic annual active users exceeded 700 million, almost 70% of which used three or more categories of Ant Financial’s services." 

Interestingly, Alibaba is (by far) Ant's biggest Customer.  If I'm reading this correctly, this "net" loss is the loss incurred after the processing/escrow fees incurred, accrued and paid by Alibaba to Ant.  So what was the processing/escrow fee actually incurred by Alibaba to Ant?

If they are indeed losing money "net" we'd be hard pressed to justify the US$150 Billion (monopoly-like) valuation indicated by the completion of the insider led Series C US$14 Billion funding round they trumpeted in the June Presser/Filing.

Ant/Alipay, by all accounts is as close to a state supported monopoly as it could be.  Incurring a loss on this business is tantamount to Rockefeller calling J.P. Morgan, at the height of the Standard Oil Trust empire and opining "Yeah....we had a really bad quarter...I just can't figure out how to raise prices!"

There are only three possible explanations for this:

    1.) Ant Financial management is the most incompetent management team on the planet.

    2.) The losses are actually due to all sorts of ill-advised, undisclosed, non performing SME loans (see "incompetent management" in #1 above)

    or:

    3.) Alibaba/Ant, most likely at the behest of the CPC, has built an amazing electronic payment system using the benevolence of US Shareholder philanthropy.  Chinese consumers and by extension, Alibaba (and US Shareholders) must be paying minuscule, unsustainable escrow/processing fees, inflating Alibaba net income, presumably to support the stock price.  It's the essence of earnings management.  It looks like yet another effort to move cost out of the BABA "ecosystem" reflecting a much higher economic value on the business than it deserves. Salivating US investors have continued to take the bait (until recently), piling in as CPC insiders have been bailing out at ever higher valuations.  American investors, as the world well knows, have always been generous souls, giving much and asking for little in return.  It's what globalization is all about. 

If you'd like some more in depth "comedy gold" on the evolution of these concepts, feel free to check out my 20-F analysis from the March 31, 2018 Year End.

https://deep-throat-ipo.blogspot.com/2018/08/the-baba-20-ffinancial-comedy-gold.html


Anyway, that's all for today.....I'm off to India.....

All the best!





Sunday, October 28, 2018

The Most Disturbing Statement...

The following is the most disturbing statement in the most disturbing report, prepared by the (2nd) most disturbing group of bureaucrats America has ever known.  (The SEC crew that approved the BABA F-1/424(b)4/IPO filings being, by far, the most disturbing group).   Here's the statement:

Treasury is deeply disappointed that China continues to refrain from disclosing its foreign exchange intervention. (Page 4 of the Report)

MORE BREAKING NEWS: Generalissimo Francisco Franco is still dead....




There really hasn't been much serious, mainstream discussion about the recent "Don't Worry....Everything is Fine.... China is NOT a Currency Manipulator" US Treasury Report to Congress, although, from my vantage, it's the most important issue facing the world today.  (No bullshit....it really is.)

https://home.treasury.gov/system/files/206/2018-10-17-%28Fall-2018-FX%20Report%29.pdf

Sadly, the Treasury report discussed herein should have begun with "Once upon a time" as its opening line.  It truly is a fairy tale.  It's now clearer to me than ever that the boys and girls at Treasury need a little help here, so I'll be happy, as always, to step in and lend a hand.  After all, it's my duty as an American citizen.  Consider this the first installment of my brand new, annual "World Trends in Finance" (WTF) Report.  I'll publish it every October....that is, of course, providing that our financial markets are still functioning in October of 2019....if not, I won't bother since I'll be too busy trying to locate food and shelter for my family.

But First....a Little Commentary on How These Things Happen....

Economists, bureaucrats and regulators are unfortunately, for lack of a better term, "odd ducks".....we are "rule followers".  We are machines.  Our personalities are devoid of imagination and creativity.  We see only what's in front of us, put our blinders on and get the job done. We parse and crunch absurd data without even considering the source, accuracy, veracity or potential impact of the (potentially nefarious) issuer's decision making and disclosure motivations.  (The PBOC Financial Stability Report describing the US$25 Trillion of "newly discovered....Oooppssss" Shadow Bank assets and the subsequent elimination of the report that disclosed same, is an incredible piece of evidence....but I digress.)

Economics is the only profession where we bring together all sorts of conflicting, contradictory data sources, produced and collected by all sorts of self interested governments, agencies and businesses, carefully throw it all into a pot and after much consternation, throw up our hands because nothing makes sense.  But that doesn't stop us.  As seasoned Economists, we forge ahead and give an opinion anyway, or worse, advise people to go full speed ahead and bet the farm on our analysis. (That's how economists get paid).  I, for one, am glad we don't design (and build) buildings, bridges and airplanes that way.

On the other hand, economists also become frustrated without "perfect data"....we continue the crunching, iterating and parsing, angered that we don't know the precise weight and speed of the (out of control) train hurtling toward us....therefore, we can't calculate the exact arrival time or the amount of destruction it will cause when it smashes into our train station.  We can't come up with data indicating that there's anything amiss, so by default, the train must be running just fine...... ..unfortunately, we are forced to make these errant, incomplete calculations and recommendations while standing on the tracks.   

The Treasury folks, financial people, regulators and economists all seem to be analyzing today's economic reports/data as though it's just another day at the train station......when, and we'll see this very clearly in hindsight (we always do) that they should, instead, be examining the financial environment as if it were a crime scene....because it is.

Ok....enough picking on Economists...we all have our shortcomings.  Time to dig into the report.

Here's What the Treasury Department Came Up WIth...

I've listed a few of the more entertaining quotes from the Report below, along with a translation provided by my patented Dick Fuld Banker Speak Translator (BST):

Page 11
At the end of the second quarter of 2018, the U.S. net international investment position stood at a deficit of $8.6 trillion (42.3 percent of GDP), a deterioration of more than $900 billion compared to end-2017. The value of U.S.-owned foreign assets was $27.1 trillion, while the value of foreign-owned U.S. assets stood at $35.7 trillion. Recent deterioration in the net position has been due in part to valuation effects from an appreciating dollar that lowered the dollar value of U.S. assets held abroad, as well as the relative underperformance of foreign equity markets compared to U.S. stock markets in 2018

BST Translation: - Remember in my last post "When Will Xi Click the SELL Button?" A breakdown of what's included in the $35.7 Trillion would have been helpful.....Stocks?  Bonds? Real Estate?  By country?  China?  Tax Havens?  Who owns it and why?

Page 17
Treasury remains deeply concerned by this excessive trade imbalance which is exacerbated by persistent non-tariff barriers, widespread non-market mechanisms, the pervasive use of subsidies, and other unfair practices which increasingly distort China’s economic relationship with its trading partners. Treasury urges China to create a more level and reciprocal playing field for American workers and firms, implement macroeconomic reforms that support greater consumption growth, reduce the role of state intervention, and allow a greater role for market forces.

BST Translation:



Page 18
Nonetheless, the persistent presence of sizeable net errors and omissions, which have been negative for seventeen consecutive quarters, could suggest continued undocumented capital outflows....... Treasury also strongly urges China to provide greater transparency of its exchange rate and reserve management operations and goals.

BST Translation:



The Unexplainable Chart......

So given the "US$/RMB exchange rate is just fine and dandy....China is not a manipulator"  report conclusion, fully described in the "Yay us....look what a great job we're doing" Report to Congress, while fully acknowledging that the Treasury is working with China's "cooked books" I would be grateful if someone at Treasury would take the time to explain to the American people, in a way we can understand, how the relationships in the chart below could possibly exist in an environment of relatively stable exchange rates.




















The above chart describes the impossible (exchange rate adjusted) M3 relationship for the US$ (Blue Line) Yen (Green Line) Euro (Purple Line) and the RMB (Red Line) in Trillions of US$.

In open currency markets, you'd expect that as the supply of a currency increases/decreases then the exchange rate (relative value) would (generally) decrease/increase accordingly over time.  Like any commodity, the greater the "supply", the lower the value should be.  When we look at the M3 data above we see that as of 1/1/2007 all four major money supplies were within a range of between US$4 Trillion and US$8 Trillion (The RMB at the lower bound with the Euro at the higher), presumably enough currency to run the respective economies effectively.  Fast forward to 2018 and we note that Europe, Japan and the US have generally tracked.  The three (3) Money Supplies have increased to a range of US$ 9 Trillion to $14 Trillion, this time with US M3 taking the lead at the top of the range with US $14 Trillion and the EU bringing up the rear at US $9 Trillion.  Now let's take a look at China's M3, hitting a high of US$ 28 Trillion in the Spring of this year before the recent "China dip" down to US$ 26 Trillion.

Based solely on the gigantic relative increase in China's M3, you'd think that the RMB would weaken substantially.  Now let's take a look at the three exchange rates, RMB, Euro and Yen, relative to the US$.





















The exchange rate movement of both the Euro and the Yen makes some sense based on the M3 Relationship.  Both currencies have strengthened slightly compared to the dollar, as US M3 has expanded more quickly than Europe's and Japan's.  Note that the Chinese exchange rate, presumably because of the currency/capital account controls and limitations, has remained in the same managed range 6.75:1 +/- for years. 

You'd think that, based on the above schedule and the Treasury Report commentary, that the CPC/PBOC would have us believe that they've actually achieved the "Impossible Trinity".  They've been able to accomplish free capital flows, independent monetary policy and a fixed/managed exchange rate.  The "Impossible Trinity" condition has long thought to be, well, impossible....yet, at least for now, it exists.

I'd suggest, as food for thought, since no economist on the planet believes that the "Impossible Trinity" is achievable, that the relationship above is actually a ticking time bomb to the global financial system.



What if I Were a Chinese Banker?

Now, again with the aid of the Dick Fuld Banker-Speak Translator (BST), I'd like to spend a few minutes playing that hot, new party game that's taking Chinese living rooms by storm.  I'm of course referring to "What would I do if I were a Chinese Banker?"  It's all the rage.

Here are the rules: The party host asks his guests "If you were a Chinese Banker and your book was comprised of 40% dog-shit, non-performing loans; and you knew the RMB was imploding; and you had hundreds of party bosses breathing down your neck, forcing you to help them get their stolen funds offshore, what would you do?  (A Xinjiang prison camp is, of course, always an option.)

The guests take turns and imagine stepping into the poor beleaguered bankers shoes, giving their opinion on how they'd handle the situation.  The best answers are submitted to the party for implementation.  The CPC has always been big on focus groups.

So now, let's pretend that the following, possibly real life version of a hypothetical, party game discussion (over lunch) between Mr. Sun Yu, Chief Overseas Business Officer of the Bank of China, might (or might not) have  actually taken place on a Yacht, moored in Georgetown, Grand Cayman, sometime in the winter of 2015, between Mr. Yu and a group of bankers we'll refer to as Jimmy P Money, Gary Sacks and Sonny Street.  The following is a Dick Fuld - BST Translation of this totally imaginary, hypothetical discussion that, again, may or may not have taken place.
















Mr. Yu is seated at the second deck galley table.  Mr. Money, Mr. Sacks and Mr. Street enter the cabin from the starboard, aft entrance and begin the obligatory small talk.  Then, the food is served, Caribbean lobster and conch, and they get down to business.

Mr. Yu: "Ok...here's the thing.... I've got about US$2 Billion RMB I need to move. I need FOREX Swaps, forwards & Repos at my discretion.  Dollars & Euros for RMB today.  You get your Dollars and Euros back down the road.  I don't want loans.  It's gotta be OBS.  What can you guys do for me?

Mr. Money:  "Well....what the hell are we going to do with RMB?  It's toilet paper."

Mr. Yu:  "I'll give you 2% over Libor and two more points up front to do the deal."

(Silence.....they are all thinking they can find a cheaper way to hedge the RMB & lay off the FOREX risk.  They can probably swap the RMB back for Dollars or Euros in Hong Kong.)

Mr. Street: "Libor plus 2 to hold your cash?....and two points up front?  Really?  All OBS? What's the term?"  

Mr. Yu:  "Five years"

Mr. Sacks:  "I'll go one."

Mr. Money:  "I'll go six months."

Mr. Street:  "I'll go one.."

Mr. Yu:  "Three years or no deal....I've got other options."

Mr Sacks, Mr. Money and Mr. Street:  "Done....three years it is."

Mr. Yu: "Agreed.  Gentlemen, It's been a pleasure doing business.  We'll wire the RMB tomorrow & expect your return dollar wire same day.  On your way out would you mind asking the guys from CITI to come aboard?  They should be waiting on the dock.  I'm a busy man...."  

I'd suggest that variations of this hypothetical conversation have taken place on yachts, at country clubs and in offices in the Caymans, BVI, Bermuda, Luxembourg, Hong Kong, Singapore and all over the planet like they never have before.  Like our old friends, Mortgage Backed Securities (MBSs), Collateralized Debt Obligations (CDOs) and the linked Credit Default Swaps (CDSs), the OBS Forex Market and the misunderstood risk associated with these contracts will be ground zero for the (next) upcoming financial crisis.

Let's be clear.  There are only two (2) Reasons to participate in FOREX Swap/Repo/Forward transactions.
  1. Insulate other transactions from foreign currency risk.
  2. Speculation.
For those of you who need a quick refresher course on FOREX Swaps here are a couple of sentences describing same for the purpose of this post.  Mr. Yu above is willing to "Swap" the notional value (today's value) of US$2 Billion RMB for the same value in US Dollars.  In three years (by agreement) Mr. Yu will "Swap" the same dollars he held back to the Caymans Bankers in exchange for the same RMB he pledged as collateral.  In essence, the Swap is an OBS (Off Balance Sheet) loan of US Dollars, secured by the RMB he "swapped".  Mr Yu is willing to pay interest on the RMB and the Caymans Bankers are willing to pay interest on the swapped dollars at the prevailing or negotiated rates.  Mr. Yu is now able to use the dollars as collateral and lever up on other US/European Assets.  The US$2 Billion RMB (notional value) is now converted to US$2 Billion of dollar collateral sitting in the Caymans.  Depending on how aggressive Mr. Yu is, if he's operating on a capital ratio of 20% he can lever up, loan out and invest US$10 Billion.  Because the transaction is "Off Balance Sheet" the only reporting required is that the notional value (in aggregate) must be reported in the financial statement footnotes.  i.e.) He still has bank Capital of the US$ 2 Billion with levered bank assets of $10 Billion.  The expenses associated with the transaction would be:1.) Net Interest paid on the Swap.  2.) The gain/loss on the notional value of the Swap as the currency is marked to market.

For an illustration of just how significant the exposure to Swaps/Forwards/Repos/Derivatives can be, I'd refer you to the post I published three years ago entitled "Why Genius is about to fail.....Again....."   

In that post I focused on the fragile, opaque, insufficient capital structure of America's big banks.  When we look at the "Big Three" custodial, global banks (JPM, State Street and Citi) we see that OBS activity for all derivative classes (FOREX, Interest Rate and Equity Based Contracts) and the related exposure continues to increase geometrically.
  • JP Morgan Assets Under Custody $23.469 Trillion (12/31/17) up from $16.120 Trillion 12/31/2010 (10-K - Page 66)
  • Citi Bank - Assets Under Custody $17.4 Trillion (12/31/17) up from $12.6 Trillion 12/31/2010   (10-K - Page 24)
  • State Street - Assets Under Custody (12/31/17) $33.12 Trillion up from $21.5 Trillion 12/31/2010 (10-K - Page 2)  
The Off Balance Sheet (OBS) notional inventory/exposure for the AUC held be the three (3) banks above has increased by 50%, to US$74.02 Trillion up from US$50.2 Trillion.  Again, let me be clear, there is no detail provided whatsoever, other than the GAAP reporting requirement to disclose that the notional amount in aggregate.  Investors have no idea what the US$74 Trillion consists of.  Of course, it shouldn't have any impact on the profitability of the banks, because they are custodial assets.  The only thing we know for sure is that these assets exist, and whoever owns the assets would naturally absorb the valuation risk. 

Note that the 10-K's of JP Morgan, Citi and State Street all have very clear boiler plate language stating that they are very conservative and don't speculate on these OBS assets.  Like the casino operator, apparently they are just facilitators for someone else's speculative addiction.  So that should at least make us feel a little better about all of this.

How much of it is RMB exposure?  Of course we'll never know until it's too late.  No matter how you look at it, the activity, and hence the risk and exposure (to someone) is growing much faster than we can possibly understand.

However, as you also might suspect, unlike our friends at the Treasury, who would probably respond to a car jacking by requesting that the perpetrators "Please stop waiving that gun in our face, and, if at all possible, when you're done with my car, if you could return it with a full tank of gas I'd be grateful....no hard feelings!"...... based on just about every document prepared by the CPC, I'd suspect that the Chinese government has a great deal to do with the gigantic increase in OBS Assets. 


Holy Cats!....Forex Swaps...Would Ya Look at That!

Probably the best source for data on Off Balance Sheet Assets (Forex Swaps) is the Bank of International Settlements.  Last fall, (September 2017) the BIS published a thought provoking report entitled FX swaps and forwards: missing global debt?

The focus of the report is, as I've described, that the volume of these Off Balance Sheet transactions (and the related risk) continues grow at an unprecedented pace.  Here's my favorite chart:




















We observe, as of the end of 2016, open FOREX swaps (notional value) stood at roughly US$ 60 Trillion, nearly doubling from 2009.  About 75% of the contracts were one year term (or less).  i.e.) the contracts have to be closed out or rolled over within a year.  Roughly 60% of the contracts are written/held by non-dealer counter parties.

Now let's take a look at the most current data (12/31/17).

   
When we look at the most current data (12/31/17) we see that total Forex Swaps have increased to US$76.438 Trillion (US$50.487 Trillion + US$10.679 Trillion), up roughly US$16 Trillion in just the last year.  Eighty Five percent (85%) of these Swaps (Including Options) have the US$ as the currency on "one end" of the transaction. US$33.5 Trillion or Thirty Eight Percent (38%) of these Swaps (Including Options) have "Other Currencies" reported as a currency on the "other end" of the transaction.  Although not reported, it would be a worthwhile endeavor to determine exactly how much of this "other currency" is relevant and related to Chinese capital flight.  How much of the "Other Currencies" is RMB?

Final Thoughts

Don't get me wrong.  The Treasury (like the SEC) has an abundance of brilliant, capable, experts who have access to detailed transaction data and are fully capable of investigating this.  Our only hope is that the "Everything is Fine....China is NOT a Currency Manipulator" Treasury Report is a public head-fake intended to give confidence to naive, main street investors, while the Treasury is actually "all over" this, working behind the scenes to unwind this mess and minimize the damage. 

On the other hand, if there is actually no covert, behind the scenes effort by the Treasury to unwind this, and they really don't see any of this coming, the "Don't Worry....Everything is Fine.... China is NOT a Currency Manipulator" US Treasury Report to Congress is the equivalent of Freddie Fleet shouting from the crows nest of the Titanic.... "Hey guys....I think I see a few ice cubes floating ahead.....I sure wish I had some data on it ...nothing to worry about though....full speed ahead!"

It should also be crystal clear now that, like the freeze up of the credit markets back in 2009, as the CPC deleverages, there will be an ever increasing, cleverly disguised pressure on OBS assets, Forex markets and eventually credit markets.  As these Swaps fail to close and the cost to roll them over becomes prohibitive, like Lehman's plight, nobody will want to play in this sandbox, the Swaps will default and US institutions will be left holding the bag.

The RMB exchange rate will finally reset and much of the paper wealth of the world, which has been artificially created over the last half decade will be destroyed.  A significant portion of this fake wealth has already been transferred to China through this con game.  The CPC has managed to print fake currency and exchange it for hard assets, businesses, real estate, ghost cities, infrastructure, transportation, intellectual property, industrial know how on the mainland and, according to the US Treasury, some portion of the $35.7 Trillion of US Assets held by foreign owners, along with, I'd imagine a comparable proportion of European, African and South American assets.  This is the mother of all contagions building and it can't possibly end well.






Additional Reading:

Japan China Swap Agreement
https://uk.reuters.com/article/uk-china-japan-agreements-swap/china-japan-sign-three-year-forex-swap-deal-of-up-to-30-billion-idUKKCN1N00GN

State Street Assets Under Custody (9/20/18) $30.12 Trillion up from $21.5 Trillion 12/31/2010
https://www.sec.gov/Archives/edgar/data/93751/000009375118000471/exhibit992-3q18earningsrel.htm

JPM Assets Under Custody $23.469 Trillion (12/31/17) up from $16.120 Trillion 12/31/2010
https://www.sec.gov/Archives/edgar/data/19617/000001961718000057/corp10k2017.htm

Citi AUC $17.4 Trillion (12/31/17) up from $12.6 Trillion 12/31/2010
https://www.sec.gov/Archives/edgar/data/831001/000083100118000040/c-12312017x10k.htm

Swaps BIS Stats
https://stats.bis.org/statx/srs/table/d5.1?p=20172&c=

China Uses Swaps Market to slow RMB slide
https://www.wsj.com/articles/china-uses-lower-profile-swaps-market-to-slow-yuans-slide-1533654315

The first time I taked about this is in my post....
https://deep-throat-ipo.blogspot.com/2015/10/why-genius-is-about-to-failagain.html

China Japan FOREX Swap Deal
https://uk.reuters.com/article/uk-china-japan-agreements-swap/china-japan-sign-three-year-forex-swap-deal-of-up-to-30-billion-idUKKCN1N00GN

Sun Yu - BOC - Chief Overseas Business Officer
http://www.boc.cn/en/investor/ir6/201504/t20150402_4830131.html

Bank of China -  America Branches
http://www.boc.cn/en/aboutboc/ab6/200812/t20081216_494260.html

UST Report
https://home.treasury.gov/system/files/206/2018-10-17-%28Fall-2018-FX%20Report%29.pdf