Sunday, August 4, 2019

The Yen Is A Major Conduit For Wealth Leaving China

The link between China and Japan recently raised its head in the currency markets when President Trump upped the ante over trade-talks. Following a session in Shanghai that yielded only anger, the American trade-talk delegation quickly left for home. It appears that China has little intention of altering its course and will concede little or nothing in future talks. This highlights that China is a state-run economy based on a business model geared to expand by crushing its competition. Within hours, President Trump threatened to increase tariffs on Chinese goods flowing to America. This signals a growing impatience on the part of the White House to move trade-talks forward and finalize a deal.  

China Faces Growing Trade Problems
Immediately currency markets witnessed the yen surge in response. This makes it difficult to argue that a correlation does not exist between the value of the yen and problems in China. The yen has become a major conduit by which wealth is transferred out of China. This tight relationship can be seen each time trouble surfaces in China's economy. When this happens the yen rises in value as wealth exits China through business back-channels. It is also important to remember that economic weakness in China carries over and has a negative impact on Japan's overall GDP. Feeding into this relationship is the fact Japan does not desire a stronger yen which hurts exports. Since the yen constitutes just about 4 percent of the global world currency reserve the boost in its value is generally short-lived as the wealth flowing out of China moves on to other countries across the globe.

Last year, the U.S. combined goods and services deficit with China was a hefty $309.8 billion US dollars. Presidents Trump and Xi Jinping at their April 2019 meeting at Mar-a-Lago mapped out a strategy to remove trade irritants from the overall relationship and established a 100-day plan to reach an agreement. So far this map has led nowhere. The opinion that China may be stalling in hopes that Trump is not reelected is gaining traction. This has generated a tougher attitude in the White House that could have decades-long consequences. Trump claims he is hellbent on ending China's system of subsidizing Chinese companies in a multitude of ways that allows them to export goods at slightly below cost in exchange for manufacturing jobs. This is not stupid it is predatory
Trade Deficit Continues Running Ahead Of  2018
As you may recall, in May with great fanfare the “initial results” of the plan were revealed in the form of a ten-point program.  Sadly, many of the Chinese concessions listed were pre-existing obligations that China had already agreed to. In truth, after stripping out the pre-existing Chinese obligations and including new American concessions the May 11th deal does little to decrease the U.S. trade deficit with China. We have seen this play out in recent months as the trade deficit continues running slightly ahead of last year’s near-record pace despite efforts by the Trump White House to reduce them

There is even talk of not implementing the new deal until 2025. Many Americans see this as totally insane and take it as a sign that America has no stomach for playing hardball. Other issues also play into this discussion, as we focus on China taking advantage of America we tend to give a pass to Japan. America's "far too generous" relationship with Japan is rooted in a longtime post-war relationship. I contend it is time to question whether Japan deserves such treatment considering the strong economic ties Japan has formed with China. Up until now, Trump has left Japan relatively unscathed when it comes to demanding trade concessions, however, just like Mexico, Japan has the potential to become a prime target because of the strong economic links it has developed with China. Trade flows are far more complicated than many people realize. Most Americans remain oblivious to the fact that because of the huge trade deficit Mexico has with China the money Mexico receives from trading with America quickly passes through its lands and flows to Asia.

Over the years Japanese direct investments and technology have played a critical role in the development and competitiveness of China’s global supply chains. A strong link exists between China and Japan because of these major investments in China. It is clear China has exploited this relationship to learn the advanced industrial skills and production techniques of its neighbor. An example of how strong those links are can be seen at call centers in China where young workers speaking flawless Japanese answer customer service calls for a Japanese company. In western Japan, a new commercial Chinatown is rising in Kobe City's rebuilt port area. Instead of the gaudy restaurants in old Chinatown, the new area contains nondescript office buildings that are leased to Chinese companies focusing on everything including biotechnology.

This increased trade with China while bolstering the Japanese economy has also driven costs down significantly for Japan's long-suffering consumers which also played into the deflation factor. As for the yen, with a government gross debt to GDP ratio of 253 percent, Japan has the unwanted title of ranking highest in the developed world. The recent budget requests by Japan's central government ministries and agencies for fiscal 2019 total a record-high 102.77 trillion yen. Recently Japan's trade balance has again swung into deficit territory and a matter that has not garnered enough attention is how the economic problems that continue to develop in China will most likely spill over and affect Japan.

Between slowing economic growth and rising protest in Hong Kong, it seems China's problems may be about to get worse. China's economy is hooked on new credit and government stimulus. China’s debt mania, by this I mean madness, craziness, and frenzy is now the largest ever experienced in the postwar emerging world. As the China story unfolds it is clear the scope for a debt meltdown in China remains immense. China watchers, economists, and investors have been forming battle-lines for years as they debate the true strength and sustainability of China's economy and its role as a global player. Those of us that paint a picture of future collapse and a day of reckoning are often accused of spreading "doom-porn" for claiming the Chinese have masked over their dire situation by continually expanding credit.

In January alone, Beijing injected a staggering $685 billion in new credit into its financial system and the money continues to leak out causing assets to rise across the globe. Today China continues to prop up the "unpropable," and yes, while no such word exists, when it comes to China's economy it should. A matter that has not garnered enough attention is how the economic problems that continue to develop in China will spill over and affect Japan. The Japanese economy is very vulnerable to a negative economic feedback loop flowing from China. Recent market action should not be misinterpreted as the yen strengthening, but as simply a temporary bump before the wealth moves on to a safer place. This wealth shift will have a major impact on currency markets going forward. expect the yen to be a popular vehicle by which wealth flees China and enters the global economy.

1 comment:

  1. Interesting analysis, thank you.

    I had not known about how the J Yen would be tied into capital flight from China, and the further knock-on effects.

    I also think that China is weaker than many think.

    You (and/or some of your readers) might like "Aftermath", the new book by Jim Rickards.