“The great ball of China money is moving away from bonds and stocks to commodities,” said Zhang Guoyu, a Shanghai-based analyst at Tebon Securities Co. “We’ve seen a lot of people opening accounts for commodities futures recently.”
Chinese speculators have a new obsession: the commodities market.
Trading in futures on everything from steel reinforcement bars and hot-rolled coils to cotton and polyvinyl chloride has soared this week, prompting exchanges in Shanghai, Dalian and Zhengzhou to boost fees or issue warnings to investors. While the underlying products may be anything but glamorous, the numbers are eye-popping: contracts on more than 223 million metric tons of rebar changed hands on Thursday, more than China’s full-year production of the material used to strengthen concrete.
“The great ball of China money is moving away from bonds and stocks to commodities,” said Zhang Guoyu, a Shanghai-based analyst at Tebon Securities Co. “We’ve seen a lot of people opening accounts for commodities futures recently.”
The frenzy echoes the activity that fueled China’s stock market last year before a rout erased $5 trillion, and follows earlier bubbles in property to garlic and even certain types of tea. China’s army of investors is honing in on raw materials amid signs of a pickup in demand and as the nation’s equities fall the most among global markets and corporate bond yields head for the steepest monthly rise in more than a year.
Hao Hong, chief China strategist at Bocom International Holdings Co. in Hong Kong, says the improvement in fundamentals and the availability of leverage to bet on commodities is making them irresistible to traders.
“These guys are going nuts,” Hong said. “Leverage exaggerates the move of the way up, but also on the way down – much like what margin financing did to stocks in 2015.”
The gain in steel prices isn’t just on the futures market, with spot prices for the physical product also rallying amid a sudden shortage as construction activity accelerates. Rebar prices have risen 57 percent this year on average across China, according to Beijing Antaike Information Development Co., a state-owned consultancy. Even after output of steel increased to the highest monthly volume on record in March, rebar inventory is still falling, signaling a supply deficit.
To cool activity, the Shanghai Futures Exchange increased transaction fees while the Dalian Commodity Exchange raised iron ore margin requirements. The bourse in Dalian also tightened rules on what it called abnormal trading, which now includes frequent submission and withdrawal of orders and self-trading. The Zhengzhou Commodity Exchange urged prudent investment on cotton futures amid “relatively large price fluctuations.”
“There’s a lot of liquidity and there are people looking for opportunity,” said Ben Kwong, a director at brokerage KGI Asia Ltd. in Hong Kong. “Investors are just boosted by recent rebound in those commodity prices and it’s speculative behavior.”
Futures slid Friday after the exchange clampdown, with contracts on rebar closing down 4.8 percent at 2,619 yuan a ton, its biggest daily decline in six weeks. A gauge of materials shares sank 2.7 percent on the mainland as the benchmark Shanghai Composite Index advanced 0.2 percent.
Officials cracked down on speculators using borrowed money to buy equities after a surge in debt exacerbated the boom-to-bust of the world’s second-largest stock market. When China was spurring lenders to pump credit to aid growth in 2008 and 2009, investors speculated on everything from Pu’er tea to garlic. Easy money is again surging, with new credit topping $1 trillion in the first quarter.
“The market is moving so quickly, yesterday felt just like the stock market in June last year before the crash,” Tiger Shi, a managing partner at Bands Financial Ltd. said by phone from Hong Kong. “I think how it goes up, that’s how it will come down.”
* HSBC, Citigroup, Commerzbank economists discuss Friedman idea
* Inflation still weak despite interest rate cuts, bond-buying
After more than 600 interest-rate cuts and $12 trillion of asset purchases failed to move the inflation needle enough, central banks may need to head even deeper into uncharted territory.
The way to get the world out of its disinflationary rut could lie in them directly financing government stimulus — a strategy known as deploying “helicopter money” after a 1969 proposal from Nobel laureate Milton Friedman.
Economists at Citigroup Inc., HSBC Holdings Plc and Commerzbank AG all published reports to investors on the topic in the past two weeks, while hedge fund titan Ray Dalio sees potential in the idea. European Central Bank officials are already squabbling about what President Mario Draghi calls a “very interesting concept.”
“We don’t know for certain that ‘helicopter money’ will be the next attempted silver bullet, however the topic is receiving considerably more attention,” said Gabriel Stein, an economist at Oxford Economics Ltd. in London. “The likelihood is reasonably high of some form being implemented somewhere.”
The theory — never attempted by a modern major economy — is to fuse monetary and fiscal policies now both running out of room. Cash-strapped governments sell short-term debt straight to their central bank for newly printed money that is then injected straight into the economy via tax cuts or spending programs. The usual intermediaries, like banks, are bypassed.
The idea is to spur spending and investment directly rather than influence bond yields or sentiment. Central banks can be saved from permanently underwriting governments by establishing growth or inflation limits.
In a 2002 speech that earned him the nickname “Helicopter Ben,” then-Federal Reserve Governor Ben S. Bernanke said taking to the skies would “almost certainly be an effective stimulant to consumption and hence to prices.”
Reviving the debate is the failure of inflation to accelerate in much of the world despite Bank of America Corp.’s calculation that as of early February central banks had cut rates 637 times and spent $12.3 trillion on assets since the financial crisis in 2008. It also estimated 489 million people now live in countries where rates are negative.
To Dalio, the founder of $154 billion Bridgewater Associates, that means the next step should be to do even more to spark demand.
“If you look around the world, our risk is not inflation and our risk is not overheating economies,” he told Bloomberg Television’s Erik Schatzker on March 3. “They’re going to have to go more directly to spenders.”
So what’s not to like? Critics say spraying money around would eventually mean Weimar-style runaway inflation and bloated government debt. The independence and credibility of central banks would be potentially damaged. And the policy could backfire if households sit on the money.
Bundesbank President Jens Weidmann has already said “helicopter money” would “rip huge holes in central bank balance sheets” and leave governments and taxpayers to “pay the bill in the end.”
Then there’s the law. The ECB is prohibited from financing states and lacks a single Treasury to work with, while the Fed is constrained in what assets it can buy.
“The helicopter option is simple, easily implemented and, for some, offers the closest thing to a free lunch,” said Stephen King, senior economic adviser to HSBC. “If this sounds too good to be true, that’s because it is.”
Draghi last week said that while the ECB has not studied the concept “it clearly involves complexities, both accounting-wise and legal-wise.” Colleague Peter Praet, nevertheless declined to rule it out as an option when asked.
The debate may remain academic. In the U.S., prices are shifting higher and the International Monetary Fund still forecasts inflation in advanced economies to accelerate next year to 1.7 percent from 1.1 percent.
Revisiting the Unimaginable
“I don’t think helicopter money gets rolled out quite yet,” said Ewen Cameron-Watt, chief investment strategist at BlackRock Inc. “You need a considerable downturn and further decline in inflation expectations first.”
Still, if economies do slide anew, Jonathan Loynes of Capital Economics Ltd. in London, noted central banks have shown willingness to revisit once-rejected ideas.
“The clear lesson of recent years has been that seemingly unimaginable policy measures previously confined to the theory or history books can become reality if extraordinary economic circumstances persist for long enough,” he said.
* From discipline’s margins, new theory challenges deficit taboo
* Calls for fiscal help are growing as post-2008 recovery lags
Ignored for Years, a Radical Economic Theory Is Gaining Converts – Bloomberg Business
In an American election season that’s turned into a bonfire of the orthodoxies, one taboo survives pretty much intact: Budget deficits are dangerous.
A school of dissident economists wants to toss that one onto the flames, too.
It’s a propitious time to make the case, and not just in the U.S. Whether it’s negative interest rates, or helicopter money that delivers freshly minted cash direct to consumers, central banks are peering into their toolboxes to see what’s left. Despite all their innovations, economic recovery remains below par across the industrial world.
Calls for governments to take over the relief effort are growing louder. Plenty of economists have joined in, and so have top money managers. Bridgewater’s Ray Dalio, head of the world’s biggest hedge fund, and Janus Capital’s Bill Gross say policy makers are cornered and will have to resort to bigger deficits.
“There’s an acknowledgment, even in the investor community, that monetary policy is kind of running out of ammo,” said Thomas Costerg, economist at Standard Chartered Bank in New York. “The focus is now shifting to fiscal policy.”
That’s where it should have been all along, according to Modern Money Theory. The 20-something-year-old doctrine, on the fringes of economic thought, is getting a hearing with an unconventional take on government spending in nations with their own currency.
Such countries, the MMTers argue, face no risk of fiscal crisis. They may owe debts in, say, dollars or yen — but they’re also the monopoly creators of dollars or yen, so can always meet their obligations. For the same reason, they don’t need to finance spending by collecting taxes, or even selling bonds.
The long-run implication of that approach has many economists worried.
“I have no problem with deficit spending,” said Aneta Markowska, chief U.S. economist at Societe Generale in New York. “But this idea of the government printing money — unlimited amounts of money — and running unlimited, infinite deficits, that could become unhinged pretty quickly.”
To which MMT replies: No one’s saying there are no limits. Real resources can be a constraint — how much labor is available to build that road? Taxes are an essential tool, to ensure demand for the currency and cool the economy if it overheats. But the MMTers argue there’s plenty of room to spend without triggering inflation.
The U.S. did dramatically loosen the purse strings after the 2008 crisis, posting a deficit of more than 10 percent of gross domestic product the next year. That’s since been trimmed to 2.6 percent of GDP, or $439 billion, last year.
The Congressional Budget Office expects the gap to widen in the coming decade, as retiring baby-boomers saddle the government with higher social security and health-care costs. That’s the risk often cited by fiscal hawks.
Mainstream doves accept the long-term caveat. But they point to record-low bond yields and say investors aren’t worried about deficits right now, so why not spend?
MMT takes that argument even further. The question is: Who’s listening?
“They’re shut out of the central banks, the finance ministries, the Treasuries of the world,” said Joe Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and former Federal Reserve Board economist. Gagnon doesn’t subscribe to all MMT arguments, but thinks there’s enough slack in the global economy that “it’d be a good time for them to have influence.”
If MMT seems marginal now, Randy Wray, an economics professor at the University of Missouri-Kansas City and one of the doctrine’s founders, recalls a time when it barely registered at all.
Wray, who wrote “Understanding Modern Money” in 1998, says he used to meet with like-minded colleagues and count how many people understood the theory. “After 10 years, we had to go a little beyond two hands — we had to use a few toes,” he said.
Now, thanks to the blogosphere, he says there are thousands around the world, especially in struggling euro-area countries like Italy and Spain. MMT was among the early doomsayers on the single currency, arguing the lack of monetary sovereignty would render governments helpless in a crisis.
In the U.S., one presidential candidate is at least listening to MMT economists. Advisers to Bernie Sanders include some of the school’s leading advocates: Stephanie Kelton, a Sanders hire to the Senate Budget Committee, and James K. Galbraith, whose father helped shape President Lyndon Johnson’s “Great Society” programs.
The match makes sense. Sanders is promising massive investments in health, education and infrastructure. Economists who see more danger in fiscal austerity than looseness make natural allies.
Ask the campaign, though, and they’re quick to point out that the Vermont senator is a “deficit hawk” whose spending plans are matched dollar-for-dollar by tax increases.
“He’s not interested in theory,” said Warren Gunnels, Sanders’ policy director. “He’s interested in making sure that we rebuild the middle class, increase wages and make sure that we no longer have one of the highest poverty rates of any developed country.”
So even a left-leaning candidate with MMT economists on staff shies away from endorsing the doctrine — an indicator of what a hard sell it is.
Those who push back sometimes argue that money-printing puts countries on a path that eventually leads, in a worst-case scenario, to Zimbabwe — where money-printing debased the currency so badly that all the zeros could barely fit on banknotes. Or Venezuela, whose spending spree helped push inflation to 180 percent last year. Japan’s a more mixed picture: years of deficits haven’t scared off borrowers or unleashed inflation, but haven’t produced much growth, either.
There’s also a peculiarly American enthusiasm for balanced budgets, according to Jim Savage, a political science professor at the University of Virginia. He’s traced it to the earliest days of the U.S., rooted in a “longstanding fear of centralized political power, going back to England.”
Wray says there are episodes in American history when a different understanding prevailed. During World War II, he says, U.S. authorities learned a lesson that’s since been forgotten — that “we’ve always got unemployed resources, including labor, and so we can put them to work.”
Savage says Americans have historically tended to conflate household and government debts. That category error is alive and well.
“Small businesses and families are tightening their belts,” President Barack Obama said in 2010 as he announced a pay freeze for government workers. “Their government should, too.”
It’s not just MMT economists who winced at the comment. Many more agree that it’s precisely when households are cutting back that governments should do the opposite, to prevent a slump in demand.
That argument doesn’t carry much sway in Congress, though. That’s one reason the Fed has had to shoulder so much of the burden of keeping the recovery alive, Societe Generale’s Markowska says.
“When it comes to deciding on monetary easing, it’s a handful of people in the room,” she said. “It’s going to take more pain to build that political consensus around the fiscal stimulus.”
Wray says he’d expected attitudes to start shifting after the last downturn, just as the Great Depression gave rise to Keynesian economics and the New Deal, but “it really didn’t change anything, as far as the policy makers go.”
“I think it did change things as far as the population goes,” he said, citing the anti-establishment campaigns of Sanders and Republican Donald Trump. It might take another crash to change minds, Wray says.
Most economists don’t expect an imminent U.S. recession. But financial-market turmoil and America’s political upheaval have added to a sense that nobody has figured out a cure for the economy’s malaise.
Bill Hoagland, a Republican who’s vice president of the Bipartisan Policy Center, has helped shape U.S. fiscal policy over four decades at the Congressional Budget Office and Senate Budget Committee.
He says a farm upbringing in Indiana helped him understand why “it’s engrained in a number of Americans outside the Beltway that you equate your expenditures with your revenue.” He also acknowledges that government deficits are different, and could be larger now to support demand, so long as there’s balance in the longer term.
Most of all, Hoagland says he sees profound change under way. The “catastrophic event” of the 2008 crash may be reshaping American politics in a way that’s only happened a handful of times before. And economic orthodoxy has taken a hit too.
“We’re going through a very strange period where all economic theories are being tested,” he said.
Money is pouring out of China as rapidly as it once poured in. That’s a dilemma for Xi Jinping.
You don’t need to be a finance expert to know that something’s wrong when an interest rate reaches almost 70 percent. With China’s growth outlook darkening and capital flowing out of the country, speculators have been betting heavily against the yuan. The People’s Bank of China effectively declared war on them in early January, directing state banks to buy large sums of the currency in Hong Kong to support its value and burn the short sellers. With the yuan suddenly scarce in Hong Kong, the annualized cost of borrowing it overnight there hit 66.82 percent on Jan. 12—more than 10 times the usual interest rate. (It receded to 8 percent the next day.) Michael Every, head of financial markets research at Rabobank Group, called the rate spike “murderous” and predicted that things wouldn’t end well for Chinese authorities. Central banks “usually win a round like this, but lose in the end,” he told Bloomberg.
China’s central bank isn’t freestyling. It takes its instructions from the government, which means President Xi Jinping. Xi has shrewdly consolidated power since his ascension in 2012, but he seems befuddled by free markets, at times allowing them to operate and at times trying to throttle them—as with the circuit breakers that have failed to arrest the slide in stock prices.
One of the big questions for the global economy in 2016 is what Xi will do next to stop the flight of capital, which threatens to sap funds from China when growth is already weak. One option is to lure money back by making the country more inviting to both Chinese and foreign investors. That would involve decontrolling interest rates and halting directed lending to heavily indebted state-owned enterprises and local governments. But doing so would require loosening the Communist Party’s control over the economy and harm some powerful domestic constituencies, like long-favored companies and provincial chiefs. So the temptation to amp up command-and-control will be great. True, a clampdown would jeopardize China’s ambition to become an equal of the U.S. in global finance. But it would insulate China from the ungovernable swings of the global financial markets, which investor George Soros once memorably said are more a wrecking ball than a pendulum.
Some China watchers say the question of Xi’s direction is already being answered. “China will become increasingly closed to the rest of the world,” predicts Alicia Garcia-Herrero, chief economist for Asia and the Pacific at Natixis Asia, a unit of Groupe BPCE, France’s second-largest banking company. “Xi Jinping’s mindset is one in which China is at the center of the world’s economy but not necessarily open to the rest of the world, or at least not vulnerable to it.”
Xi seems to realize that he paid a high price for the honor of having the Chinese yuan included, starting this October, in the International Monetary Fund’s basket of reserve currencies along with the dollar, the euro, the yen, and the British pound. To be included in the basket, China had to demonstrate that the yuan was “freely usable.” That forced it to lower some investment barriers—enabling the capital flight now bedeviling the leadership. The Institute of International Finance estimated in October that net capital flows out of China would reach $478 billion in 2015. New estimates due this month could show even larger outflows, the IIF says.
It’s worth taking a close look at what “capital flight” really means for China. Capital flows out of the country aren’t necessarily bad; they’re simply the mirror image of its trade surplus. Whenever China chooses to use a dollar, euro, pound, or ringgit earned from exports to buy a foreign asset, it’s sending capital abroad. Many foreign acquisitions strengthen the country, economically and politically.
The problem now is that more money wants to get out of the country than wants to get in. Here’s the math: Last year, the IIF estimates, China had a little more than $250 billion coming in from the surplus on its current account, the broadest measure of trade. It got an additional $70 billion or so in net capital from nonresidents, including Chinese companies’ overseas affiliates. But those inflows were swamped by a record $550 billion in net outflows by individuals and companies inside China.
Who stashed all that money abroad? The Bank for International Settlements attempted to answer that question in its Quarterly Review in September using the example of a hypothetical Chinese multinational. During the boom years, BIS economist Robert McCauley wrote, such a company made money by borrowing at near-zero rates in the U.S. and Europe, converting the money to yuan, and investing in China at higher yields. Now, he wrote, it was reversing course: borrowing more in yuan and holding more money in foreign currencies.
That’s the dynamic the government is trying to overcome with its yuan-buying. The IIF projected in October that the government would need to sell off more than $220 billion of its reserves last year to meet the demand for foreign currency. The actual number was probably closer to half a trillion. The nation’s stockpile of foreign exchange reserves has dwindled to about $3.3 trillion. The cushion is shrinking. “Considering China’s foreign debt, trade, and exchange rate management, it needs around $3 trillion in foreign exchange reserves to be comfortable,” says Hao Hong, chief China strategist at Bocom International Holdings.
What Xi is running up against is what international economists call the trilemma, or the impossible trinity. It says that a country can’t have all three of the following things at once: a flexible monetary policy, free flows of capital, and a fixed exchange rate. They fight one another. As soon as China started allowing free (or at least freer) flows of capital, it was inevitable that it would have to give up on one of the other two objectives. If it wanted to keep the yuan from falling, it would have to raise interest rates higher than is good for the domestic economy, essentially giving up on setting an appropriate monetary policy. Or, if it wanted to set interest rates as it pleased, it would have to allow the yuan to sink.
“It really is a puzzle,” says Steven Wei Ho, a Columbia University economist. “We can only speculate,” he adds, which option the leadership will choose. To University of Macau economist Vinh Dang, the answer is obvious: Because flexible monetary policy is essential and China is too big to wall itself off from the world, “exchange rate control must be given up,” he wrote in an e-mail.
Judging from China’s stop-and-go policies, its leaders haven’t completely wrapped their heads around the idea that they must make a choice. They still want all three parts of the impossible trinity. Calls for a large depreciation are “ridiculous,” Han Jun, the deputy director of China’s office of the central leading group on financial and economic affairs, said on Jan. 11 at a briefing in New York.
It can’t be easy for Xi to suffer the indignity of losing a fight against the world’s financial markets. That’s one reason to think he’ll try to escape the trilemma by restoring at least some controls on capital. Garcia-Herrero, the economist for Natixis, predicts that permission to send or keep money abroad will be doled out more stingily in the future. The One Belt, One Road initiative to make China a hub of Asian commerce should have no trouble getting financing, she says, but an investment that doesn’t obviously serve the national interest could be rejected. Chinese authorities will remain open to investing or extending credit outside the country when it’s fully under their control, she predicts. An example would be the nascent “panda bond” market, which allows foreigners to borrow money in yuan inside China.
Kevin Yan, an analyst at Stratfor, a geopolitical intelligence firm based in Austin, agrees with Garcia-Herrero that the short-term trend is toward closing China off from the world, but he’s more optimistic about the long term. “It’ll be opening and closing, opening and closing, but slowly moving in a positive direction, probably over the next 5 to 10 years,” Yan says.
The worst thing China’s leaders could do now would be to fall back on the tired old trick of supporting employment by building roads, bridges, and apartments. Gunther Schnabl, a professor at the University of Leipzig, says that lax lending merely keeps zombie enterprises on their feet: “If you do not have a hard budget constraint, you do not have an incentive to put forward dynamic, innovative investment.” Judging from the amount of capital flight that China is experiencing, a lot of people in the Middle Kingdom are worried about precisely that.
* JPMorgan’s average rate for developed nations is still sub-1%
* Central bank balance sheets to top $1.3 Tln, according to BofA
The era of easy money in the world’s major economies isn’t close to being over.
Even after Federal Reserve Chair Janet Yellen and colleagues raised the target range for the federal funds rate to 0.25 percent to 0.5 percent, that’s still way below its 2 percent average since 2000 and the 3.2 percent of 2000 to 2007.
It also means JPMorgan Chase & Co.’s average rate for eight developed nations and the euro-area weighted by size is on course to end 2016 at just 0.36 percent. That’s a full 3 percentage points below the average of 2005 to 2007.
If the Fed lifts its benchmark to 1.5 percent a year from now, as JPMorgan predicts, the bank’s economists still see the rate for the key industrial economies undershooting 1 percent next December as the European Central Bank and Bank of Japan stay on hold.
Low for Long
The upshot for the world economy is, as Bank of England Governor Mark Carney described this week, an environment of “low for long” rates even with the Fed hiking. While there are questions over the potency of monetary policy, weak inflation and lackluster growth around the world will require it to remain loose.
“The Fed’s path is slow and nobody of any size is following through behind it,” said David Hensley, director of global economics at JPMorgan in New York. “The ECB and the Bank of Japan are absolutely not going to be raising rates for the foreseeable future.”
There may even be about as many rate cuts as hikes in the next twelve months. Of the 31 central banks it monitors, JPMorgan predicts nine will ease further including China, Sweden, New Zealand and Malaysia. A reduction in the number of emerging markets pegging their exchange rates to the dollar mean many won’t have to trail the Fed as they once did.
Still, ten central banks aside from the Fed are seen tightening by JPMorgan, including the Bank of England in the second quarter and the Bank of Canada in the fourth. Hensley says some emerging markets may also find themselves having to hike more than he now anticipates.
Regardless of rates, there are also still bumper balance sheets, swollen by years of quantitative easing. Bank of America Corp. calculates those of the four major central banks will expand to $13.5 trillion by the end of 2017 from $11 trillion today.
The Fed doesn’t plan to reduce its stock of assets before the hiking cycle is cemented, while BofA predicts the ECB and Bank of Japan will accelerate their bond-buying.
With the Fed’s balance sheet now around 25 percent of gross domestic product, it estimates the ECB’s will reach 33.8 percent by May 2017 and the BOJ’s will rise to almost 108 percent of GDP by the end of that year.
“A sizable amount of liquidity will be added to global markets over the next two years, if not longer, even as some central banks slowly hike rates,” Michael Hanson, an economist at BofA, said in a report this month. “This combination should help to maintain a very accommodative policy stance globally, which in turn should give a lift to global growth, help put a floor under inflation, and support demand for risky assets — all the while keeping a lid on longer-term bond yields.”
Unconvinced is Steve Barrow, head of Group-of-10 strategy at Standard Bank Group Ltd. in London, who argues the world is at an “inflection point.” Rate cuts and bond-buying elsewhere don’t wield the same heft as those from the Fed because the dollar remains the prime international currency and its set to stay strong, he said.
“The bottom line is that weaning the world off the Fed’s monetary largesse is going to be hard, even if does not seem this way initially,” said Barrow. “We’d be prepared for higher volatility and a higher dollar, but lower prices for risk assets.”
If the U.S. does slip back into recession at some point, rock-bottom rates will also again be the order of the day, former U.S. Treasury Secretary Lawrence Summers told Bloomberg this week in giving odds of 50-50 that such a slump will occur within two years.
“We are not saying goodbye forever to the zero-lower bound,” said Summers.