The economic ruse that is run by Communist China is growing bigger by the
day. The formula behind what has been the Great Red Engine of global growth
is really very simple: Print new money and funnel it through the state-owned
banking system in order to entice businesses and individuals to incur a
debilitating amount of non-productive debt.
Historically speaking, countries that have utilized this ersatz form of
economics have suffered a currency and bond market crisis. But the command
and control government of China always seems to be one step ahead of the laws
of economics; and has been able to defer the inevitable day of reckoning due
to its large currency reserves.
However, those reserves have dwindled as the nation was forced into
selling its dollar-based assets and defend the value of the yuan. The
People's Bank of China (PBOC) has spent trillions of dollars over the past
four years doing just that.
To aid in propping up the yuan, China has deployed a unique cocktail of
regulations and market trickery. In addition to outright currency
manipulation, trading bands and strict capital controls, China has now
resorted to simply making up prices for its currency.
The China Foreign Exchange Trade System, which is managed by the PBOC,
changed the way it values the country's currency each morning and the way it
is allowed to fluctuate through the day. The government currently sets a
benchmark value for the yuan against a basket of currencies for which the
yuan is then allowed to fluctuate in value by 2 percent during the day. You
would assume the opening benchmark level would be based on the currency's
closing value the day before.
But the Chinese government contends that the market just isn't getting it
right. Therefore, they are introducing a "countercyclical variable".
The omniscient Chinese government will now determine the opening benchmark
value of the currency. Because after all, the government of China is great at
pretending it has a better view of supply and demand than millions of
individuals voting with their wallets each day.
But the currency manipulation doesn't end there. The Chinese government
still has the less regulated offshore yuan to contend with. Investors that
believe the yuan will fall in value will go short the currency outside of
China. This involves borrowing yuan in Hong Kong, swapping it for dollars and
then repatriating it back at a more favorable rate. There are risks
associated with borrowing the yuan. When these risks rise it can force
investors to close out this trade, which has the effect of pushing the yuan
higher.
Therefore, in order to crush the Yuan bears, China followed up its
countercyclical variable by sending margin costs for borrowing the offshore
yuan through the roof and forcing a short squeeze. The overnight CNH Hibor
rate, spiked from 5.35% on May 30th, to 42.8% by June 1st, making the cost of
borrowing new yuan funds prohibitive; and thus forcing many speculators out
of their positions. And with this it appears China's currency will live to
die another day.
We are living in a world where market manipulation has reached
unprecedented proportions and any vestiges of the free market are extremely
hard to find. This is especially true throughout the developed world. China
sets a GDP target and then fudges with the number to ensure its accuracy. It
fabricates economic numbers and is the world leader in the production of
alternate facts. Spinning a fairy tale as it pretends to move towards a more
market-based system.
But to imagine China can repel these economic forces forever would be to
defy centuries of data that says otherwise. The offshore Yuan speculators
represent the incipient dissolution of confidence in the government and its
currency. The Chinese government can only manipulate the message from the
market for so long.
For example, the US dollar had supreme confidence following WWII and the
Bretton Woods agreement. But by the early 1970's money printing caused the
government to abandon the dollar's gold backing, and stagflation soon
followed. Heck, even the Roman Empire couldn't hold back the forces of
inflation forever.
This destruction of confidence in governments and their fiat currencies do
not happen overnight. But history is clear that markets always win and
governments always lose...reality triumphs over fiction. China's fairy tale
will come to an end. A pernicious end that will be shared by the Euro and the
Dollar as well. Those seeking a much better ending will need to park their
wealth in gold.
