The Strong Dollar Spells Trouble For China and Europe

Get ready for a stronger Dollar...

By Gerardo Del Real Written Thursday, December 22, 2016

A few weeks back I wrote about the global war on cash and how the dollar and the bond market were engaged in a dangerous dance. RSDP subscribers received a more in-depth analysis about why the dollar would break the bond market and how the stars were lining up. The most important takeaways from that article were: That a rising dollar increases the likelihood in major sovereign defaults among emerging markets that issued their debt in dollars. As the dollar rises, the debt becomes more expensive to pay back. That will be a problem since emerging-market non-bank borrowers have accumulated more than $3 trillion in dollar-denominated debt, according to Bank for International Settlements data. Money rotating globally out of the bond markets will lead to simultaneous new highs in the dollar, the U.S. stock markets, and gold… just not yet for gold. Here we are a few weeks later with Dow 20,000 on the horizon, the dollar just hit 14-year highs and, sure enough, gold has pulled back and is on target for a further decline... hopefully one last leg down that scares the remaining weak hands. Weak hands that will buy back in at higher prices. Back to the stars lining up and what that means. Phoenix Capital recently wrote an editorial called “The $USD Strength Just Became a REAL Problem For China.” It highlighted that between November 8th and December 5th, investors put $97.6 BILLION into U.S. stock ETFs. To put this into perspective, for the ENTIRE year of 2016, they put in just $61.5 billion. It then went on to opine that “this is the hallmark of mania.” A point I couldn’t disagree with more for the simple fact that retail participation in the U.S. stock indices is very low and the global bond markets are still holding massive amounts of capital, capital that will continue to rotate out and eventually land here, but I digress. It went on to highlight that China’s multiTRILLION-dollar bond market broke last week. The cause? A tiny increase in the Federal funds rate and the fear that Janet Yellen may make good on projections of further hikes in 2017. Advertisement Geopolitics and Gold In the late ’70s, the world was a mess... Between the Soviet war in Afghanistan, the Cold War, and the Iranian Revolution, there was a lot of panic going on. And thanks to these fears, gold went on a record 743% run... Today, we have a similar confluence of chaos and turmoil... with daily reports of urban warfare in America, terrorism in Europe, and markets down everywhere. It is undeniable that there exists a precarious balance in the world today. And one small push in any direction could send the whole system toppling. If and when that happens, gold will absolutely skyrocket. For the first time ever bond trading had to be suspended briefly on Thursday December 15, 2016, until the People’s Bank of China injected about $22 billion into the money markets. The PBOC also extended emergency loans to financial firms to encourage them to keep trading. For years the government's been propping up China’s bond market. Companies have been issuing bonds in place of relying on bank lending. The result is a bubble that is starting to show serious signs of popping. Corporate bond yields are on the rise and new issuances have been cancelled. Here’s how The Wall Street Journal described it: China’s central bank tried this year to tighten credit, but its power is limited. The People’s Bank of China shares oversight with the China Banking Regulatory Commission and China Securities Regulatory Commission, an arrangement that allows financial institutions to move assets around to deceive regulators. Powerful interests within the government also want to keep the money spigots open to hit growth targets. But questions about the durability of that growth are increasing. Easy money has eroded productivity. Companies evade capital controls and move their money abroad into dollars. Beijing’s foreign-currency reserves, while still massive, shrink month by month. Keeping the yuan from devaluing too quickly will require raising domestic interest rates, which will hurt growth and cause some companies to fail. Even though the Chinese bond market doesn’t price risk accurately, it still reflects interest-rate expectations. Last week’s mini-tantrum suggests investors understand that China’s central bank won’t be able to keep rates low if the Fed carries through on its promised tightening. A stronger dollar is set to test China’s financial institutions and its real economy. Since November, China’s bond market has joined the global selloff, sparking worries we will see a repeat of the June 2013 cash crunch or the summer 2015 A-share stock market crash. Year-to-date the yuan has fallen 7% against the dollar. Despite the cancellation of bond offerings and capital injections into the money markets, China is learning — albeit on a tiny scale relative to what’s coming — what Europe and Japan are coming to grips with…. that there may be “tools in the toolbox” but they’re increasingly less effective and at times counterproductive.