Contagion – From China , Europe, & now Japan – Trump in 2016


Change happens slowly and then all at once” is an old maxim.  Merely three weeks ago we wrote about the contagion hitting China & its impact on the rest of the world. In that article, we pointed out that “Chinese Foreign exchange reserves fell by over $500 billion in 2015“. That number has been doubled in the last three weeks. Experts like Larry McDonald of Societe General now report that outflows from China were $1.1 trillion in 2015, about 10 times the 2014 outflows of $134 billion. 

China is caught in a massive pincer movement of two forces – outflows from China due to fear of currency devaluation and steep fall in exports from China because it’s currency is overvalued. Three weeks ago in our article 2000, 2008, & Now 2016 – My Time Yet? – Asks the Contagion, we discussed two ways China could devalue its currency – fast & brutal vs. slow & gentle. Either way, China would be exporting its contagion to the rest of the world. So we asked in that article, “Why would the rest of the world …. accept that?”

We got the answer in the past 7 business days – kick them when they are down.


Europe, especially its dominant economy Germany, depends on exports. And the Europe-China trade is the largest segment of global trade. Europe is already suffering from the bust in its trade with Russia, a major trading partner due to sanctions about Ukraine. Their exports to China are also down significantly because of the slowdown in Chinese industrial economy. So can Europe cope with import of additional deflation from a devalued Chinese Yuan? Not this Europe that is desperately fighting its own homegrown deflation.  

So on Thursday, January 21, 2016, Mario Draghi explicitly committed the European Central Bank to additional Quantitative Easing. Look what instantly happened to the Euro:

Embedded image permalink

Europe has no real choice except devaluing the Euro. It is the only way they can try & compete in the global economy. But Europe is also a rich continent of people that have lived with crisis for centuries. Europeans are unlikely to send bulk of their monies to the safety of the U.S. Dollar. So Europe doesn’t face a pincer movement like China does.


At least Draghi’s move was not that unexpected. But that move led the markets to speculate about Bank of Japan following Draghi. That was promptly squelched a week ago by Haruhiko Kuroda, the Governor of the BoJ.

Then in a stunning move on Friday, January 30, Kuroda announced his new policy of negative interest rates. Look what instantly happened to the Yen:


And look what happened to global interest rates? Japanese interest rates from 3-month to 5-years went negative. Merely three weeks ago we had described the fall in the 5-year interest rate in Germany, our favorite indicator:
  • from plus 0.155% in October 2014 to minus 0.005% in January 2015 and now to minus 0.13% on January 8, 2016.
Now, in a small span of three weeks, the German 5-year rate has collapsed by 0.18% to -0.31%. Talk about change happening all of a sudden. And it is happening all over the developed economies:
Negative rates

3.Japan vs. China

What impact did Kuroda’s move have on China? Simply put:

  • Simon RabinovitchVerified account ‏@S_Rabinovitch – No, not the yen. It’s the yuan. With JPY 15% of CNY basket, Kuroda is testing China’s will to let yuan fall vs USD yen-yuan 2

Remember the Chinese Yuan is still pegged to the U.S. Dollar. So when the Euro and the Yen depreciate against the U.S. Dollar, they automatically depreciate against the Chinese Yuan as well. What a body blow to Chinese hopes of stimulating their economy via gentle depreciation of the Yuan?

Talk about hitting them when they are down.

4. Momentous Reversal

The mega event of the 21st century has been China’s entry into global trade in 2002. Chinese growth has been the linchpin for global growth from 2002. What China achieved in these 14 years is unprecedented in human history – urbanization of 500 million people, higher incomes to a 1.4 billion people and a jump to the second largest economy in the world.

Currency management was a big factor in this explosive growth just as it was for the explosive growth in Japan 40-50 years ago. With that came access to lower interest rate loans. All this allowed China to achieve stunning export growth by keeping their currency low and taking manufacturing jobs away from the rest of the world. As a result, China built a mammoth war chest of $ 4 trillion reserves.

One consequence of this was an explosion in debt in China. According to Larry McDonald of Societe General, total debt in China exploded from $2 trillion in 2000 & $5 trillion in 2005 to $35 trillion in 2015 – a 300% debt to GDP ratio.

This was unsustainable & China finds it impossible to sustain it any more. The world is now inflicting damage on China by saying no more. And not just Europe and Japan but other emerging markets as well. The carnage in EM currencies has made the Chinese Yuan grossly overvalued against them as well. 

Everything that was strong about China is now going down including their war chest of US Dollar Reserves. As a recent Bloomberg article pointed out:
  • “If just 5 percent of its 1.3 billion population sent the maximum $50,000 allowed out of the country, it would deplete the entire $3.3 trillion in reserves”
And that is assuming the reserves are all liquid which they are not. And how soon could the liquid portion of the reserves run out?
  • “China has a large reserve but at this rate or higher, the liquid portion of the reserve 
    may run low in months — not years,” said Victor Shih, a professor at the University of California at San Diego who studies China’s politics and finance
Chinese FX Reserves running low in months? That’s a change that is happening all of a sudden.
5. Enter Donald Trump

Coincident with China’s explosive growth was the steady relentless decline in jobs & incomes of industrial America, the people who fathers had built America into what it is today. Their jobs went to Mexico in the 1990s and to China & other EM countries in the 15 years of this century. At least Mexico is a neighbor & an ally of America and not a military & strategic competitor that China has become. Chinese arrogance after the US financial crisis in 2008 was very hard on American psyche. So there is virtually zero tolerance in middle America, especially industrial America, about China exporting its problems back to America. 

All of this is visible in the unwavering support for Donald Trump in America’s middle class. As even left wing pro-Obama anchors like Chris Mathews of MSNBC have publicly acknowledged, the silent support for Donald Trump is broad and deep. America’s psyche is wounded and Americans want to win. And nothing will be more psychologically rewarding than a visible public win over China.

Accepting a 20% decline in the stock market will be a small price to pay for that win. Heck, that might even contribute to reducing the inequality in America. A financial accident in China, Asia or Latin America might be just the ticket for non-believers in Trump to support him just as the Lehman bankruptcy was what made many non-believers in Obama finally support him in the fall of 2008.

Change is happening all over the world. Trends that have been in place for the past 16 years are changing before our eyes, perhaps changing all of a sudden. That makes 2016 a very interesting year indeed.

Send your feedback to [email protected] Or @MacroViewpoints on Twitter