Even the IMF Has Thrown In the Towel On Global Recovery

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The GC repo rate opened this holiday-shortened week right where it shouldn’t have been. Ever since September 17, monetary authorities and the public have been paying closer attention to this part of the global money markets. An unexplained eruption finally created some skepticism, forcing the Federal Reserve to respond. A fourth adjustment to IOER, a first to the RRP, constant overnight repo operations, term repos, and now a balance sheet expansion plan that isn’t QE.

And for all of that the repo rate published by DTCC on Tuesday was an astounding 47 bps above the RRP wholesale floor. Wednesday was not meaningfully better, a spread of almost 37 bps.

One key reason is how despite the names the US central bank gives to some of the things it is doing they are quite removed from the target. An overnight repo operation isn’t the Fed intervening by injecting liquidity into the repo market, as you are led to believe, it is the Fed mimicking a repo transaction between itself and some of the 24 specific primary dealers.

More smoke and mirrors from moneyless monetary policy while the consequences, big and small, keep piling up. The repo market is one risk and now relatedly the WTI futures market and its curve has flipped into contango, a more ominous sign just like last October.

It is most ominous for China. The place with the world’s biggest dollar problem has a lot riding on what may seem by comparison the small matter of tens even hundreds of billions in US$ repo liquidity. The latter feeds the former, a condition that country can increasingly not afford. The externality of any elevated dollar issue becomes internal to Chinese money adding to the volatile mix of growing economic fears and political paralysis.

More than a slowdown, more than a downturn, China is being pushed dangerously into reactionary territory.

In March 2016, as is customary Premier Li Keqiang sat next to President Xi Jinping during the plenary sessions of the National People’s Congress. According to media reports, they never shook hands, speaking with one another only briefly while quite obviously avoiding eye contact. An uncomfortable spectacle.

That contrasted sharply with each’s behavior during the National Congress held the year before, in 2015. Xi and Li, China’s top two leaders, were photographed glad-handing and smiling for the TV cameras if nothing else.

In between, of course, Euro$ #3 and the negative impacts it held for China’s struggling economy. In August 2015, seemingly out of nowhere, the Chinese yuan had been “devalued” sharply leading to all sorts of financial chaos around the world. Wall Street even experienced a limited crash two weeks later.

Because it wasn’t a devaluation at all; it was the dollar shortage escalating beyond the capabilities of China’s beleaguered leaders to handle. That much became increasingly clear as the nation’s economy plodded its way toward the end of 2015 under suspicions of a “hard landing.”

Undoubtedly, that’s why at the outset of 2016 China’s leadership panicked. They reached back into the Keynesian playbook that they’ve all been taught (more often than you might think at Western universities steeped in Economics) and unleashed a third round (since 2008) of presumably awesome stimulus. The same sort of fiscal engineering (via fixed asset investment through state-owned entities) which is always cheered by Economists and media in the West.

Strangely enough, though, it didn’t seem to have been given the full approval of Xi Jinping. In May 2016, an unusual article appeared in the People’s Daily, the Communist Party’s propaganda outlet. Written by an anonymous “authoritative figure”, the fact that it had been published at all indicated that was true. Many speculated it might have been authored by Xi himself.

The piece was, essentially, pointed criticism of the kind of stimulus being undertaken by the Chinese government. It equated such measures with trying to “grow a tree in the air”, the exact wrong thing to do because in the author’s estimation China was facing a more permanent change in condition rather than a temporary dip as the stimulus designers had imagined.

“I need to stress, that the L-shape will last for a certain period of time, and it’s certainly longer than one or two years.”

If not Xi as author, some have pointed toward, and I agree, Liu He. Affectionately known as Uncle He in Xi’s circles that’s because Lui and Xi are reportedly very close and have been since the two were young. He is, in fact, Xi Jinping’s effective number two inside what’s really a Xi faction within the state.

Before Hu Jintao stepped down in 2012, it wasn’t immediately clear who would replace him atop the government and the Communist Party. Many were thinking it was going to be Li Keqiang, a more logical and direct choice. After all, Li came up, as Hu did, via the extremely powerful Communist Youth League.

A graduate of Peking University, it was Li who gained a reputation as an economics wizard instrumental in helping Hu (along with massive “dollar inflows”) engineer China’s miracle growth years. Li, not Xi, was Hu’s confidante and protégé, having gained a doctorate in economics and being counted as one of the more cerebral set of officials.

Xi Jinping, by contrast, was a princeling and a party boss. His father had been one of the revolutionary leaders who alongside Mao had ushered China into its backward Communist age. Caught up in the confusion of the backlash following the disastrously genocidal Great Leap Forward, his father, Xi Zhongxun, who had been a vice premier and Central Committee member, was purged by Mao in 1962 after being accused of harboring non-conformist views.

It was exactly that kind of power which led Deng Xiaoping in the seventies (after Mao’s death and the purge of his wife and her supporters, the Gang of Four) to move in a radically different direction. Never again would China’s Communist Party allow the cult of leadership that gave Mao unchecked authority. The duties of government, party, and military would be separated, and no person would sit atop any of them for more than two five-year terms.

Rather than resent Mao for what he had done to his father, by all accounts Xi Jinping admired the man for his idealism (purported, anyway) and pragmatism. Seen by many as the anti-intellectual, Xi is the more proto-typical where the ends justify everything.

That much was certainly on display in the pivotal early months of 2016.

On April 15, 2016, Li visited Xi’s alma mater, Tsinghua University in Beijing. In his rival’s backyard, his speech focused on the science and technology aspects of the high-minded approach of idealism he and Hu hold close. Accompanied by Guo Jinlong, Beijing’s Communist Party leader, and another disciple and close fried of Hu Jintao, it was seen as a challenge to Xi especially since in addition to Guo there were other leaders and members of the Communist Youth League in attendance in a place more connected to Xi than Li.

That message was heard loud and clear. Just five days later, on April 20, Xi Jinping made a surprise and very public inspection tour of the Central Military Commission's joint operations command center. As also Chairman of that Commission, Xi is effectively China’s military as well as political leader. And he was quite openly and purposefully dressed in a camouflage uniform, an act of military solidarity his predecessors Hu and Jiang Zemin would never have considered.

They, like Deng, desired separation between civilian and military authority. Images of Xi in military garb went viral, as was likely the point. A message sent in return to Li.

On the one hand, there was Dr. Li as China’s number two and traditionally the authority put in charge of the economic plans. Acting like the Western Keynesian he is, as Premier Li led China’s stimulus believing that he was counteracting “transitory” forces (after all, that’s what Janet Yellen and Mario Draghi kept saying) by good practice of standard countermeasures. China, as many in the West were claiming, would reclaim its pre-crisis miracle growth with a little push.

On the other, Uncle He’s “L” no doubt under authority of Xi Jinping the budding strongman and authoritarian watching in horror as China’s economic miracle kept fading further and further into history no matter what. Suspicious of these intellectuals, more pragmatic by nature, Xi went along with “stimulus” I believe because at the time he hadn’t yet consolidated his support.

In a lot of ways, that’s just what China’s 2016 stimulus panic allowed him to achieve. As the May 2016 article in the People’s Daily said, Xi’s side wasn’t at all convinced it would be effective. In a lot of ways, it sounded like a prediction intended to be date stamped and referred to again for a future “I told you it wouldn’t work.”

And that’s just what happened. Despite all the hurray and Western adoration, China’s economic rebound peaked…in the first quarter of 2017. Barely a year and at the top of it nominal GDP (a Chinese economic account less susceptible to fudging than real GDP) managed just 11.5% - not meaningfully different than the 10.5% growth registered in Q4 2013 right before Euro$ #3 struck (and CNY started falling).

By contrast, in Q3 2011, just as Euro$ #2 was getting started, China’s nominal growth had been 19.4%. In Q3 2007, just Euro$ #1, commonly known as the Global Financial Crisis, was getting started, China’s nominal growth had been 23.9%. Massive stimulus early in 2016 and substantially less than half the growth – and only for that one quarter.

Ever since Q1 2017, long before trade wars, China’s economy started slowing down again and rolling over. Xi and Uncle He have been taking more economic authority ever since.

That’s how Xi has been able to more and more consolidate power importantly by isolating Li Keqiang. By tradition, it was the Premier who had responsibility for economic matters, as Li had up until 2017.

Then came the 19th Communist Party Congress in October 2017 which took everything a step further. While Western officials and the media were dazzled and distracted by “globally synchronized growth” and what was a real hysteria over the limited prospects for a worldwide inflationary breakout, Xi Jinping effectively ended the charade (again, long, long before trade wars). In his crucial address opening the Congress, Xi spoke of a Chinese economy suddenly dedicated to “quality” growth.

Rapid, sustained growth had always been the payoff, the people’s part of the deal going all the way back to Jiang Zemin and even before. Jiang’s Three Represents combined economic growth with hardened Chinese cultural characteristics in order to reach a future where “the fundamental interests of the majority” would be reflected in all things, including, one might imagine, the politburo.

In other words, China would stay China culturally while embracing the capitalist market features of the West in order to transform itself away from Mao’s backward communes and into a truly wealthy, modern society that the majority of Chinese would readily accept as true Chinese Communism. Steady culture, economic reform, and then political reform while keeping with dogmatic Marxist progression (societies must become rich before they can become true socialist).

The Chinese people have put up with a lot along the way. Placing political reform far into the future as China ascended economically meant getting along with an authoritarian government with the power to redraw the physical as well as intellectual landscape. Pollution, corruption, and displacement were the price China’s vast peasant classes were willing to pay so that they could see their children and grandchildren move off to a wholly different and better life living in those glittering new modern cities springing up all over the country.

And then in October 2017, the country’s leader with the backing of the military says, effectively, we’re done. According to Xi’s 19th Party Congress, China has reached (or will in 2020) that level of wealth presumed by the Three Represents. The Communist government is shifting into managing what has already been attained.

Somehow, I doubt political reform will be on the agenda, even as that was the ultimate bargain behind the Three Represents. Xi has spent the last two years consolidating the government’s position as well as his own within it. Loyalists have been given the top jobs, and any in opposition like Li have seen their responsibilities whittled down or their portfolios taken away entirely.

Xi is effectively the leader for life, having removed Deng’s term limits while at the same time allowing for Xi to be on top of everything, lord over the Party, the Government, and the military.

There have been growing whispers and reports of a return to the cult of leadership tactics. Reactionary China. No growth, no reform, and the strongman back again up top.

But he isn’t all the way there yet. Li Keqiang may be diminished, but he is not gone. Very curiously, the Communist Party broke with tradition by not holding its 4th Plenary Session under the 19th Party Congress last fall. That’s the one in which China’s top economic officials meet and hammer out the long-range economic plan. It was speculated that Xi wasn’t eager to let Li punch back, switching places and allowing the latter to criticize the former’s handling of an economy spiraling further downward.

In November 2018, China’s titular number two Li failed to even mention China’s number one Xi in two speeches he gave while traveling abroad visiting Singapore. Instead, Li talked about Deng Xiaoping and the wisdom of rejecting one-man rule.

Even though Li may be a favorite of the intellectual class, it may also be that he has China’s middle and lower classes on his side, too. After all, like the peasants, the middle class working Chinese have a stake in economic growth. They’d very much like things to continue as they are. After having waited and suffered for economic security and comfort, Xi’s mantra of “quality” growth should be terrifying to them.

And it’s difficult not to see these potential fault lines and fissures in some of the more recent moves made, and language used, by Xi’s government. Just a few days ago, the man atop a government that has become so sensitive to criticism it banned the image of Winnie the Pooh used the phrase fěnshēn suìgǔ when speaking about more than what’s taking place in Hong Kong:

“Anyone who attempts to split any region from China will be crushed with shattered body and bones.”

Bluster, perhaps, but there’s also definite hints of Shakespearean desperation, too.

The entire regime is stuck and so officials are unsure what to do moving forward – because there is no realistic way for them to move forward. On the one hand, the reactionary who is reacting rationally to years of empirical evidence where global money and the economy is concerned in order to take China back. On the other, the Western-style academics committed to reform and liberalization by doing more of the things that haven’t, and won’t, work.

A positive vision of growth but one that is more accepted as unattainable versus grounded and reactionary darkness.

No one is sure how the divisions within Chinese society will actually line up if, maybe when, the temperature reaches its critical point.

Behind it all is repo, dealers reacting to the increasing risks deeply rooted within what is the global system’s primary pivot. An unstable China is a more dangerous world.

Hand in hand, the lack of dollars contributes most to the world’s lack of stability. That may have been the primary lesson of Euro$ #3 – the (euro)dollar rules over all, even China. There is no escape, not a realistically positive one so long as things remain as they are. Some get that; most do not see it yet. The possibilities keep bending toward social and political breakdowns.

A dozen years onward, even more desperate for some breathing room, the world keeps trying to grapple with the deepening consequences of moneyless monetary policies. The Chinese once blessed with the world’s biggest dollar target are now cursed as it has flipped entirely the other way. With no path forward, how far backward might they go? What does that mean to the rest of the world?

A lack of global recovery, for one thing. That much is once more apparent. Even the IMF has thrown in the towel, saying recently we are now in a globally synchronized slowdown. If only someone there or at a central bank somewhere would attempt to figure out why. US$ repo would only be the start.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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