US Tax Cut and Rate Hikes Threaten China Currency

Authored by Valentin Schmid via The Epoch Times,

Seven was the line in the sand.

But the Chinese yuan never crossed that line vis-à-vis the U.S. dollar. It only crept up to 6.96 yuan per dollar on Dec. 16, 2016, before starting an impressive comeback, down to 6.5 in the middle of this year.

Last year was a bad one for the Chinese economy. Growth was slow, and the world was worried China would finally land the hard way, as many have been predicting for years.

And more than GDP growth or any other metric, the Chinese currency was the barometer of whether China could keep things stable - stability is the mantra of the ruling communist regime - or suffer a crisis of debt deflation.

If it declined in value, it meant citizens and companies were moving money out of the country in droves because they didn’t believe in the Chinese dream anymore.

So another measure of how bad things had gotten in the second-largest economy of the world was capital outflows.

According to the Institute of International Finance (IIF), a record $725 billion left China in 2016, putting pressure on the currency and the Chinese interbank market.

All these factors have changed in favor of the dollar in the last quarter, and it’s going to be hard for China to compete.

Trying to stem the tide, the central bank sold record amounts of foreign currency. Chinese foreign exchange reserves, $4 trillion at the peak in 2014, went down to $3 trillion, and analysts started to question whether this was enough to finance the world’s largest trading economy.

Then, miraculously in time for the 2017 National Congress of the Communist Party, all of this stopped. The yuan never went above 7, the exchange reserves never went below 3, and capital outflows subsided thanks to draconian regulations making it harder for individuals and companies to move money out of the country.

Weak Dollar

But something else helped China to strengthen its currency to reduce capital outflows and to balance foreign exchange reserves: a weak dollar.

The dollar didn’t only decline against the yuan. It declined against virtually all of its major trading partners in 2017, dropping 12 percent from its Jan. 2 peak to its Sept. 4 trough.

A weak dollar takes pressure off the yuan and makes it less desirable for Chinese to invest in U.S. assets if they stand to lose money on the currency. A weak dollar makes Chinese foreign currency holdings in other currencies worth more.

But the weak dollar is bound to reverse in 2018, and for China, this means going back to the uncertainty of 2016.

Currencies move for a myriad of reasons, but this year’s drop in the dollar had three major pillars.

The first one was political. After the dollar spiked 8 percent in the wake of the election of President Donald Trump last November, it dropped when it became clear Trump could not quickly push through his “America first” agenda, which included tax cuts and getting tough on trade with China and Mexico.

 

The second pillar was the interest policy of the Federal Reserve. The Fed always lagged behind its announced rate hiking schedule for 2016 and 2017, thereby disappointing market expectations of higher interest rates and a higher yield for the U.S. dollar.

 

The third pillar was the economy. Relative to expectations, the United States underperformed against the emerging markets, including China and even Europe and Japan in the first half of the year.

Strong Dollar

All of these factors have changed in favor of the dollar in the last quarter, and it’s going to be hard for China to compete.

Trump managed to deliver on key campaign promises in the last inning of 2017. The tax bill is a boon for national and international corporations, making it more competitive to invest in the United States again. It also incentivizes companies to bring back trillions in offshore money. Although this money likely won’t come from China, it will boost the dollar and indirectly punish the yuan.

China, on the other hand, has become ever less competitive both regarding taxes (the corporate rate is 45 percent) as well as cheaper wages. Its main advantage nowadays is scale. So according to a report by The Wall Street Journal, China is already preparing a contingency plan to counter the Trump reforms by raising interest rates, tightening capital controls, and micromanaging the currency by intervening in the foreign exchange markets.

President Trump managed to deliver on key campaign promises in the last inning of 2017. The tax bill is a boon for national and international corporations, making it more competitive to invest in the United States again

Lower taxes for companies and individuals in the United States should also boost an already much-improved economy and therefore make U.S. assets like stocks and real estate more attractive for foreign buyers again.

But the United States is also threatening China on trade, whose $309 billion good trade surplus in 2017 provides powerful support for the yuan.

In late November, the United States filed a legal submission to the World Trade Organization (WTO) as a third party in a case China had brought against the European Union (EU) in late November. China is unhappy that, despite some WTO provisions, the EU has not granted it “market economy” status 15 years after joining. The United States rejects China’s arguments and sides with the EU.

On Dec. 18, Trump accused China of challenging American power and stealing intellectual property as he unveiled his national security strategy.

“The United States will no longer tolerate economic aggression or unfair trading practices,” his letter states, without mentioning China by name.

If the administration follows through with its tough talk and uses the investigation into Chinese intellectual property theft under Section 301 of the Trade Act of 1974 to impose sanctions on China, a smaller trade surplus will hurt Chinese exports and the currency at the same time. Although a trade war will be costly for both sides, China has more to lose here.

Independent of politics, the Fed is also starting to deliver on its interest rate hikes, making the dollar more attractive in international markets. It raised its benchmark policy rate 0.25 percent to 1.50 percent at its December meeting on Dec. 13.

The Chinese promptly followed suit, with the People’s Bank of China raising its benchmark rate by 0.05 percent to 3.25 percent. But research firm Capital Economics believes this won’t be a game changer and that financial conditions in China are still relatively loose.

“Despite this, we aren’t convinced by the narrative of policy tightening. A five basis point move in rates is too small to have a meaningful impact,” it writes in a note to clients.

However, if China doesn’t deliver on its reform schedule sooner than anticipated, it’s going to be 2016 all over again.

China"s Rise, America"s Fall

Via Golem XIV"s blog,

Will the rise of China mean the fall of America?  In a word, yes. Although decline might be more accurate.

Why do I think this?  Because China is about to launch the PetroYuan and when it does the demand for dollars and for dollar denominated debt will shrink. When it does, I question whether the world will be so sanguine about the level of debt that America carries. If that happens then the value of the dollar is in question.

At the moment no matter what level of debt America carries, other countries need dollars. Dollars to pay for oil, since oil is traded in dollars.  Dollars for their financial system so their banks can settle contracts for goods and services traded in dollars.

But over the last few years China has been systematically putting in place everything it needs to launch the Yuan as not only a rival to the dollar in trading and settling oil contracts but as a rival to the dollar as the world’s reserve currency.  At the moment the only rival to the dollar is the Euro. I think it fair to say the relationship between the two currencies and their issuing powers, has been… ‘delicate’.  The news that Sadam Hussein was going to start trading his oil in Euros came just a few months before America and its lap dog GB, decided Sadam was a threat to world peace and went to war with him.  Something similar happened to Colonel Qaddafi.

Under Qaddafi Libya’s currency was backed by the country’s large holdings of gold and silver. This had allowed Qaddafi to finance, for example, the entire construction of the Great Man Made River without going to Western banks for a single loan. Libya was debt free and owned its own resources and infrastructure. Obviously a very unsatisfactory state of affairs for any third world country to get ideas so far above their station.  Worse, he had a very public plan which he had laid before the Pan African Congress, to create a pan African currency backed by gold and silver to be launched by 2023. It was not too long before Hilary Clinton arrived in a freshly bombed Libya and crowed to CBS, “We came, we saw, he died.” Charming woman. I was only surprised she didn’t say “Mission accomplished.”

Libya and Iraq were small enough, that their pretensions to threaten the hegemony of the dollar and have the jumped up arrogance to think they could trade their own resources in their own currency or a currency of their choice, could be dealt with by shock, awe and death. I think China might not be so easily dealt with.

China’s plans for the replacement of the dollar and the positioning of their own currency are very like Libya’s. China too has had the idea to back its new settlement and perhaps one day its reserve currency, with gold.  And China is not alone. Russia has been a part of the BRIC group with an interest in the plan. Russia, like China has been a very large buyer of gold.

As reported just a few weeks ago by the Irish Independent,

…the Bank of Russia has more than doubled the pace of gold purchases, bringing the share of bullion in its international reserves to the highest of Mr Putin’s 17 years in power, according to World Gold Council data.

In the second quarter alone, it accounted for 38pc of all gold purchased by central banks.

The article goes on to explain how purchasing gold has meant that Russia has not had to buy foreign currencies.  For foreign currencies think Dollars.

The gold rush is allowing the Bank of Russia to continue growing its reserves while abstaining from purchases of foreign currency for more than two years.

China and Russia have very large holdings of gold between them. China actually produces 12% of the world’s gold and keeps much if not most of what it produces. The new Petro Yuan will be backed by Gold,  Something the IMF decades ago, said no paper currency should have.  A clear break with the Bretton Woods Dollar-world agreement.

Who will use this new currency?  Over the past few years a network of bilateral agreements has been created around China and Russia. Back in 2012, in an article called   A new Reserve currency to challenge the dollar – What’s really going on in The Straits of Hormuz, I pointed out that not only had China and Russia agreed to bypass the dollar and trade direct in their own currencies but that,

the India Times reported that India was talking to Iran about moving out of dollar settlements so as to be able to buy Iranian oil despite a US embargo. India said it was discussing settling in Gold. Remember, India has just signed a settlement agreement with China to use the Yuan.

Remember also, Russia recently eclipsed Saudi as the number one supplier of China’s oil. And if I remember correctly Angola was number two. Promoting perhaps the recent state visit this year of Saudi’s King Salman to see Mr Putin. As The Guardian put it,

Saudi king’s visit to Russia heralds shift in global power structures

 

King Salman agrees new areas of cooperation with Vladimir Putin on first official trip by Saudi monarch to Moscow

In addition Japan and China have agreed to trade in Yuan, by-passing the dollar, as has Iran. They are now trading their oil in Yuan or euros, but not the dollar. Ever wondered why Iran is ‘the axis of evil?  It’s because they don’t use the dollar.

Then came the news in 2015 that Qatar had opened the first and so far only financial centre in the Middle East, for trading and clearing oil, gas and anything else, in Yuan. China’s ICBC is the central banking concern in the hub, allowing any Middle Eastern country to trade oil and gas and settle in Yuan. In the previous few years China’s trade with Qatar had tripled.  And now, guess what? Qatar has been declared by the US to be a sponsor of terrorism and US allies in the gulf , led by Saudi, have begun to blockade Qatar’s trade.  Hmm.  Any pattern emerging?

The problem for the US is how much debt is too much for any country or business? Clearly it is not any magic figure or particular debt to GDP ratio. America and China carry huge debts and no one has balked…yet. How much debt you can carry is a function of debt to the estimated future productive  capacity of the country in question. That creates the demand for its currency and the demand for the currency creates a market and demand for debt denominated in that currency.

At the moment the US can carry a huge debt load because everyone needs dollars to trade oil. And China can carry a huge debt because everyone needs yuan to buy the goods whose production was off-shored to China by our globalist leadership.

 

But what happens to demand for Dollars and dollar debt when, not if, oil starts to be traded less and less in dollars?  I suggest the world’s appetite will diminish quite quickly. As it does so, the world will start to see US debt in a different light.  While the opposite will happen to China. And this is what interests me and makes me think China has a plan.

At the moment China also has a very large debt load. I have argued that the Central Chinese authorities have not got the control they would like to have over the growth of that debt. Of course I have no inside information. But the on again/ off again attempts of the Chinese central authorities to deflate its housing-debt bubble and its quite out-of-control shadow banking lending suggests, to me at least, that the central authorities have not and can not control the level of debt being accumulated by provincial governments, their off-book, arm’s length financial vehicles, regional banks, property developers and the vast, largely unregulated trade in wealth management vehicles.

Chinese debt already overflowed once back in the 90’s. Four companies were created to take the debt off the banks’ books and trade it away. Decades later these companies still exist and still have the bad debts from the 90’s hanging around. You will see headlines telling you how those companies have been doing well, making money. Suggesting their trade in bad chinese debt has been going well. The reality, if you dig a little deeper, is that those companies lobbied for and were given permission to engage in ‘proper’ banking activities. Which meant they began to make their own loans – to property developers.  As the property bubble continued to inflate over the last decade and a half they have ridden it and that, not trading the old bad-debt, is why they have made a profit.  But now those ‘bad’ banks, have themselves started to find some of their own loans going bad. In any hard-landing or financial paroxysm the ‘bad-banks’ will need to be rescued by a new bad banks. Bad banks for bad banks is not really a solution.

I think the Chinese authorities can see this. It doesn’t take a genius after all.  What can they do?  Well if you already have a huge debt problem and know many of them are going to go bad and will do so overnight in the event of another global banking crisis, and know you are not able to reign it all in, then a very tempting alternative would be to get the world to agree that you can carry  more debt – a lot more.  And what could help convince the world? Well if your currency could become far more sought after, that would be peachy.

And so I think the long standing Chinese goal of making the yuan an important international currency which China, and Hong Kong in particular, have been working towards for years, has now taken on a far greater import and urgency.  I think the Chinese central government’s  best way of avoiding a politically disastrous  domestic debt implosion is to get the Yuan to be used as a settlement currency for oil and not long after that to become a de facto rival to the dollar as the world’s reserve currency.

Recently I argued at length with a military analyst who disagreed that China would risk such a break with America. Too dangerous he felt. China, he pointed out has such huge holdings of American debt. He argued that the Chinese would prefer to work alongside the dollar.  I feel that even if the Chinese would prefer to ‘work alongside’ the dollar, this  will prove very difficult if not impossible. Once a flow of countries and trade moves away from the dollar there will be a momentum the Chinese will not be in control of.  Cooperation between dollar and Yuan as clearing and reserve currency, especially for oil, will be like trying to dock two super-tankers in a high sea.  In theory possible. In practice – not going to work.

As for Chinese holdings of US debt – I think the advantages of avoiding a domestic debt implosion and projecting the Yuan to world centre stage, will outweigh the losses. I also think, If I were the Chinese, I would imagine a scenario where the dollar does begin to look vulnerable. Its value begins to be questioned, nations holding dollars and dollar debt will feel America’s profligate indebtedness is a global danger. They will blame America. How wonderful then, for China to arrive and say to a worried world, on the edge of a huge crisis, “Fear not, we have thought ahead and can offer you the use of a new currency – one backed by GOLD not paper debts. We are here to save you. To offer a ride on a sound ship as an alternative to the rotten and leaking ship you have been riding on.”  China will be able to position their rise not as an aggressive act, not as trying to destabilise the world, but as trying to save it, from the collapse of an internally divided, corrupt, aggressive and indebted America.

America’s decline will be both financial and political. Financial due to the recalibration of what the world thinks of America’s debt load, and therefore their confidence in and need for the dollar. Political, because America has got used to being able to enforce its foreign policy through sanctions and embargoes. But once oil and other goods and the nations trading in them, no longer need the dollar for their trade, and do not have to use US clearing or custodial banks, then this power evaporates.

Try to imagine the shift in power when Wall Street’s banks are no longer guaranteed top position as the world’s custodial banks and Manhattan’s Southern District Court (Wall Street’s court)  is no longer in a position to dictate to whole nations via decisions upon Wall Street Custodial banks, what debts those nations and their custodial banks must pay and to whom.  The whole edifice of Bilateral Investment Treaties and the trade agreements they sit inside, depends for enforcement upon the US banks being the custodial banks and the Southern District court’s rulings being able to tell those banks what they must do.  Take that power away, which will happen if the dollar is no longer pre-emininent, and America will no longer be able to enforce its foreign policy or world view via economic sanction.

I think the main US banks will be positioning themselves to try to bridge this decline by having a major presence in Hong Kong. They are all already there but will be working to be part of the new Yuan-world of trade and clearing.

Of course this is speculation. But it seems to me the underlying evidence of the previous decade makes it worth thinking about.

If I am in any way correct then I think other things follow.

 I think the House of Saud knows it’s future is in question. I have written a lot about how I see Qatar rising to rival Saudi. Qatar not Saudi has the Yuan clearing house.  Saudi is late to the party.  Can Saudi risk being seen to move away from its traditional ally, America?  If it does, too quickly, and signs yuan trade deals it risks falling as soon as Americal turns its back.  If it doesn’t move quickly enough it risks being completely eclipsed by Qatar,  having to go to Qatar cap in hand to trade its oil with Russia and China.

I see the political changes within the House of Saud as signs of the internal struggles to decide which way to go.  I personally think the House of Saud will fall.

I also think the position of Israel under its present leadership is also very fragile.  Israel needs Saudi.  While they may seem to be on opposite sides, in many ways they are on the same side.  If the House of Saud falls or changes allegiances from America to Russia/China then Israel will become even more isolated than it is.  And of course if America is eclipsed and does enter a period of decline, then Israel will go with it.

If any of the above is near the mark, will it mean the end of America? Of course not. American’s will still work and sleep and raise their children like everyone else.  But the pre-eminence of the dollar and American finance will decline as the stock of dollar denominated bonds and debt agreements expires, and with it the power and wealth of many of America’s elite. How that decline will sit alongside America’s still overwhelming military power I don’t know.

Of course what I have suggested above is merely speculation but  personally I think another debt crisis will happen, because never ending QE and Central Bank debt buying cannot go one for ever, and what China does in the next few months could very well destabilise the whole unstable system.   Many people will suffer and lives will be blighted. But I wonder if, when we all look back from a decade or a generation after, if we won’t think it lucky the crisis did finally come and the system we have been slaving under since 2007 as well as those who have forced it upon us for their own enrichment, were called to account.

It is difficult to accept that such historic changes could occur.  But history has not ended despite what some have claimed.

Rumours of History’s end have been, in my opinion, greatly exaggerated. History is very much alive and happening to us, now. We are, as the Chinese saying goes, living in interesting times.

Neck and Neck: Russian and Chinese Official Gold Reserves

Submitted by Ronan Manly, BullionStar.com

Official gold reserve updates from the Russian and Chinese central banks are probably one of the more closely watched metrics in the gold world. After the US, Germany, Italy and France, the sovereign gold holdings of China and Russia are the world’s 5th and 6th largest. And with the gold reserves ‘official figures’ of the US, Germany, Italy and France being essentially static, the only numbers worth watching are those of China and Russia.

The Russian Federation’s central bank, the Bank of Russia, releases data on its official gold holdings in the Bank’s monthly “International Reserves and Foreign Currency Liquidity” report which is published towards the end of the third week of each month, and which confirms gold reserve changes as of the previous month-end.

The Chinese State releases data on its official gold holdings via a monthly “Official Reserve Assets” report published by the State Administration of Foreign Reserves (SAFE) that is uploaded within the Forex Reserves pages of the SAFE website. This gold is classified as held by the Chinese central bank, the People’s Bank of China (PBoC). The SAFE report is published during the 2nd week of each month, reporting on the previous month-end.

In both reports, official gold reserves (i.e. monetary gold) are specified in both US Dollars and fine troy ounces. Monetary gold is gold that is held by a central bank or other monetary authority as a reserve asset on a central bank’s balance sheet.

Delta: 63 Tonnes

For the Bank of Russia, its latest report, published on 19 September 2017 addressing August month-end, shows the Bank holding 57.2 million fine troy ounces of gold (1779 tonnes). For the Chinese State, the latest SAFE release is reporting Chinese official gold reserves of 59.24 million ounces (1842 tonnes).

Russian gold reserves, as officially reported, now total 1779 tonnes, and are now just 63 tonnes shy of the ‘official’ gold reserves of the Chinese central bank. Given that the Bank of Russia is expected to add about another 36 tonnes of gold to its official reserves during the remainder of 2017,  then if the Chinese State does not reveal any increase in its ‘official’ gold reserves between now and the first quarter of 2018, Russia will most likely surpass China in terms of official gold reserves by April 2018.

While its possible and probable that the Chinese State / PBoC really holds more gold than it claims to hold, any upcoming scenario in which the Bank of Russia surpasses the People’s Bank of China in terms of gold holdings would at least be symbolic in terms of international monetary developments, and would be sure to generate some chatter in the financial press.

Although the official gold reserves of these two key nations are now nearly neck and neck, there are still some interesting contrasts between them, not least the way in which the Bank of Russia’s reported gold holdings have been steadily increasing month on month, while the reported gold holdings of the People’s Bank of China have remained totally unchanged for nearly a year now, since the end of October 2016.

Therefore the situation which is now emerging, i.e. the distinct possibility that Russian official gold reserves will surpass those of China something in early 2018, is a situation which is emerging precisely because the Russian Federation keeps adding to its gold reserves, while the Chinese State seemingly does not.

Differing Styles of Communication

The routes via which these two strategically important nations have amassed their official gold reserves are also quite different, at least at a public reporting level.

Bank of Russia Gold Reserves: 2006 – September 2017, Source:www.GoldChartsRUs.com

It wasn’t so long ago (2007) that the gold reserves of the Russian Federation were still in the region of 400 tonnes. However, beginning in about the third quarter of 2007, the Bank of Russia began a concerted campaign to rapidly expand its official gold holdings, a trend which never subsided and which has been ongoing now for exactly 10 years. By early 2011, official Russian gold reserves had exceeded 800 tonnes. By the end of 2014, the Bank of Russia was reporting holding more than 1200 tonnes of gold. And by the end of 2016, Russian official gold were more than 1600 tonnes. For full details on the Bank of Russia’s gold holdings, including gold storage, gold reserve management, gold purchases and Russian government views on gold, see “Bank of Russia, Central Bank Gold Policies” at BullionStar’s Gold University.

From the above chart, it can be seen that during 2014, 2015 and 2016, respectively, the Bank of Russia added 171 tonnes, 208 tonnes, and 199 tonnes to its gold reserves, or in total 578 tonnes over a 3 year period. In 2017, with the Bank of Russia having added another 164 tonnes of gold for the year to end of August, its official gold reserves now stand at 1779 tonnes.

The route to the Chinese State accumulating 1842 tonnes of gold is a different one to that of the Russians, again at least from a publicly reported angle. While the Bank of Russia has historically published changes to its gold reserves on a monthly basis, the Chinese central bank has chosen to remain very secretive, and between 2001 and mid 2015 had only issued four public updates addressing the size and growth of its gold reserves. These 4 updates were as follows:

• 4th Quarter 2001: From 394 to 500 tonnes: A 106 tonne increase


• 4th Quarter 2002: From 500 to 600 tonnes: A 100 tonne increase


• April 2009: From 600 to 1,054 tonnes: A 454 tonne increase


• July 2015: From 1,054 to 1,658 tonnes: A 604 tonne increase

Beginning in July 2015, however, the Chinese State started to report changes in its official gold reserves on a monthly basis, and by July 2016 was reporting 1823 tonnes of official gold holdings. The following graphic, taken from a BullionStar infographic on the Chinese gold market, illustrates the sporadic reporting of Chinese official gold reserves between the early 2000s and July 2015. Note that between July 2016 and October 2016, the Chinese State through SAFE reported that the PBoC had acquired another 19 tonnes of gold, taking its total reported gold reserves to 1942 tonnes as of the end of October 2016.

Chinese Official Gold Reserves, 2003 – 2016 Source: Chinese Gold Market Infographic, BullionStar

The sparse official reporting by the Chinese is also clear in the below chart from the GoldChartsRUS website, which shows cumulative holdings of monetary gold by the People’s Bank of China (PBoC) between 2000 and 2017. Looking at the top panel of the chart, it can be seen that between 2001 and 2015, there were only 4 distinct jumps in the quantity of gold held by the PBoC.

This was followed by a period of about 15 months from July 2015 during which SAFE reported small monthly accumulations in PBoC’s gold holdings, as can be seen from the gradual increases in the bars in the top panel from July 2015 to October 2016, and the corresponding presence of frequent activity in the monthly changes in the lower panel of the chart.

Official Gold Reserves of the Chinese central bank: Divulged Holdings 2000 – 2017. Source:www.GoldChartsRUs.com

By September 2016, Chinese State gold reserve holdings had reached 59.11 million ounces. In October 2016, the SAFE report announced that Chinese official gold holdings had reached 59.24 million ounces, a 0.13 million ounce increase from the previous month. However, then something unusual happened, at least in terms of monthly updates. Since October 2016, Chinese official gold reserves have not changed at all. The SAFE updates are still published each month, but the gold holdings figure has remained unchanged at 59.24 million ounces (1842 tonnes).

Therefore, for nearly a year now, the Chinese authorities are signalling that they have not acquired any new gold. At least that is what they want the public to believe. Hence the constantly recurring headlines from the financial media, such as this one from Reuters a couple of weeks ago, “China gold reserves steady at 59.24 mln ounces at end-September – central bank”.

But is it true that China only holds 1842 tonnes of gold and that it has not been active during the last year in continuing to accumulate monetary gold as part of its reserve assets? And for that matter, is it the case that the Bank of Russia and Russian Federation only hold 1779 tonnes of monetary gold?

While its difficult to know for sure, it is possible that the People’s Republic of China and the Russian Federation both hold additional gold that is not reported by their monetary authorities. This is so for multiple reasons, including the opaque ways in which these monetary gold reserves are accumulated, the traditional secrecy of both governments, and the fact that both countries have access to other investment pools that might hold gold that can be transferred at short notice into the respective central banks’ official gold holdings.

How Much Gold could the Chinese State really have?

The historical track record of the Chinese State in sporadically communicating the size of its monetary gold holdings shows that there has often been a large gulf between the true size of its gold reserves and what the Chinese claimed to have via its piecemeal and rare updates. For example, even based on its official numbers, the PBoC accumulated over 600 tonnes of gold between April 2009 and July 2015 but did not reveal this until July 2015.

The nearly year-long hiatus between October 2016 and the present, during which the Chinese authorities, via SAFE, claim that the PBoC’s gold holdings have remained at 1842 tonnes, could be true, but only in so far as the Chinese State does not wish to inform the world about its sovereign gold reserves. Beyond this, the true gold holdings of the Chinese central bank may be significantly higher than even official published figures suggest.

There is very little transparency into how the Chinese authorities accumulate monetary gold. In July 2015, when SAFE announced the first update to its gold holdings since 2009, it stated that the “major channels of accumulation” of gold were from purchases in foreign markets, domestic gold production, domestic scrap sources, and other transacting in the domestic market. But beyond this, the Chinese authorities never comment on where they source gold from.

There is lots of evidence that the Chinese State purchases significant quantities of gold in the international market, including in the London Gold Market, and then monetises this gold (i.e. classifies it as monetary gold) , before transporting it back to Beijing. See “PBoC Gold Purchases: Secretive Accumulation on the International Market”, at BullionStar Gold University for further details.

The Chinese State is also a possible candidate for having purchased a tranche of the IMF’s gold during IMF gold sales in 2010. See BullionStar blog  “IMF Gold Sales – Where ‘Transparency’ means ‘Secrecy’” for further details.

There are also plenty of other State entities and state controlled entities in addition to the Chinese central bank that could conceivably be holding gold reserves that could in time be reclassified as PBoC gold, and brought into the sphere of reporting. See section “Gold Transfers from other Chinese State entities” in BullionStar Gold University article “Gold Policies of the People’s Bank of China” for further details.

There is also evidence to suggest the Chinese State is really buying about 500 tonnes of gold per year, and that it has a first step target of holding at least 4000 tonnes of gold. This evidence, which is from 3-5 years ago, comes from senior people in the China Gold Association (CGA). See section “How much gold might the PBoC be buying each year?” in article PBoC Gold Purchases.

A gold reserves-to-FX reserves ratio of 5% would currently put Chinese state gold holdings at nearly 4000 tonnes. A gold-to-GDP ratio of about 1.77%, which is the equivalent of the gold-to-GDP ratio of the US, would currently put Chinese state gold holdings at nearly 5000 tonnes of gold.

Russia: Golden Pipelines and Stockpiles

In its “Methodological Notes to International Reserves of the Russian Federation“, the  Bank of Russia defines “monetary gold”  as:

“standard gold bars and coins with a purity of at least 995/1,000 held by the Bank of Russia and the Government of the Russian Federation. It comprises gold in vault, en route and in allocated accounts, including that which is held abroad. The item monetary gold includes unallocated gold accounts with non-residents.”

The primary source of gold flowing to the Bank of Russia comes from Russian gold mining production, with the Russian Federation acquiring a large percentage of domestic gold mining production each year. In practice, a small group of state influenced Russian banks are authorised to intermediate between the gold mining companies and the State, acting as a gold pipeline between the mines and the Bank of Russia / Government. These banks finance the mining companies, purchase their gold output , have it refined into gold bars by Russian gold refineries, and then offer this gold to the Russian State.

Some of these banks include Sberbank, VTB, Gazprombank and Otkritie. For details see section “Russian Banks as bulk buyers of Russian Gold” in the Russian gold market article in BullionStar’s Gold University.

But its possible that some of this gold ends up not with the Bank of Russia, but with other Russian State entities, one of which is the “Gosfund” or “Precious Metals and Gems fund” operated by “The Gokhran”.

This Gosfund could be buying a portion of Russian gold mining output, stockpiling it, and intermittently releasing some of its stockpile to the Bank of Russia. When I asked the Gokhran last year could it reveal its gold holdings, the Gokhran replied to me that “it does not publish information about the amount of gold reserves in the Russian Gosfund nor any data about its precious metal operations.” See letter reply from Gokhran below (for those who can read Russian):

Gokhran reply January 2016 to query on whether it could publish its Gold Holdings.

Conclusion

Given the high degree of opacity with which both the Russian State and Chinese State accumulate monetary gold, and the fact that they both can probably tap additional gold stockpiles to boost their official gold reserves, it will be interesting to see whether China, through SAFE, announces any increase in the PBoC’s gold holdings between now and the end of Q1 2018.

Because if China does not do so, the Russian Federation will soon have the distinction of being the world’s 5th largest gold holder, pushing China into 6th place. Will China update its gold holdings before the end of 2017, or at least by early 2018? Nothing is certain, but with an ‘official’ difference of only 63 tonnes of gold between them, the race is on.

This article first appeared under the same title, "Neck and Neck: Russian and Chinese Official Gold Reserves" on the BullionStar.com website.

"Dear President Trump: America Is In For A Rude Awakening In January"

Authored by James Rickards via DailyReckoning.com,

Dear President Trump,

Over the last couple of years I’ve been all over TV… from Fox News to CNBC, CNN and Bloomberg. I’ve been telling our fellow Americans that the financial global elite was planning to issue their own globalist currency called special drawing rights, or SDRs.

And that those elites would use this new currency to replace the U.S. dollar as the global reserve currency.

I’ve even written about this extensively in my best-selling booksThe Road to Ruin and The New Case for Gold.

I’m sure some people in the mainstream media thought I was out of line — but the United Nations and the International Monetary Fund (IMF) have both confirmed this plan to replace the U.S. dollar is real. I’ve made this warning many times, but it seems to be falling on deaf ears. That’s why I’m writing directly to you.

Here’s the proof that the U.S. dollar is under attack, right in front of our eyes:

The UN said we need “a new global reserve system… that no longer relies on the United States dollar as the single major reserve currency.”

And the IMF admitted they want to make “the special drawing right (SDR) the principal reserve asset in the [International Monetary System].”

More recently, the IMF advanced their plan by helping private institutions, such as the UK’s Standard Chartered Bank, issue bonds in SDRs.

Although our mainstream media ignored this major event, the UK media reported:

This is all happening. And on January 1st, 2018, this trend to replace the U.S. dollar will accelerate. That’s when the global elite will implement a major change to the plumbing of our financial system.

It’s a brand-new worldwide banking system called Distributed Ledger Technology. And it will have a huge impact on seniors who are now preparing for retirement.

When this system goes live, many nations will be able to dump the U.S. dollar for SDRs.

For now, the U.S. dollar is still the world’s reserve currency. Other nations have to hold and use the U.S. dollar for international trade, instead of their own currencies.

This creates a virtually unlimited demand for U.S. dollars, which allows us to print trillions of dollars each year to pay for wars, debt and anything we want. It keeps our country operating.

Now, we can see that the global elites are working to unseat the U.S. dollar as the global reserve currency.

Here are the three key pieces of information that prove this will happen.

Fact #1 — The IMF issues a globalist currency called special drawing rights, or SDRs.

Fact #2 — The IMF has confirmed they want to replace the U.S. dollar with SDRs.

Fact #3 — The IMF has confirmed Distributed Ledgers can be used for “currency substitution”… and they’ve even set up a special task force to speed up implementation.

The IMF is using this technology to create an SDR payment system, because that’s the currency they issue.

As you know, Christine Lagarde, head of the IMF, is the woman in the middle.

When asked about the task force, she said:

“As I see it, all this amounts to a brave new world for the financial sector.”

Yes, a brave new world where the dollar is no longer the world reserve currency.

Barbara C. Matthews, a former US Treasury Department attaché to the European Union, has reached the same conclusion.

She said the link between the globalists’ currency and Distributed Ledgers “is impossible to avoid.”

And that “the IMF seems to be exploring the possibility of permitting a broader use of [their globalist currency] beyond internal transactions among member central banks.”

Make no mistake, if the IMF is planning to use Distributed Ledgers to replace the U.S. dollar with SDRs. And just to be clear, when SDRs take over, the American people will be left with devalued dollars.

Once other nations start accumulating the globalist currency through Distributed Ledgers, they will no longer need to hold dollars. Once Distributed Ledgers go live, other nations will no longer need to buy Treasury bonds.

And that means our government — your government — will no longer be able to finance its normal operations, including welfare programs like Social Security. For those who have their retirement account parked in stocks, they could watch it evaporate in a matter of days. The weakest companies in the stock market could collapse once this plan goes live.

Just look what happened the last time we had a big change in our global financial system. In 1971, Nixon announced the U.S. would no longer officially trade dollars for gold. That created a lot of uncertainties, turning that decade into a nightmare for stock investors.

Take a look… the Dow Jones, an index of “stable” blue chip stocks (the kind most retirees like to hold), was cut in half. Stock investors bailed out of the market and, for the most part, didn’t come back for a decade.

I expect something similar once Distributed Ledgers go live.

The transition from a U.S. dollar system to a new system dominated by SDRs will be messy. Stocks will collapse… and will stay down. There will be no recovery this time, because the U.S. government won’t be able to come to the rescue like they did in 2008.

You won’t even have funding for normal operations, let alone enough funds to save stock investors.

I know that governments have been patiently watching Distributed Ledger (often referred to as blockchain) technology develop and grow outside their control for the past eight years. Libertarian supporters of Distributed Ledgers celebrate this lack of government control.

Yet, their celebration is premature, and their belief in the sustainability of powerful systems outside government control is naïve. Governments don’t like competition especially when it comes to money.

You probably know that you, or any government, cannot stop Distributed Ledger technology — in fact you probably don’t want to. Governments and monetary elites want to control it using powers of regulation, taxation, and investigation.

An elite U.S. legal institution called the Uniform Law Commission, which proposes model laws intended for adoption in all fifty states, has released its latest proposal called the “Uniform Regulation of Virtual Currency Businesses Act.”

This new law will not only provide a regulatory scheme for state regulators, but will also be a platform for litigation by private plaintiffs and class action lawyers seeking recourse against real or imagined abuses by digital coin exchanges and facilities.

We know the U.S. government will want to use this technology for its benefit. One step toward government control just occurred a few weeks ago.

On August 1, 2017, the SEC announced “Guidance on Regulation of Initial Coin Offerings,” the first step toward requiring fundraising through Distributed Ledger, or blockchain-based tokens to register with the government.

But consider the following additional developments:

• On August 1, 2017, the World Economic Forum, host body to the Davos conference of global super-elites, published a paper entitled “Four reasons to question the hype around blockchain.”


• On August 7, 2017, China announced they will begin using Distributed Ledger technology to collect taxes and issue “electronic invoices” to citizens there.

Perhaps most portentously, the International Monetary Fund (IMF) has weighed in.

In a special report dated June 2017, the IMF had this to say about Distributed Ledgers: The IMF favors control by a “pre-selected group of participants” or “one organization,” rather than allowing “anyone” to participate.

This paper should be viewed as the first step in the IMF’s plan to migrate its existing form of world money, the SDR, onto a DLT platform controlled by the IMF.

They’re telling you exactly what their plan is. It would be foolish to ignore them, or assume the U.S. dollar will remain the global reserve currency much longer once this plan is implemented, as early as January 1, 2018.

You know the global elites’ aren’t your biggest fan. You know the U.S. dollar has been under attack.

This is the global financial elites’ plan to remove the U.S. dollar from its position of power and to attack your administration all at once.

Who do you think American’s will blame when the stock market crashes, or Social Security runs out? We can hear the talking heads already.

Best,

 

China Capitulation: Corriente Advisors' Mark Hart Ends 7-Year Bet On A "Massive Yuan Devaluation"

China bears like Kyle Bass claimed victory last year after bets that the Chinese yuan would weaken paid off handsomely – particularly if they were supercharged by leverage. Hopefully, for their sake, yuan decided to lock in those gains early this year. Because since January, China’s currency has whipsawed higher, reversing most of its 2016 depreciation as the US dollar has endured a period of broad weakness, and Chinese policy makers have turned their attention to managing the currency’s valuation against a basket of currencies.

But Mark Hart, who, like Bass is a Texas-based fund manager, and who built his bear case against China on the theory that the PBOC would opt for a series of one-off devaluations in the yuan, instead of allowing it to gradually depreciate, which would be tantamount to a policy error.

Here’s more from a post on Hart’s outlook that we published last year:

“Hart believes that the Chinese crawling devaluation is an error as it carries with its the latent threat of much more devaluation in the future, thus encouraging even more outflows, which in turn forces China to sell even more reserves, which destabilizes the economy even further, forcing even more devaluation and so on.

Instead, a one-off devaluation would allow policy makers to “draw a line in the sand” at a more appropriate level for the yuan, easing pressure on China’s foreign-exchange reserves and removing an incentive for capital outflows, according to Hart, who’s been betting against the currency since at least 2011. He adds that China should devalue before its $3.3 trillion hoard of reserves shrinks much further, he said, because the country can still convince markets it’s acting from a position of strength.”

According to Hart, while a devaluation this year would be “jarring” and may initially accelerate capital outflows, it would ultimately put China in a stronger position. He said the country could explain the move by saying it would put the yuan at a level more reflective of market forces and allow the currency to catch up with declines in international peers.

However, the 50% devaluation that Hart had been anticipating never materialized. So, after seven years, Bloomberg is reporting that Hart has (pun intended ) had a change of heart after spending $240 million on his losing bet against the currency, which nearly cost him his sanity.

Hart is now taking the other side of the trade, joining the ranks of Bridgewater Capital’s Ray Dalio and other yuan bulls:

“Mark Hart spent seven years and $240 million waiting on a crash in China’s currency.

He lost sleep. He lost clients. He damn near lost his sanity.

And now he’s lost his conviction: Hart, who called for a more than 50 percent yuan devaluation last year, has turned bullish on China and its currency.”

According to Bloomberg, Hart’s dedication to his short-yuan position left employees demoralized at his Fort Worth, Texas fund. Hart claims that his investing thesis was sound. His biggest mistake? Hart says he was “too early” in putting on the trade.

“His reversal hasn’t come easily. From his base in Fort Worth, Texas, the hedge fund manager spent countless nights on the line to Hong Kong, parsing market news and exchange rates. At times, the stress took a toll on Hart personally and left his employees demoralized.

‘I always thought we had a good risk-reward trade on, but we made a number of mistakes, including being way too early,’ Hart, who started the yuan bet after predicting both the U.S. subprime mortgage bust and the European debt crisis, said in a telephone interview. ‘And now the world has changed.’”

Hart now believes that G-20 leaders tacitly conspired to a “Plaza Accord”-type agreement to stanch the dollar’s appreciation while putting a floor under the yuan last February during a G-20 summit in Shanghai.

“In cool hindsight, the 45-year-old founder of Corriente Advisors sees last year’s Group of 20 summit in Shanghai as a key turning point. Like many investors, Hart suspects the meeting resulted in a tacit agreement among world leaders to prevent the yuan from tumbling. He calls it China’s “whatever it takes” moment - when policy makers resolved to prop up the currency at any cost.”

The agreement has tremendously benefited China, Hart says.

“‘China now has the breathing room it needs to either temporarily stave off a slowdown with fiscal and monetary stimulus, or reform, grow and upgrade itself into the world’s largest developed economy,’ Hart said.”

Regardless of whether Hart’s “conspiracy theory” is accurate, China has clearly succeeded in stabilizing the exchange rate. The yuan ended a three-year slide in late December and has rallied almost 7 percent in 2017. China’s central bank strengthens its daily reference rate for onshore yuan for a ninth day on Thursday, the longest run of increases since January 2011. The PBOC raised the yuan reference rate by 0.06% to 6.5269 per dollar, extending the strengthening streak since Aug. 28 to 2%. Meanwhile, the offshore yuan surged, sending the USDCNH below 6.50 for the first time since May 3, 2016.

Even at its weakest point, the yuan never weakened enough for the options that Hart originally purchased in 2009 to pay off. His dedicated China funds, which had fixed lifespans, bought options that were designed to deliver one of two outcomes. According to Bloomberg, a massive payoff in the event of a currency crash, or a near total wipeout if a major devaluation failed to occur.

Revisiting Saudi Arabia

By Chris at www.CapitalistExploits.at

In May of last year I was attempting to figure out if there was an asymmetric play to be had in the land of sand and black gloop. There were a lot of moving pieces to deal with. I think it"s worth revisiting but first it"s worth reviewing what I thought just over a year ago. Much has subsequently happened so we can piece a little bit more together now.

A few years ago, when living in Phuket, Thailand, a group of Saudis stayed for a week’s holiday in a neighboring villa.

Outside of the religious and social confines of the land of black gold and endless sand, this group made a bunch of spoiled 5-year olds left to run amok in a candy shop without adult supervision look positively angelic.

They were very visible, with an entourage of young Thai “ladies” and a fleet of Land Cruisers to haul them about. On one occasion, after my son witnessed one of the guys buying a beer and throwing a US$100 bill at the waiter, telling him to keep the change, he asked me how come they had so much money to waste.

I explained that Saudi Arabia has two things in abundance: sand and oil. And though the world doesn’t need sand as much as it does oil, they have grown very wealthy selling the oil to the rest of the world.

Depending on whose numbers you take, somewhere between 75% and 85% of Saudi Arabia’s revenues come from oil exports, and fully 90% of revenues come from oil and gas. Clearly the Kingdom is dependent on oil revenues in the same way that an infant is dependent on its mother’s milk. And unless you’ve been living under a rock for the last few years, you’ll have noticed that the price of oil has collapsed.

Now, in a “normal” market the reduced revenues would manifest in a weaker local currency as demand for Riyals declines.

But governments and central bankers don’t believe in “normal” markets and so the Saudi riyal has been pegged at 3.75 to the US dollar since 1986.

It’s not hard to see a situation where Saudi Arabia may very well be forced to de-peg the currency to curb the fall in the country’s FX reserves should low oil prices persist.

Let’s look at some of the potential catalysts for this.

Could Yellen Kill The Peg?

While the Sheiks contemplate how to deal with their predicament from diamond encrusted cars and golden toilets, across the pond we find that monetary policy in the US has been tightening albeit modestly. What’s important to understand is that in order for Saudi Arabia to maintain its currency peg it needs to follow FED monetary policy.

By following Yellen the Saudis land up sacrificing growth, and by diverging they sacrifice FX reserves in order to maintain the peg. Clearly neither are attractive propositions. According to the Saudi Arabian Monetary Agency (SAMA), for every 100 basis point increase in the Saudi Interbank Offered Rate (SIBOR) this leads to a 90 basis point decline in GDP in the subsequent quarter, and a further 95 basis points in the following quarter.

Falling GDP in a country where over 60% of the population are under 30 brings about its own set of problems. Political instability in the Kingdom has been rising and the royal family is increasingly fighting for survival. After all, they had the experience of watching the Arab Spring unfold on their flat screens.

If, on the other hand, they opt not to follow the stumpy lady, the gap between interest rates in the US and Saudi Arabia will be quickly exploited by people like me as arbitrage opportunities open up.

So this is what we’re all looking at right now: SAMA will have to buy riyals in the open market by selling from its hoard of dollar reserves. Any rise in interest rates in the US will mean SAMA will have to further deplete reserves.

As I have mentioned before, all pegs eventually break. The question is one of timing.

How long do the Sheiks have under current oil prices?

The falling oil price since mid-2014, has significantly reduced Saudi Arabian revenues. So much so that the scorecard for 2015 showed a deficit of $98bn, and SAMA is estimating a further $87bn deficit this year.

The Saudi government have been funding this deficit by drawing down on forex reserves, spending $132bn in the year to January of this year. With current prices and current reserves they can easily last another 4 years.

Some things I’m thinking about:

• Iran will bring additional supply to a market in surplus. Saudi Arabia will be forced to keep the pedal to the metal on production, not wanting to lose any market share. And so I’m not convinced we’ll see oil rising in the next 12 to 24 months.


• Internal domestic political pressures can be "addressed" with creating an external pressure or conflict. It wouldn"t be the first time.


• We’re in a US dollar bull market as I’ve stated here,here, and here and many other times. Dollar strength will put pressure on the price of oil and thus revenues to the Kingdom.

This could certainly get interesting and traders have begun speculating on a de-pegging from the dollar.

Should low oil prices persist for the next 3 to 4 years, Saudi Arabia will be forced to decide whether it prefers to either cut the production or loosen the currency peg.

I could be wrong but I feel like it’s too early to play this trade and the costs of entry are not astoundingly cheap. Saudi Arabia has almost no debt and can easily access the credit markets. With debt to GDP of just 2% they have a lot of room to move. Coupled with the upcoming partial listing of Aramco their ability to tap international markets for capital is certainly a factor I’m not sure all currency speculators are considering.

What is worth watching are neighbour states. While Kuwait, Qatar, and the UAE all have dollar pegs, they too have vast central bank reserves and sovereign wealth funds. But what looks pretty precarious to me are Oman and Bahrain who could run out of reserves in less than three years. Both these countries have resorted to issuing debt to extend the longevity of their reserves but issuing dollar denominated debt which is essentially asset underwritten by the price of oil in an environment of persistently low oil prices certainly looks like a precarious bet to be making.

Investors looking for asymmetry in markets will do well paying attention to the currency markets, and existing dollar pegged currencies in particular. As I mentioned before… all pegs break, and the returns that can be made in such situations are of the life changing variety.

– Chris

“If Saudi Arabia was without the cloak of American protection, I don’t think it would be around.” – Donald Trump

Ok, so that was over 12 months ago. Fast forward to today and we have some of the answers... and we"re a little further down the road.

Oil

Still looks like isht. The supply and demand setup hasn"t gotten any better, and this is not what the house of Saud wants. Nothing shocking to what we expected anyway.

Rates

The tubby lady at the FED has gone ahead with a divergent policy (raising rates). As you can see, I discussed in that article what effect the raising of rates could (or would have) on the finances in Saudi Arabia. Again, nothing we never expected.

Conflict

I penned an article on Qatar here. I do think the spat with Qatar has less to do with them than it has to do with Iran and with the Saudi"s domestic problems - both financial and political. In the article above, I mentioned some stupid conflict but wouldn"t have put it up there as a probability over 50%. And yet now it"s happening in real time. Does it subside, does it blow up, or something else?

The question I think we need to ask ourselves today is this: now that the conditions have been met that do nothing to assist the Saudis with their finances (and at the same time they"ve chosen a path of "external" enemy) where does that leave us with original idea of looking for an asymmetric payoff on the riyal having to de-peg their currency?

I"m watching the dollar index very, very closely. If we break higher, then the Saudis will have a very, very serious problem on their hands as their balance sheet blows out. This could get interesting... and profitable.

- Chris

"Rockefeller once explained the secret of success. Get up early, work late - and strike oil." — Joey Adams

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Is This The Scariest Chart For Central Banks?

Reminding us of what McKinsey reported over a year ago, namely that the world never deleveraged after the financial crisis, Citi"s Hans Lorenzen released a fascinating presentation today discussing the "invincible" stock rally, and pointing out its Achilles heel, which happens to be the thing that made it possible in the first place: central banks.

As the first charts below show, the permissive factor that allowed the world to "emerge" from the financial crisis and the global recession, was a surge in debt, which on a consolidated basis is above 360% of GDP in all five select developed regions. The chart on the right shows that while private sector releveraging has been slow, it has been drowned out by a historic surge in public sector debt.

What made this coordinated global releveraging possible? Central banks of course, who have bought over $10 trillion in public (and recently private) sector debt in the past decade, and between the world"s six largest central banks they now collectively own securities amounting to 40% of the world"s GDP.

However, it is this same unprecedented central bank balance sheet expansion that is now the biggest threat to not only the global recovery and ongoing attempts to stimulate the much needed reflation (if only to inflate away the world"s debt load), but also to capital markets around the globe.

Which bring us to what may be the scariest chart for central bankers: Citi"s forecast of what happens to the global central bank "impulse", or annual change, over the next two years and - as Lorenzen shows - its correlation to inflation expectations via real 5Y5Y forwards. The chart cleary shows the recent contraction in global central bank assets (including Chinese FX reserves) which took place as deflation fears swept the globe and as global stocks tumbled in late 2015 and early 2016. More importantly, the chart projects when the next such contraction is expected to take place...

The chart also shows that when it comes to the S&P, the Fed"s
balance sheet is all that mattered for years until recently both the BOJ and ECB
picked up the torch and spread the "liquidity load" making the recent all time highs in the market possible, even as
the Fed"s balance sheet has been flat and the Fed has been cautiously tightening.

As Citi puts its best: "the principal transmission channel to the real economy has been... lifting asset prices." That however has required continuous CB balance sheet growth, and with the Fed, ECB and BOJ all poised to "renormalize" over the next year, the global monetary impulse is set to turn negative in the coming year.

Meanwhile, as financial markets scramble to maximize every last ounce of what central bank impulse remains, we get such bubbles as London real estate, bitcoin and vintage cars, or as Citi puts it: "the wealth effect is stretching farther and farther afield."

One final chart: how does it all end, and what is the "key risk" to financial stability? Here, unlike the ECB, Citi"s opinion is just a little different, and echose what we have said since the beginning:

"Monetary policy has left the allocation into risky assets stretched at very high prices in a modest recovery with major structural issues still unresolved. The efficacy of existing policy tools in the future seems greatly diminished."

Citi"s conclusion: the "Achilles heel is the potential unravelling of distortions built up by monetary policy itself." It hardly needs an explanation.

Qatar Is Running Out Of Dollars

While the Saudi-led campaign to starve Qatar"s citizens may end up short of the target, with both Turkey and Iran volunteering to provide needed staples to the isolated Gulf nation while local entrepreneurs have started a cow paradropping campaign to offset the decline in milk imports, a more pressing problem has emerged: Qatar"s financial system is running out of dollars. As Bloomberg reports, several Qatari banks have boosted interest rates on dollar deposits to shore up liquidity as the Saudi-led campaign to isolate the gas-rich Arab state intensifies.

To boost their hard currency reserves, Qatar banks are now offering a premium of as much as 100 basis points over LIBOR to attract dollars from regional banks, some 80 bps higher compared to the rate they offered prior to last week"s crisis. A similar picture is visible on the 3-Month QIBOR, or Qatar Interbank Rate, which has surged to 2.3% as of Tuesday.

According to the central bank, at the end of April, Qatar"s banks held 21.4% of their customer deposits in foreign currency. Non-resident deposits made up 24% of the overall deposits of 781 billion riyals ($213 billion). A separate estimate from SICO Bahrain, Qatari banks have around 60 billion riyals ($16.5 billion) in funding in the form of customer and interbank deposits from other Gulf states. Most of this could eventually be withdrawn if the crisis continues.

Adding to concerns of a monetary blockade, Bloomberg also reports that some banks in neighboring countries have been cutting their exposure to Qatar amid concerns of a widening of the blockade.

In a Tuesday report, Capital Economics" Jason Tuvey wrote that while banks are unlikely “to be thrust into a crisis,” borrowing costs “look set to rise and banks are likely to become more cautious with their lending,”  “If local banks struggle to rollover their external debts, they could be forced to shrink their balance sheets and tighten credit conditions." For now the local central bank has said that Qatar"s banking system is functioning without disruption, although market indicators suggest liquidity stress is rising. Likewise, Qatar National Bank, the biggest lender in the Middle East, said it didn’t see any “significant” rate increases since the standoff began, according to statement emailed to Bloomberg on Tuesday.

The good news for Qatar - the world"s wealthiest nation on a GDP/capita basis - is that it has enough financial firepower to withstand a prolonged financial siege, and defend its currency and economy, Finance Minister Ali Shareef Al Emadi told CNBC in an interview broadcast Monday. Al Emadi played down the impact of the crisis on the country, saying the plunge in Qatari assets last week was a “normal” reaction to the standoff.

While so far there has been no suggestion that Qatar would commence liquidating its reserves, investors have already begun selling Qatari assets and speculating against the riyal, concerned how long Qatar can weather the crisis without having to devalue its currency or sell any of its global holdings. Qatar’s 12-month riyal forwards closed at 588 basis points against the dollar on Monday, the highest level since at least 2001, according to data compiled by Bloomberg. Rates eased slightly to about 500 basis points on Tuesday.

Despite the spike in interbank rates, S&P is confident that Qatari banks are strong enough to survive the pullout of all Gulf money and then some. The ratings agency ran two hypothetical scenarios of capital flight, and concluded that Qatar’s lenders could survive the withdrawal of all Gulf deposits plus a quarter of the remaining foreign funds the banks keep. Still, that did not prevent S&P from lowering Qatar’s long-term rating by one level to AA- last week.

Separately, Reuters reports, that the dollar shortage has also spread over to money exchange houses in Qatar on Sunday, making it harder for worried foreign workers to send money home.  

"We have no dollars because there is no shipment or transportation from the United Arab Emirates. There is no stock," said a dealer at the Qatar-UAE Exchange House in Doha"s City Center mall. "The shipment is blocked from the UAE" the dealer added, although it was not quite clear if it was physical cash that was being transported.

Other exchange houses in Doha also told Reuters they had no supplies of dollars. At Qatar-UAE Exchange, dozens of people - some of the foreigners who comprise nearly 90 percent of the population of 2.6 million - waited quietly in line to change money or make remittances to their home countries.

"I spoke with my wife this morning. She said, "Send your savings to me now." I am not panicked but my family are scared," said John Vincent, an air-conditioning repairman from the Philippines.

"I sent 2,000 riyals ($550) home but I have some more savings left here in Qatar. I will see what the situation is in coming days before I decide what to do."

Sudhir Kumar Shetty, president of UAE Exchange, which has eight branches in Qatar, said his firm was continuing to handle remittances and currency buying as usual in that country. He said the firm hadn"t seen any major change in remittance volumes due to the diplomatic tension.

But he added that dollar supply was not meeting demand in Qatar and attributed this partly to flows of the U.S. currency from other Gulf countries being disrupted.

"Everywhere, all the banks and exchange houses, there are no dollars. All the exchange houses are trying to get currencies from other countries," the dealer at Qatar-UAE Exchange said, adding that his firm was hoping for a shipment from Hong Kong.

For now most Western banks with a presence in Qatar have continued business as normal, partly because they did not want to lose out on billions of dollars of building projects which Qatar plans before it hosts the soccer World Cup in 2022.  But other Western banks have halted new Qatar business including interbank and syndicated lending, while continuing to service existing business, banking sources said, declining to be named because of political sensitivities.

"Everybody is shocked - they"re not worried about Qatar"s credit, they"re worried about compliance and the risk that the local sanctions could be escalated to an international level," said one foreign banker in the region.

In a worst case scenario, bankers expect Qatari banks to borrow from the central bank"s repo facility if they become short of funds. However, central bank rules limit the size of the repos to 2% of each bank"s private sector deposits. Bankers speculate the central bank may lift this cap although the central bank did not respond to Reuters requests for comment.

World Money: Five Hidden Signals From The IMF

Authored by Craig Wilson via The Daily Reckoning blog,

Less than a month ago a handful of the world’s policy makers gathered in Washington at the International Monetary Fund (IMF), no surprising headlines were run - but an obscure meeting and a discreet report launched exclusive signals for the next global economic crisis.

The panel, which included five of the most elite global bankers, was held during the IMF’s spring meetings to discuss the special drawing rights (SDR) 50th anniversary.  On the surface the panel was a snoozefest, but reading beyond the jargon offers critical takeaways.

The discussion revealed what global central banks are planning for a future crisis and how the IMF is orchestrating policy for financial bubbles, currency shocks and institutional failures.

Why the urgency from the financial elites?

In theApril 2017 “Global Financial Stability Report,” IMF researchers targeted the U.S corporate debt market and how extreme changes in its equity market has left the global economy at risk. While the report may have been missed by major financial news outlets, it was enough to give major concern to those paying attention.The IMF research report noted:

“The [U.S.] corporate sector has tended to favor debt financing, with $7.8 trillion in debt and other liabilities added since 2010…”

In another segment the IMF report said:

“Corporate credit fundamentals have started to weaken, creating conditions that have historically preceded a credit cycle downturn. Asset quality—measured, for example, by the share of deals with weaker covenants—has deteriorated.”

“At the same time, a rising share of rating downgrades suggests rising credit risks in a number of industries, including energy and related firms in the context of oil price adjustments and also in capital goods and health care. Also consistent with this late stage in the credit cycle, corporate sector leverage has risen to elevated levels.”

This report  together with the panel discussion highlights a very concerning trend. Jim Rickards, a currency wars expert and macroeconomic specialist, has identified the special drawing rights (SDR) as a class of world money that is a tool used to bailout central banks during crisis.

World Money, The IMF and Signals for Economic Crisis

World money was praised for its ability to be a catalyst for international loans during the IMF spring panel discussion.

The panel discussion was moderated by Maurice Obstfeld, an established academic who serves as a Director of Research at the IMF. Obstfeld is connected, knows the right people, and can see the macroeconomic implications of SDRs.

In his opening remarks Obstfeld identified, “There has been increasing debate over the role of the SDR since the global financial crisis. We in the Fund have been looking more intensively at the issue over whether an enhanced role for the SDR could improve the functioning of the international monetary system.”

“The official SDR is something we are familiar with but is there a role for the SDR in the market or a market SDR? What is the SDR’s role for the unit of account?”

Here’s the five most important signals from the world money panel, what they could mean for the international monetary system and the future of the dollar.

1. China Spars for the SDR Market

Yi Gang, the Deputy Governor of the People’s Bank of China disclosed to the IMF panel that, “China has started reporting our foreign official reserves, balance of payment reports, and the international investment position reports.”

“All of these reports, now, in China are published in U.S dollars, SDR and Renminbi rates… I think that has the advantage of reducing the negative impact of negative liquidity on your assets.”

What that means in real terms is that China views the opportunity of being a part of the exclusive world money club as an opportunity to diversify away from the U.S dollar.

The Bank of China official took that message even further saying that he hopes that China could lead in world money operations by integrating it into the private sector.

“If more and more people, companies and the market use SDR as unit of accounts – that would generate more activity in the market with focus on the MSDR. [The hope would be] that they could create more products and market infrastructures that would be available for trade products to be denominated in SDR.”

The People’s Bank of China official referenced how this trend was already underway. Just last year Standard Chartered bank began to maintain accounts in SDR’s. “In terms of the first and secondary markets they will develop fairly well.”

Perhaps the most important segment that the Chinese official signaled was his reference that, “The Official Reserve SDR (OSDR) that allocation from the IMF is very important. [This allows] Central Banks to make the SDR an official asset, and easier for them to convert that asset into the reserve currency they need.”

What that means is that China will become an even greater player in the world money market.

Nomi Prins, an economist and historian stated when analyzing China’s economic positioning, “The expanding SDR basket is as much a political power play as it is about increasing the number of reserve currencies for central banks for financial purposes.”

2. Special Drawing Rights: The Case for Liquidity and Central Banks

Jose Antonio Ocampo, one of the foremost scholars on international economics and a board member of the Central Bank of Colombia noted, “The main objective of SDR reform is actually… for it to be a major reserve asset for the international monetary system.”

“First of all, it is a truly global asset. It is backed by all of the members of the IMF and it doesn’t have the problems that come with using a national currency as international currency. Second, it has a much better form of distribution of the creation of liquidity. Because it is shared by all members of the IMF… in that regard, it does serve as unconditional liquidity.”

That means that IMF and institutional economists view the SDR as a potential way of financing not only national government loans, but markets.

The most fascinating point that Ocampo made about the SDR was about the position of conditional reserves and what it could mean for more SDR reform. Conditional reserves reference the ability of central banks to borrow and repay loans in a timely manner with conditionality.

“Countries that hold excess SDR’s should deposit them in the IMF. The IMF then could use those SDR’s to finance its lending. [This will reduce] the need to have quotas, borrowing arrangements and methods to finance IMF programs. Like any decent central bank in the world they could use their own creation of liquidity as a sort of financing of that central bank.”

While the IMF has been a “central bank for central banks” this proposal would see the international monetary system shift entirely.

Jim Rickards takes his analysis a step further showing that the liquidity and lending offer the IMF the ability to act during a crisis, as it did during the most recent global financial crisis.

Rickards, The New York Times best-selling author, reveals, “The 2009 issuance was a case of the IMF ‘testing the plumbing’ of the system to make sure it worked properly. With no issuance of SDRs for 28 years, from 1981–2009, the IMF wanted to rehearse the governance, computational and legal processes for issuing SDRs.”

“The purpose was partly to alleviate liquidity concerns at the time, but also partly to make sure the system works in case a large new issuance was needed on short notice.”

3. Elites Signaling the Blueprint Plan for World Money

Mohamed El-Erian a former Deputy Director of the IMF and the Chief Economic Adviser at Allianz (affiliated with PIMCO) was the premier panelist to discuss the future blueprint plan of world money.

El-Erian started out his discussion, “If the SDR is to play a really important role you cannot go through the official sector only today.”

He outlined the current political landscape for world money saying, “The politics today do not favor delegating economic governance from national to multilateral levels. Yet the case for the SDR is very strong.”

“It is not only about the Triffin Dilemma and [acting as] the official reserve, it’s because if you ask anybody do you want to reduce the cost of self-insurance, they’ll say yes. Do you want to facilitate diversification? They’ll say yes. If you ask anybody, do you want to make liquidity less reciprocal, they’ll say yes.”

“The SDR helps address every one of these issues. So, it solves problems not just at the official level but it solves problems in the private sector.”

To break that jargon down Jim Rickards offers, “In other words, the latest plan is for the IMF to combine forces with mega-banks, and big investors like BlackRock and PIMCO to implement the world money plan.”

“El-Erian is ‘signaling’ other global elites about the SDR plan so they can prepare accordingly.”

4. The SDR Signals Death of the Dollar

Catherine Schenk, a professor of International Economic History at the University of Glasgow, is one of the top scholars of economic relations. While speaking she took up the case of what the special drawing rights meant for the U.S dollar.

Dr. Schenk when asked whether the international market could proceed without a “lender of last resort” she pressed, “Why would you use a relatively illiquid element when you have the U.S dollar?”

“The U.S dollar has a lot of problems, some of it is unstable but the depth and liquidity of it in financial markets are unrivaled. The history of trying to create bond markets for other currencies or other instruments shows that it takes a long time.”

She then elaborated later in the conversation the premise that, “What we are talking about with the market SDR is trying to turn it and add more facilities to turn it into money. That will take time. Having reluctant issuing, I am worried about how that market it going to be created.”

As the dollar continues to have its issues what central banks like the Federal Reserve select to do matters significantly.

Christopher Whalen pens, “Whether you look at US stocks, residential housing markets or the dollar, the picture that emerges is a market that has risen sharply, far more than the underlying rate of economic growth. This is due to a constraint in the supply of assets and a relative torrent of cash chasing the available opportunities.”

Whalen then asks the bigger question and one that could specifically matter for the SDR when he notes, “What happens when this latest dollar super cycle ends?”

How the competition for the top world reserve position unfolds between the SDR and U.S dollar will be answered in time.

5. World Money Becomes Central Bank Money

During the final Q&A for the panel on the SDR’s, they were asked what the political climate looks like facing the issues of world money and the direction of political headwinds?

In response Jose Antonio Ocampo said, “In the issue of liquidity, we still have a basic problem during a crisis – which is, how do you provide liquidity during crisis?”

Ocampo, the Colombian central bank official disclosed, “My view is that it is a function for the SDR as central bank money, let’s say.”

The SDR specialist took it further, “The real question is whether any of the major actors… and whether the U.S, either from the previous administration or the current administration, was willing [to politically act]?”

He offered, “From the point of view of the U.S the use of SDR’s as a market instrument should be more problematic than the reforms of the SDR to be used as central bank money.”

Under such circumstances the demand and confidence for the U.S dollar as a global reserve would be diminished.

Jim Rickards summarizes, “By the time the final loss of confidence arrives, much of the damage will already have been done. The analytic key is to look for those minor events pointing in the direction of lost confidence in the dollar.”

“With that information investors can take defensive measures before it’s too late.”

As was confirmed by both the IMF report and the elite panel on special drawing rights, the U.S dollar is facing severe competition while undergoing a fiscal crisis.

Rickards leaves a stark warning, “The U.S. is playing into the hands of these rivals by running trade deficits, budget deficits and a huge external debt.”