Some days you sit back and laugh at the absurdities. You have to. Otherwise theyâd depress you. And we already live in a depression, which is depressing enough. Other days, itâs serious. Today, itâs serious, with just a hint of absurdity.
On the serious side, a great money migration is reversing. For the first time since 1988, investors are pulling more money out of emerging markets than theyâre putting in. Over $500bn is being sucked out of emerging markets by foreign investors, according to the Institute of International Finance.
The net outflow is the end â or at least the reversal â of a long-term bet on growth in China and the developing world. That bet saw money flow into China and a handful of resource-rich exporters. Capital flows to emerging markets briefly went negative in 2008, too. But, though I hesitate to say this, this time is different.
Different how?
The 2008 incident began with the failure of Lehman Brothers in the United States. It was a crisis in the banking sector of the developed world that drove capital from the periphery of the global financial system to the centre.
Government bonds, especially US Treasuries, were the main beneficiary.
Itâs not so clear who benefits today, or how long global capital will stay away from China and resource-dependant economies. The answer depends on what China does to make itself attractive to capital again. More on that in a minute. But in the grand scheme of things that happened this week, this was a big signal.
Itâs been building all summer. But itâs a little like those great migrations David Attenborough talks about on TV. Itâs seasonal and cyclical. The signal is that winter is coming. The next question is, how long the Kondratieff winter will last?
Winter is coming
The subject of Kondratieff is beyond the scope of todayâs Capital and Conflict. Nikoali Kondratieff was a Russian economist who developed a theory that markets move in cycles lasting roughly 60 years. Price movements in various asset classes move within those 60-year cycles. The single cycleâor waveâis followed by a depression. That depression is called the Kondratieff winter.
âWinter is comingâ, said Bill Bonner earlier this week on the podcast.
The death of German prudence
Germanyâs culture memory of what happens when money dies may, itself, be dead. Thatâs a subject that came up on yesterdayâs show with Ben Traynor. [not got the audio, so no link yet] Look for that later today. Ben talked with Nick and me about the role of German bankers in the European Central Bank (ECB). The Germans have a reputation for being safe stewards of monetary policy.
That reputation is hard-earned. The Weimar inflation destroyed lives and wealth in Germany. It also happened in Austria and Hungary. Those nations and cultures have a living memory of what happens when inflation rips through a disintegrating and no longer cohesive society. People are still alive who remember what life was like when money was worthless.
But, as Will Ferrell says, most people will die at some point in their lives. The prudent Germans who remember the destructive effects of hyperinflation are dead or dying. Replacing them at the heart of German financial and corporate institutions is a new generation of economic stewards.
Like others in their position all over the globe, the main experience of this new generation of leaders is different. For them, every time liquidity in the financial system is threatened by the failure of a key player/borrower, a central bank somewhere (usually the Fed) lowers interest rates or arranges a bailout.
Everything is too big to fail in the modern world. Which makes the failure of everything much more likely.
The belief that others will clean up your mess leads to ever more reckless behaviour. And thatâs not including the outright cheating and fraud that you see more of when money is cheap. Itâs alarming, to me anyway, that Germany is viewed as the rock-solid and prudential heart of the European Union and the euro currency.
In the last two weeks youâve seen the scandal at Volkswagen. Youâve also seen the chief financial officer at Siemens Argentina (a branch of the German parent) plead guilty to conspiring to pay $100m in bribes. Itâs possible these are two isolated incidents that donât tell you anything useful or worrying about German corporate culture in general. And German beer is still excellent.
But itâs also possible that thereâs something rotten in the heart of Europe. If and when the next global liquidity crisis comes, donât be surprised if it comes from the continent. Everyone expects it to be China. Or perhaps a leveraged commodities trader. Or some theoretical âBlack Swanâ no one saw coming. Maybe the source of the next crisis is hiding in plain sight. More on that next week.
475 days and counting
If you consider yourself a strategic adversary of the United States and you want to make a territorial move to establish new âfacts on the groundâ, youâd want to make your move sometime in the next 475 days. Thatâs what we discussed with Charlie Morris on our podcast a couple of weeks ago.
Thatâs the great thing about bringing guests into talk, by the way. Even if youâre not listening to the shows, theyâve become a useful laboratory for us to ferret out important ideas that need more thought and analysis.
One such idea is that a lame-duck Barack Obama will be neither willing nor able to do anything to stop Russia, Iran and China from pressing their various regional claims around the world. He only has 475 days left in office. By the way, how you feel about those claims doesnât really matter. My main concern is whether the increased posturing and actual deployment of armed forces will destabilise investment markets.
At the very least, the study of geopoliticsâthe influence of geography on policy and the economyâshould be back in vogue. In the Kondratieff winter, there will be plenty of fighting for the scraps of global growth that remain. Or, plenty of fighting over control of key trade routes and natural resources.
UnionPay and capital controls
Finally, itâs not only foreign investors taking their money out of China thatâs causing the net capital outflows. Chinese savers and investors are heading for the exits too, wherever they can find them. Which brings me to UnionPay. Ever heard of it? Let us enter the realm of the absurd.
I hadnât heard of it either, until yesterday and a long feature story from Reuters. UnionPay is the worldâs second largest debit/credit card, by transaction. It processed $2.5trn in payments in the first half of 2013, trailing only Visa with $4.6trn. UnionPay is accepted in 142 countries and there are 3.53 billion cards in circulation. What is it?
UnionPay is both a card brand and a payment network. It was established by the Peopleâs Bank of China (PBOC) in 2002 as part of Chinaâs plan to liberalise its capital account and increase the use of the Chinese renminbi in international trade and finance. To that extent, itâs worked. The renminbi recently overtook the euro as the second most used currency in global trade finance. Only the US dollar is ahead of it.
But UnionPay is also the means by which members of Chinaâs elite and the Communist Party are getting around domestic capital controls that limit daily withdrawals of cash from the mainland at US$3,200. Offshore in Macau, you can walk into a luxury watch shop and get HK$300,000 in cash (US$50,000) in a âcash backâ transaction.
You can then take the cash and stuff it down your trousers and fly to Sydney or Vancouver. Or, in a slightly more refined escape plan, you can âlose itâ at one of Macauâs casinos, which will then help you âfind itâ in another foreign country.
UnionPay transactions for âjewellery and watchesâ in Macau were over $16bn in the first four months of 2012. On that pace, they would have reached $45bn by year-end. That would have made up the vast majority of $50bn in total UnionPay transactions on the island. Thatâs a lot of watches.
In the context of our recent discussions about banning cash and having digital money issued by the government, you can see how this goes. Once the communist cronies spirit their illegal-gotten cash out of the mainland, via Macau and UnionPay, ordinary Chinese savers will have daily withdrawals on cards strictly limited or maybe even eliminated outright.
The capital flight will be halted once all the insider money has been safely secreted into apartments on Bondi beach, tasteful flats in Paris and Zurich, or high-rise buy-to-lets in Vancouver. Rules and capital controls, you see, are for the little people. Not just in China, but the West as well.
Reuters estimates that since the mid-1990s, nearly 18,000 âcommunist party officials, businessmen, CEOs and other individuals have âdisappearedâ from China⌠taking with them some 800 billion yuan, or $133 billionâ.
It makes you wonder what happens next. When Chinaâs local government debt crisis gets really bad, will there be anyone left in Beijing to clean up the mess?
Category: Economics